The opportunities and advantages offered by triple net (NNN) lease properties tend to attract even the most conservative investors. However, some things can be too good to be true. NNN leases are no exception. While there’s appeal from passive income and hands-off involvement, you should still watch out for triple net lease red flags that could threaten your long-term success.
Below, let’s look at what you need to spot to ensure that you’re making a wise decision.
1. Questionable Tenant Creditworthiness
The tenant and the property type are two major factors that affect the profitability of an NNN property. If the tenant fails to cover the three net operating expenses on their end due to insufficient funds, then there’s a high risk of tenant default and vacancy. As such, it’s important to thoroughly evaluate every prospective tenant who wants to lease your property.
If the tenant has poor credit, inconsistent financials, or a history of defaulting on obligations, that’s a major red flag. Sure, they may look appealing because they’re part of a national franchise, but is that parent company backing the financials, or is it more of an individual solely responsible for the lease payments? It’s important to verify the credit rating and determine whether the lease is corporate- or franchisee-backed.
2. Poor or Declining Location
A location experiencing lower demand also makes for a risky investment. Some properties may have lower values, but that’s because they’re in a weak location. So, make sure to assess the asset's location to look for red flags such as the following:
- Population decline in the area
- Lack of nearby complementary businesses
- Limited accessibility or inadequate parking
- Competition is moving into stronger locations nearby
Taking a look at the anchor tenant is also a good move. These are the main businesses driving traffic to the location, such as healthcare facilities, big-box retailers, and entertainment venues. If they’re leaving or won’t renew their lease, then that location may soon face dwindling foot traffic.
3. Unfavorable Lease Terms
NNN leases only let the tenant handle property taxes, insurance, and maintenance costs. The rest needs to be negotiated in the lease agreement. If there’s too much responsibility left to you, which may lead to future hidden costs, then the investment may be a red flag. Additionally, overly short lease terms or minimal renewal options may create instability and reduce resale value.
It’s also worth looking at the rent escalation clauses. Some agreements may have caps on how much rent can increase, which may not keep up with inflation. Instead, a green-flag rent escalation clause would allow you to adjust rent based on metrics such as the consumer price index (CPI) or to include an annual fixed percentage increase.
4. Overpriced Property or Low Cap Rate
NNN leases tend to have lower cap rates since the main goal is stability and consistent income over high profits. However, some cap rates can be so low that you’re hardly earning anything. Most properties have a cap rate of 4–10%, calculated by dividing the annual income by the price of the property when purchased with cash. A figure lower than 4% puts you at risk since you’re not earning enough to keep up with inflation and other risks.
Wrapping Up: NNN Red Flags To Watch Out For
From less-than-ideal cap rates to declining locations, from unfavorable lease terms to prospective tenants with weak finances, there are plenty of red flags investors must watch for when choosing NNN investments. It’s always good practice to work with your financial advisor or broker to better spot these warning signs and find an investment that delivers on its promises.
Sources:
https://www.investopedia.com/terms/c/creditrating.asp
https://www.investopedia.com/terms/t/triple-net-lease-nnn.asp
