Triple net (NNN) leases are reliable on paper, offering steady income and passive involvement for investors or landlords, plus letting tenants handle the net operating expenses reduces your exposure to market volatility. However, like any other real estate investment, the true value goes beyond surface-level numbers.
To determine whether a property has a high chance of returning your investment and providing a profit, you’ll want to conduct a thorough triple net lease evaluation and look into the smaller details.
In this article, Realized 1031 shares tips on how to determine if your NNN investment is priced reasonably for the promises it offers and the risks you may face.
There’s no real way to determine the exact profitability of an asset. However, capitalization rates (cap rates) can serve as a close approximation, showing a potential rate of return if you bought the property for cash.
Cap Rate = Net Operating Income (NOI) / Property Value
Given how the tenant handles property taxes, insurance premiums, and maintenance costs, the NOI is simply the rent you receive.
Let’s say that a property is calculated to provide $50,000 as an annual base rent. This asset is valued at $600,000. With the formula, the cap rate is 8.3%, which means that it would take around 12 years to recoup the capital you invested.
Keep in mind that there is no “good” cap rate that applies to all commercial properties. Lower cap rates usually indicate stability, while higher numbers mean riskier investments. For NNN leases, cap rates between 4 and 8% are generally favored since they represent a balance between risk and reward. If the number is significantly lower, especially when contrasted with the NOI of other NNN properties in that location, then you might be overpaying.
As you compare NNN properties, the cap rates of each one can provide a snapshot of the possible income and how many years it may take to reach ROI. However, cap rates don’t provide the full picture. There are other NNN valuation aspects you’ll want to look into to gain more insight.
Given how most NNN leases have single tenants, profitability can also be determined by the occupant’s financial health. National credit tenants, which are large companies with strong credit ratings, often command higher prices and lower cap rates. However, the stability they provide can justify paying more for the property.
Details within the lease contract can significantly affect long-term value. For example, longer remaining lease terms (10 to 20 years) provide more income stability and are valued higher than short-term leases. Rent escalation clauses can also provide relief in inflationary environments, ensuring that income remains stable to compensate for the increased prices of goods and services.
Various market conditions can affect the projected profitability of an NNN property.
It’s essential to consider these other factors when assessing NNN properties. Tenants may come and go, but location is forever.
Before committing to an NNN investment, it’s important to conduct a thorough analysis of its profitability through various valuation methods. Looking at cap rates is one strategy, but checking tenant credit rating, location, and even the lease terms can help provide the full picture. With the right analysis, you’ll not only avoid overpaying but you’ll also ensure your NNN investment supports your long-term financial goals.
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