Barnett Properties

Sep 12, 2011

Retirement Income and the Triple-Net Trap.


Income has always been a hallmark of commercial real estate, and retirees are just the latest group to discover the value of income secured by property ownership. Investor capital is protected by asset ownership and rental income is available for living and other expenses. That well-located commercial real estate historically outperforms inflation is but the frosting on a very attractive cake. Retirees find this combination of income and asset preservation a perfect match. Instead of having their assets at risk from the vagaries of the stock market, they can preserve their capital and meet their expenses from rental income rather than asset sales.

The reluctance of investors to handle the day-to-day burdens of commercial real-estate management and leasing has lead to the popularity of the "Triple Net" (NNN) property and, more specifically, the "Single Tenant and Triple-Net Property." An investor owns property that is leased to a major corporation or franchise on a long-term basis in which all expenses are paid by the lessee. Investor management consists of cashing a monthly rent check. The attraction is obvious, but cautious investors have learned that that very attractiveness can easily mask the dangers inherent in what Sourcenet Financial calls the "Triple-Net Trap."

The Triple-Net Trap is when the attraction of secure income today outshines the long-term diminution of that set income and the effect of that diminution on real-estate value. Consider the basic equation of property being worth its ability to create net income; if the income is fixed for twenty years (or allows minimal increases) then imagine the impact on the long-term sale price of the property. Adding to that negative impact is the fact that many NNN properties are severely overpriced in relationship to the value of the underlying dirt. That certainly is a recipe for unpleasant economic surprises. Further disappointments await if the income stream of today proves inadequate for the needs of tomorrow. 

Further surprises may arise if the investor inadvertently purchases a NNN property that has been culled from the portfolio of an institutional investor. It is not uncommon for large blocks of NNN properties to be bought and sold, followed by the less desirable properties being marked up and disposed of to unwary individual investors. A classic example is when an investor's "can't lose" purchase of a NNN fast-food franchise property did not fare well when the auto plant across the street closed seven years later. His income continued but the value of the asset plummeted, and at the end of the NNN lease his options ranged from unpleasant to ugly. The franchisee did, however, offer to spare him the expenses of maintaining or demolishing the empty shell in return for continuing to operate the restaurant rent-free.

Investors need not be ensnared by the Triple-Net Trap in the search for income and appreciation through commercial real-estate ownership. There are other ownership structures such as Tenant in Common (TIC);   Real Estate Investment Trusts (REIT); and Limited Partnerships (LP) that may allow similar benefits to the Single Tenant Triple Net. These may be structured to provide the NNN advantages without the downside. These options can be very attractive but a prudent investor needs to ascertain whether the same Single Tenant Triple Net risks are not incorporated in the fine print of the ownership agreement.

Investors should also realize that not all Single Tenant Triple Net properties unduly restrict future income and some have such high-quality locations that they will shine in any portfolio. Finding such a property can be challenging, and skepticism will serve the investor well. Impressive packaging is frequently used to disguise unappetizing content in any investment package, and the commercial real-estate industry is not an exception. Investor vigilance and professional review are a must.

As retirees access their financial future, many conclude that properly structured commercial real-estate ownership provides benefits unavailable elsewhere. They also recognize that, while it is important to be cognizant of investment risks, it is equally important to recognize the overwhelming investor benefits afforded through commercial real estate. Income, capital appreciation and asset preservation are the three legs of long-term prosperity; no other asset class can be better structured to provide that than commercial real-estate ownership.

 

Jack Creighton: Invest Magazine; August 2008 Edition

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