You’re finally ready to commit to an NNN lease investment. The promise of stable income, passive investment, and other benefits has led you to find a broker and the best deals. Now that you have a list of prospective properties or tenants, what’s the next step?
At this point, triple net lease due diligence becomes a critical phase to help you uncover red flags and ensure that the investment aligns with your financial goals.
In this article, Realized 1031 shares a definitive NNN due diligence checklist to help you out.
When assessing tenants, one important factor to check is their creditworthiness. Those with higher ratings tend to have robust financing, which allows them to easily handle the net operating expenses: property taxes, insurance coverage, and maintenance costs.
Companies like S&P and Moody’s provide definitive ratings for companies, providing an objective assessment of the tenant’s financial health. We also recommend checking financial statements, including profitability and revenue trends.
While the NNN lease outlines that the tenant will handle the net operating expenses, there are still plenty of costs in the gray area. As such, checking the lease agreement thoroughly helps you divide possible expenses in the future fairly.
You also need to check the rent escalation clauses. Having the right language allows you to increase rent to keep up with inflation.
Location plays a critical role in tenant success and long-term property value. A strong location makes it easier to re-lease or sell if needed. Check the following to determine if the asset is still in an in-demand or profitable location.
Property condition also plays a role in tenant stability and long-term value. It’s critical to thoroughly check the current state of the property with the help of inspectors. That way, you can address problems that may cause friction with tenants or major capital expenses in the future. Key areas to check include the following.
Paying more than the market value reduces your returns and limits exit strategies. As such, we recommend benchmarking metrics like cap rates against other properties. Let’s say that the asset has a cap rate of 4% while the other NNN properties are showing 6% or above. The 4% may indicate that you’re overpaying for the property when compared to other assets.
Beyond cap rates, other metrics you can assess include rent per square foot as well as the selling prices of similar NNN properties in the area. These numbers can give you the full picture of the asset’s profitability.
Although tenants cover these expenses, you should confirm amounts and payment history to ensure compliance. Mismanagement could create liabilities for the landlord, especially since you’d still be responsible for oversight.
Conducting your due diligence for NNN investments is a time-tested method to protect your capital and find the right tenant or property. Checking the areas we outlined above helps you spot red flags and invest in opportunities that increase the chances of long-term stability and income.
Sources:
https://www.spglobal.com/ratings/en/credit-ratings/about/understanding-credit-ratings