The following Q&A was completed as part of our conversational Commercial Real Estate FAQ Interview Series, we hope you find it helpful:
The best practices and valuations involved in triple net real estate are personal to the investor and what their individual goals are regarding their property and cash flow. One investor may be satisfied with an excellent tenant in a less than stellar location, while another may prefer a tenant with lesser credit in a more “sure thing” location setting. Diversifying your investments is crucial to upholding cash flow during uncertain times and within uncertain markets.
Richard Wilson: You’ve seen hundreds of triple net properties, so what valuation, best practices can you share on triple net commercial real estate?
Peter Von Der Ahe: The valuation best practices there are so many, there are a couple of different factors, you’ve got the tenant, you’ve got the location, you have the credit of the tenant, and then you have the what we would call the unit economics, which is how is the actual economic performance at that location. Finally, the cap rate and the financial metrics that you’re actually purchasing the property at, and what the lease term is, what the increases are, and how those are calculated and all that kind of stuff. So, those are all, those are about the 4 or 5 main dials that you would use to evaluate any net lease investment. Most of the time what you’ll see is that not all 4 will rate a 10 out of 10. It’s up to the individual investor themselves to figure out what they’re comfortable with.
To make an extreme example, some people may be comfortable with a very poor location but a very, very high quality tenant where the asset or the business in that location is performing very well and you get a better cap rate. As opposed to you could be in the middle of a metropolitan, the middle of a city, on a main on main location where the location is out of sight but that’s going to be priced very high and in that case, because you’ve got all the demand drivers, you may be less concerned about the credit of the tenant. That becomes a very personal decision in terms of what your objectives are.
So if you’re – the way we get into this and the way I really entered into this type of advisory part of the business is you have a couple demographic shifts happening in the country where you have massive amounts of real estate owners who have held management intensive real estate for 10, 20, 30, you know, 40, sometimes generations of years. They get to a point in their life where I heard one say the phrase to me “It’s nice to own a lot of real estate, but almost feel like the real estate owns me.” And so, one of the motivations for investing in this type of asset class is to begin to lessen your management load, take advantage of the 1031 exchange tax deferral, and in many cases your cash flow increases. So, the combo of those two things is a very nice solution for people. Not to mention the diversification and, there’s a whole other – that’s a whole other category that we can talk about for an hour. And you know we’re talking about this, we’re having this conversation in Coronavirus time, and if every investor and every asset class hasn’t learned the benefits of diversification you’ve really got a lesson in it now depending on how all of your investments have been performing over the past 6 through 8 months.