Two factors contribute the most to the success of a triple net (NNN) lease: the property and the tenant. For the latter, you must choose a tenant that can handle the financial responsibility of paying for property taxes, insurance premiums, and maintenance costs. A creditworthy tenant is naturally the ideal occupant, helping reduce the risk of default and ensuring the long-term stability of the lease. In this article, Realized 1031 shares the specifics of why creditworthiness is a critical consideration in an NNN investment. Let’s take a closer look!
Tenant creditworthiness refers to the financial strength of the company or business that wants to lease the NNN property. Since they handle three net operating expenses, the tenant must have robust financial health and borrowing ability as assurance that they can handle the payments, plus the monthly rent.
In general, nationally recognized tenants have better creditworthiness than small regional franchises or brands and are often considered safer bets because they’re more likely to meet their obligations over the lease term. A few examples are the following:
Meanwhile, smaller companies may have weaker financial backgrounds, which present a higher risk for default.
Entering a lease agreement with a creditworthy tenant is critical for an NNN investment for the following reasons.
A tenant who is unable to pay their financial obligations can result in a default. You may need to evict them from the property, resulting in a vacancy, which means financial responsibility falls back to you. Looking for another tenant also consumes time and resources. These issues can be avoided with a tenant who can meet its financial obligations.
As you lower the chances of a default, you can expect consistent and predictable cash flow for the entirety of the lease term. Meanwhile, vacancies due to tenant default not only disrupt income, but you may also need to dip into cash reserves to cover the net operating expenses.
Strong credit tenants also enhance property value, making it easier to sell the asset or secure favorable financing terms. For example, a triple net lease asset leased to a Fortune 500 company may command higher prices on the market after the lease because investors trust its long-term reliability.
The most objective way to check a prospective tenant’s creditworthiness is by looking at their credit rating. Companies like S&P, Moody’s, and Fitch provide grades based on various factors. Those who have ratings between AAA and BBB are investment grade, and they’re more likely to have strong credit. Meanwhile, those with grades between BB and DDD are generally riskier.
It’s also important to assess a prospective tenant’s financials, not just their credit rating. Evaluating their revenue growth, market share, and industry stability helps provide a complete picture of their creditworthiness. Combining these factors can help you make more informed decisions and mitigate risks.
Tenant credit is one of the foundations for a successful NNN lease. This investment promises passive income, but without a financially stable occupant, things can unravel, resulting in cash flow disruption. To choose a reliable tenant with strong financial health, check their credit rating and business financials. With a careful assessment, you can select a tenant with strong credit that will help sustain the investment for the long term.
Sources:
https://www.investopedia.com/terms/c/creditrating.asp
https://www.lawinsider.com/dictionary/national-or-regional-tenant