Robert Gamzeh

A 1031 deferred exchange is the sale of one investment for the purchase of another investment. In terms of NNN property and/or mortgage, when an NNN property investor sells one NNN investment property to buy another, like property, they can offset or even avoid capital gains tax.   In a 1031 property exchange, the NNN property sold is referred to as the “relinquished property” and the triple net property acquired is called the “replacement property”.

1. The properties exchanged must be of like-kind, meaning that they are of the same classification, and not based on their condition or quality. However, this category is broad, and can mean selling a farm to buy raw land. Or, selling an office building and buying a strip center.
2. Real estate is divided into four classifications, including property held for business use, land held for investment, property held for personal use, and NNN property held primarily for sale. The first two qualify for a 1031 deferred exchange, while the last two do not.
3. The exchange must occur in the allotted time frames.   There are strict timelines for a 1031 property exchange to work including an identification period of 45 days during which you must identify a replacement property after selling your old one.  Also, heed the exchange period of 180 days – this spans from the date you sell your old property until you must close on the replacement property
4. There must be an actual exchange overseen by a qualified intermediary or QI, and not just a transfer of NNN property for cash.  That being said, it’s always wise to seek the services of a professional early on to avoid any costly mistakes when executing a 1031 deferred property exchange.
5. Contrary to popular belief, a 1031 deferred property exchange isn’t an all-or-nothing situation. You can do a partial exchange. However, if you buy a property for a lower sale price than your original property sold for, some of the original property’s sale price is taxable. The same is true if you choose to take on less debt with the replacement property.  Let’s say you sell a NNN investment property for $1,000,000 when you have a $250,000 mortgage. You buy a property for $500,000, also with a $250,000 mortgage. The $500,000 you receive during the transaction is taxable income.  In other words, you still defer tax on the bulk of the sale of the first property. But you’ll pay capital gains tax or depreciation recapture on the money that didn’t get rolled into the new property.

For the savvy NNN property investor, a 1031 deferred exchange can defer taxes and generate more cash flow and appreciation potential. Part of the equation for higher cash flow is to structure the best possible mortgage loan. By planning ahead, exchangers will obtain their investment goals with the flexible mortgage products available in the market place. Plan your next 1031 NNN Property exchange with lending issues in mind! 

Remember, the purchase price of the property (or properties) you buy must equal or exceed the sale price of the property or properties that you sell. So if you sell a property for $500,000, you’ll need to buy another property for at least that amount in net equity. Net equity on a settlement statement NNN property for cash (or cash due seller) results from the gross selling price minus retired or paid off debt, selling expenses, sales commissions and closing costs.  Also, there’s a debt financing requirement that applies if you have a mortgage on your original triple net NNN property. In a nutshell, you’re required to carry as much debt or more with your replacement property.   

Call or Email your favorite NNN property advisors at The Triple Net Investment Group for the best insight into your 1031 deferred property Exchange.

For those unfamiliar with a 1031 Exchange NNN, the Internal Revenue Code Section 1031 allows a commercial real estate investor to defer federal and state capital gains and depreciation recapture taxes on the sale of real NNN property held in the productive use of a business or investment when replaced by “like-kind” property.

Partial 1031 exchanges are defined by an investor’s choice to not use all the net equity and debt retired in the new NNN property. The portion of the exchange proceeds that is not reinvested is called “boot,” (Cash received is “equity boot” or, debt not replaced is called “mortgage boot”) and are both subject to capital gains and depreciation recapture taxes. Note that the best time to receive cash is at the initial closing. (A clever alternative is to do a post-1031 exchange refinancing to obtain cash, or by not paying the taxes by increasing leverage.)

Since a partial 1031 exchange is more complex than a standard 1031 exchange, selecting a carefully vetted “transaction team” is key. Particularly, consult a CPA prior to the transaction to fully understand your tax consequences of a partial 1031 exchange. There may be unrelated tax implications, such as income tax losses that could be offset, which could influence the decision to engage in a partial 1031.

WHEN TO ENGAGE IN A PARTIAL 1031 EXCHANGE

If an investor knows the exact amount needed for acquisition of the replacement property, they can ensure that a specific dollar amount is distributed directly at the closing of the relinquished NNN property’s sale.

Usually, the exact amount of equity needed for the purchase of the replacement NNN property is unknown at the outset of the partial exchange. One solution is to have the qualified intermediary (QI) hold all of the proceeds from the sale of the relinquished property, and distribute the excess cash from the exchange account after the equity requirements for the replacement NNN property have been determined.

A partial 1031 exchange might make sense if the investor needs some cash for use after the transaction. E.g., relinquish a property for $6,500,000 to cover the need for $500,000 for the replacement property’s improvement by acquiring a HOT replacement property for $6,000,000 and realize a $500,000 taxable gain!

A partial 1031 exchange may also work if an investor wants to lower leverage. E.g. relinquish a property for $5,000,000 which bears a $500,000 mortgage.  If the investor wants to own the next NNN property free and clear, complete a partial 1031 exchange by purchasing a replacement property for $5,000,000 in cash and paying taxes on the $500,000 boot.

WHEN NOT TO DO ENGAGE IN A PARTIAL 1031 EXCHANGE

Generally, if the taxable boot is greater than the amount of the capital gain, it may not be worthwhile to engage in a partial 1031 exchange. Every investor should review their specific 1031 exchange situation with a tax and legal advisors before closing on the sale of the relinquished property for a partial 1031 exchange.

For outstanding advisory regarding full or partial 1031 Exchange NNN properties, please call or email your trusted “deal team” at The Triple Net Investment Group.

A triple net NNN investment lease property is leased by a tenant responsible for paying rent, taxes, insurance premiums, repairs, and utilities – as such the landlord is more or less, passive(NNN Lease Property Investments). The tenant is also committed to a lease, ranging from 5-25 years. Here are 8 facets that you should know for sure about investing in NNN triple net investment lease property:

CAP RATES:  An investor should be very familiar with the national net lease tenants and the cap rates their NNN leases are traded. The cap rates reflect the security they offer. For example, some national tenants don’t offer rental escalations in the lease.   However, these are financially secure tenants and the chance of them not paying rent is extremely low. Something like a fast-food restaurant that is operated by a franchisee can trade at a higher cap rate but is riskier.   Items like prior tenant performance at that location, market rents, re-leasing, etc. should also be evaluated.

TRUE NNN LEASE:  Often a lease will be called a “triple net lease” for convenience when in fact it is not an NNN lease. Labels like full service, modified gross or triple net,  used by brokers and landlords, will often be at odds with the clauses and legality of the lease.

NOT INCLUDED: While a true absolute NNN lease with a strong tenant can be thought of as a turnkey commercial property from the landlord or investor’s perspective, even an absolute net lease has some expenses that won’t be borne by the tenant(s). 

RISKS & REWARD:  NNN properties can be considered as low-risk investments due to their stable, predictable, and often higher returns.  Although non-investment grade tenants provide a high risk, high reward opportunity, many investors favor national brand, corporate-backed leases for risk mitigation.  

MARKET VALUE: A triple net NNN lease property is determined by the quality and location of the real estate, length of the lease, rent bumps, and, tenant credit.  Remember, triple net lease property values are based on projected future cash flows, which means that the underlying value of the asset may change over time as the duration of the lease shortens.

BOND-LIKE: NNN property leases can be stereotypically guaranteed by a long-term lease at a preset rental rate. As an investor, you will know, with certainty, the amount, timing and duration of rental income. Thus, NNN properties are considered bond-like, investments, due to their resilience in up and down, market cycles(national net lease tenants, Triple Net Investment Group ). 

INFLATED RENT:  Inflated rents in a NNN lease may make the investment return appear highly desirable if not evaluated against changing market conditions. A drop in base rent to match the market will impact resale value which may be less than the investor’s cost basis. 

NEGOTIATIONS: Most all investment-grade potential tenants have very convoluted legal language in their leases.  Beware of negotiating the terms and language of a NNN lease without an expert, legal and brokerage, help.

Call your trusted advisors at the Triple Net Investment Group as you consider your first, second or next NNN property investment. You won’t be disappointed. 

A NNN property lease is highly attractive to investors as it affords a stable income, and it minimizes the property management cost and risk for the landlord. Tenants are responsible for most or all of the operating expenses, and investors can be as hands-off as they want. 

When evaluating NNN property investments, it is mission-critical to consider the following:

1.    Lease term: NNN lease properties lease terms can last 10-15 years, or longer. For example, if a triple net lease with ten or fifteen years still left in the lease, market risk is highly mitigated, as long as the tenants are strong, and a good tenant guarantee is in place.   However, if a mom and pop franchise tenant the property and there are only 3 years left on the lease… then the investor owns a low-value, property that other investors will view as high risk.

2.    Corporate Guarantee: A strong triple net lease NNN property should be backed by a corporate guarantee from the parent corporation with particular clauses and language regarding primary obligation and an authorized guarantee agreement.  

3.    Lease Clauses: due diligence on the entire lease is key.  E.g. termination clauses give the tenant the right to terminate the lease (generally without penalty) at a specified point in time.   Other provisions give the tenant the right to terminate the lease early. Often, there are multiple options that give the tenant the right to renew/extend the lease by three or five years at a time with a specified rent increase or decrease.

4.    Tenant Credit: even if tenants have a great credit rating, it’s worth analyzing the health of their industry to predict whether their business will remain stable, or grow.  Also, many corporate tenants have a franchise model, and this means buying a property with minimal capitalization.

5.    Location: to tenant or re-tenant a property, it is easiest to do so with a well-located NNN property measured by:

• Traffic Counts (many retailers and restaurants require a minimum number of vehicles to pass the site each day)
• Demographic data (age, income, gender, etc. statistics)
• Population density (within 1,3 or 5-mile radius)
• Accessibility (due to medians, curb cuts, etc.)
• Visibility (from passing traffic)

6.    Debt on the Property: NNN investment properties may carry long-term debt that cannot be paid off early without penalties.  Sometimes there are assumption clauses that allow a new borrower to assume the existing debt, for fees(1031 Exchange Needs).

7.    Building Lot:  Having an appropriately sized property is a huge investment factor.  Many NNN tenants require a minimum parking ratio before they will consider a location. Certain retail, restaurant and medical tenants have needs that far exceed minimum standards established by city code(Net Lease Properties, NNN properties lease terms). Excess land gives the investor options to either expand the current building or to subdivide the land and construct an additional building or, sell off the excess parcel.  Also, certain buildings are very easy to convert to alternate uses, for e.g. Dollar stores, auto parts stores, and many fast-food restaurants. 

8.    1031 Exchange Needs: if the investor is in dire need of a 1031 exchange into a NNN property, then understanding the process and, having the time, access to resources, and identified, proven expert accountants, lawyers, and brokers is key, as well(Triple Net Investment Group).

Call on your favorite brokers and advisors for NNN property investment at the Triple Net Investment Group, today, for ensuring an effective, and profitable purchase or sale. 

For investors, finding the right tenant to occupy an NNN property investment property is critical to its success.  NNN tenants span the property spectrum, including office and industrial, but most commonly NNN lease property investments are in retail, which includes fast-food restaurants (Burger King, McDonald’s), grocers (Walmart, Giant, Albertsons, Publix, Whole Food) convenience stores/gas stations (Sheetz, Wawa, Pilot, etc) and big-box stores like Target, IKEA, Kohl’s, Macys, Lord & Taylor etc. 

Let’s look at the factors which are essential in understanding which type of NNN property tenant to consider:

CAP RATES/RISK: Asking prices for Triple Net properties are typically quoted based on a capitalization or “cap” rate, which is determined by dividing the property’s annual net operating income or NOI, by the purchase price.  Generally, riskier investments trade for higher cap rates, while more stable investments trade based on lower cap rates. 

CREDIT RATINGS: In general for NNN lease properties, a good choice is a nationally recognized tenant with little or no debt, or, with an investment-grade (BBB- or better) credit rating from one of the three major credit rating agencies – Moody’s, Zack’s, or S&P.  Larger or public companies are often assigned a credit rating by a credit agency.  Credit ratings represent the likelihood of a company defaulting on its financial obligations.  If private tenants are being evaluated, then investors should definitely consider:

1. Tenant Credit Report: Request and review Tenant credit profiles from one or more of these types of reporting agencies:   D&B, Equifax Small Business Enterprise, Accurint Business, and ClientChecker;
2. Tenant Business Plan
3. Tenant Sales History
4. Tenant Annual Financial Reports and AuditedTax Returns
5. Tenant Certified, Personal Tax returns

Perhaps the most important factor when considering a Triple Net NNN property investment is the credit quality of the tenant – which is largely attributable to the tenant’s ability to pay rent over the course of its lease(NNN property brokers). All else being equal, properties occupied by strong tenants with investment-grade ratings generally trade for lower cap rates than those with non-investment grade tenants.  

PARENT GUARANTEES: In addition to credit ratings, NNN property investors should look for a lease that has a guarantee from the parent corporation. For example, X is a subsidiary of Y. X may be a good tenant in its own right, but with a lease backed by the parent, Y, the investor will be better off.  In order to ensure that the parent company guarantee will hold up in court, consider the following:

·         Obtain an authorized guarantee agreement from the parent company. Doing so means that if for any reason the original tenant assigns the lease to a new tenant, the parent company can also be held responsible for ensuring the new tenant is also obligated to carry out the conditions of the lease;

·         The parent company should use the phrase “primary obligation” when describing the guarantee. By adding this phrase, a tenant’s obligation to pay rent converts into a primary obligation for the tenant’s parent company;

·         There must be actual wording in the lease from the parent company that states they obligate themselves to pay the rent and meet other lease obligations.

MARKET CYCLE RESILIENCE: Examining tenant companies that remains strong in most market cycles is another way to mitigate risk. For example, should a recession hit the United States, most people may save some cash by skipping their Starbucks coffee, but most will still refill their prescriptions. A rule of thumb: look for a tenant that sells a necessity product that is positioned to survive market downturns, such as a healthcare tenant like CVS, or Walgreens, or a Grocery tenant like Aldi’s, Walmart, Kroger, etc.

Get the guidance of top-rank NNN property brokers at the Triple Net Investment Property Group, today, to make a market-savvy decision on the best tenants for your NNN property investment.

TOP TEN SECRETS OF 1031 EXCHANGES

• The first secret is using a Qualified Intermediary or QI to perform 1031 Exchange Professional services, escrow and paperwork doesn’t cost much – about $1000 – $2000 per “round trip” i.e. 1 RQ (relinquished property) and 1 RP (replacement property) – where the property being relinquished is RQ and the property being purchased is the replacement or RP. For each subsequent RP, the fees could be as low as $400, per RP.

• Weigh this against the possible penalties of a 1031 exchange gone awry:  income tax pursuant to the sale of the RP, PLUS the penalty and interest imposed on the underpayment of tax, equal to the federal funds short term rate plus 3%. Another – the accuracy penalty – is 20% of the substantial understatement of the tax. (A substantial understatement is the greater of $5,000 or 10% of the recognized gain.) Another, a fraud penalty may be imposed of 75% of the underpayment if it is determined that investor’s intent was to evade the tax.  Also, S 6701 levies penalties if anyone assists in the preparation of the investor’s return knowing that this help may result in an understatement of tax. A $1,000 – $10,000 penalty is possible, here.

• Little known fact: all exchange documentation must be filed prior to settlement of the RP. This prevents constructive receipt and proves intent.

• The investor a.k.a. Taxpayer (TP) must never have actual or constructive receipt of exchange funds, rather the QI will manage escrow and wiring funds prior to settlement.

• The taxpayer that sells must be the taxpayer that buys. If the wife sells and then both husband and wife buy jointly, the exchange is partial.  However, it is ok if the wife sells a RQ, and buys the RP via a SMDLLC – single member disregarded LLC.

• Allowable Exchange Expenses (AEE) are those expenses that pertain directly to the exchange transaction such as broker fee, exchange fee, transfer & record fees etc. Property operation expenses are NOT allowable e.g. condo fees, taxes, insurance etc.  (AEE can be added to the purchase price of the RP to increase the taxable basis of the RP!)

• To properly qualify for use in a 1031 Exchange, a Qualifying Property must be held for Qualifying Purpose.  Law disqualifies TP residence, stock in trade, stocks, bonds, notes, securities, interests in entities, resale property, dealer property, flips etc., generally, based on time owned. Qualified property could include: home office, vacation homes for investment, etc.

• 45 Days are allowed by statute, after settlement of the RQ, within which a TP files to narrow choice of RP and comply with either of 3 RULES: 3 property rule – identify 3 properties regardless of value, or 200% rule – 200% of the Fair Market Value of the RQ, for any number of properties, or the 95% rule. RP List cannot be changed after Day 45, closed on or not.  Further, the identified RP must also meet “Trade Up/Trade Even” tax rules.

• RP must be “like-kind” – basically any real estate is ok, as long it fulfills Qualifying Purpose definitions.

•  Identified RP must be closed on before midnight on Day 180 from RQ settlement date, or when tax return is due, including extensions.

A Zero Cash Flow property (Zero) is real estate property where the net operating income matches the debt service expense on its mortgage loan and, the transaction falls under IRS code 467.

Example

If the investor is not concerned with current income, but with a free and clear property beyond 2 decades, then the zero strategy may fit.  These are not designed for the inexperienced investor with shallow pockets. Typically, an investor purchases a triple net NNN property with an investment grade tenant (CVS, Chick-Filet, Wal-Mart, etc.) with a minimal down payment (10-20%) and uses 75-100% of the free cash flow generated to pay off the mortgage (that’s why, zero cash flow). At the end of the long (15-25 years) loan term, the investor owns the NNN property free and clear and renews the lease or 1031 exchanges into another like-kind Zero cash flow property.

Trading values for Zero cash flow property are usually expressed as a % in excess of debt. 

E.g. a brand new Wal-Mart Zero with 15 years left on the loan until maturity, would price in today’s market at probably between 10% – 11% over debt, meaning if the loan is at $10MM, then the total value be about $11MM, meaning it can sell for $1MM plus, in equity.    Alternatively, a property that would otherwise trade at a 6.00% cap, structured as a Zero, one must adjust the cap rate upward with a deal premium of up to 1.5%, thus obtaining a true value near 7.5%.

Benefits of a Zero Cash Flow property

• Generate tax free equity within a 1031 or 1033 exchange

The best benefit for investors is the Pay-down/Re-advance feature which provides for the tax-free, equity via Substitute Collateral Right language in the mortgage, or, more commonly, the Pay-down/Re-advance feature, as follows:

An investor will sell property for $40MM and exchange into a triple net NNN Zero. The property is currently held with debt of $10MM and $30MM equity. The owner identifies a Zero for $40MM with $4MM as equity (trading at 11% above debt) and will assume $36MM. The owner applies $30MM in equity to purchase the Zero replacement, thus meeting the equity obligations of the 1031 exchange. Prior to closing, within the time restrictions of mortgage covenants, the owner notifies the lender to exercise the Pay-down/Re-advance directly after closing.

The owner thus applies the full $30MM in original equity to the purchase price of the Zero, and of that $30MM, $26MM is available as excess from the $4MM of equity required to purchase the Zero property. At this point, the debt re-advances from the original $10MM to the new $36MM, with the proceeds of $26MM going to the new owner of the Zero cash flow NNN property. 

As a result, the owner pulls out $26MM in tax-free cash from the 1031 exchange, holds a new triple net NNN property worth $40MM, with $36MM in debt.

• Generate passive losses to tax-shelter other investment income

Owners of Zero Cash flow property get tax benefits in the early part of ownership. This is due to the ability to report a tax loss due to structured depreciation which more than covers principal payments, under Code 467, for the first 10 -15 years of the loan.

• Significant investment upside at end of loan period

Usually an upside accrues to the investor due to market appreciation over the lengthy time period of the investment, usually greater than 20 years.

• Control real estate assets with minimal equity

Zero triple net NNN properties greatly help 1031 investors to build trusts for their families or create long-term portfolios. Due to the minimal down payment, institutional credit of tenants and little to none asset management, they are great opportunities for growing wealth, passively.

Features of a Zero Cash Flow Property

1. Investment Grade Tenants

The credit of the tenant – or guarantor – is the main thing to consider as the investor is investing in the cash flow that comes from the triple net NNN lease. The stronger the guarantor’s credit, the lower the risk of the investment and thus, a lower cap rate. In Zero 1031 exchange deals, Investment Grade Tenants are commonly used because the value in the income stream is derived from the tenant’s superior ability to pay rent, with the underlying real estate given a secondary consideration.

• Triple Net NNN Leases

NNN leases are most commonly used to structure a Zero deals since 1031investors want passive, not active, property management.  Triple Net NNN leases allow investors to acquire a single-tenant, property with the tenant assuming all expenses.  This gives the tenant de-facto control of the property while providing the investor with dependable cash flow with minimal responsibility

• Assumable debt

Lenders in Zero NNN deals stereotypically offer a nonrecourse, assumable, fixed-rate mortgage, which can be assumed very quickly, under mortgage covenants to give investors the nimbleness they need to get into (and out of) Zero property.

• Maximum Depreciable basis

When a 1031exchange investor LLC or partnership needs to offset current income with a higher depreciable basis, they may consider a Zero cash flow triple net NNN property, as their first choice. Essentially, IRS Code Section 467 allows for very flexible and aggressive structuring of depreciation, which in turn can generate maximal tax losses.

Important Considerations

• Ensure a 6-12 month cash buffer to hedge a compromised cash flow from the Zero triple net NNN property.

• Have a well-thought out plan for the end of the lease/loan for the tenant and property. 

• Don’t discount the intrinsic potential of the real estate and simply view the Zero cash flow NNN property as a security or abstract financial instrument.

• Ensure proper underwriting and due diligence is done to maximize returns.

• Conduct a last owner’s search to confirm any title defects since the date of the existing title policy.

• To protect against any untoward liens, consider buying UCC insurance, which insures the lien-free status of the new owner. Especially, consider adding an Equity Ownership rider, which insures the investor from any adverse claims that accrued prior to the effective date of the policy.
• If any bulk sales laws apply to the transaction, then failure to comply will expose the investor to liability that is otherwise the responsibility of the Seller.
• A Zero cash flow triple net NNN property is relatively illiquid, as there are fewer buyers in the market for zeros as compared to more traditional commercial property investments.

• The 1031 exchange investor needs to consider the phenomenon of “phantom income” when the property no longer amortizes at a loss (depreciation minus principal payments) – usually in Year 12  –  and the owner must pay tax on the principal pay down of the loan.   

• Investors can acquire 100% of the corporation that holds title, avoiding loan transfer fees and taxes in some states such as FL, NV and OH.  In addition, start-up costs are minimized since the investment vehicle already exists. 

Alternative/comparable investments

• If an investor has capital and an experienced real estate team, the investor could: a) buy the land and do a ground lease, or, b) participate in development, or 3) participate in both (a) & (b). When a Zero cash flow triple net NNN property is structured as a “Pre-Commit” or “Forward Purchase”, an investor contracts – at a pre-determined cap rate – with a developer to buy a new, occupied, single-tenant building. Typically, cap rates are higher under this type of purchase than other, traditional, sale structures.

• Essentially, a Zero Cash Flow NNN property can be mimicked by a zero coupon bond where an investor buys a bond, without any cash flows (i.e. no interest income or coupon).  Ultimately, this bond generates a large upside by virtue of the difference in the initial discounted purchase price of the bond versus the “face value” of the bond, resulting in a “balloon” at maturity.

Professional Involvement

• Lenders must be comfortable with monetizing the entire rent triple net NNN stream, so that the financing amounts to as much as 85 to 90 percent loan to value (LTV). Lender fees are lower for transfers of ownership and a new loan document may not be required.

• When using a title company, consider a national (versus a local) title underwriter, who is acutely familiar with such transactions. Because of their niched expertise with Zero loan and transfer documents, closings are conducted without unnecessary hiccups and delays.
• Although most real estate attorneys can navigate a Zero cash flow property transaction, an attorney who has extensive experience in this arena, is best retained.
• 1031 Exchange “agents” are also best used should an investor be using a Zero for 1031 or 1033 transaction
• Finally, contact Triple Net Investment Group real estate NNN advisors for your Zero cash flow triple net NNN property transaction and benefit from their decades of expertise in helping investors, nationally, achieve their 1031 or 1033 goals, efficiently and hassle-free.

What does the term “Zero cash flow property” imply?

Nowadays, the popularity of Zero Cash Flow Property NNN investments – leasehold or fee simple – is rapidly increasing amongst commercial real estate investors all over the globe. As the name suggests, “zero cash flow property” or “zeros” refers to the fact that the investor – in such a flow NNN Lease Property – does not receive any cash flow of income from the property until the underlying loan matures in full. In simple words, the loan payment on the investment property is equal to the net operating income of the property, hence “zero cash flow”. In such investment properties, the net operating income directly assigns to the lender to pay off debt taken on to purchase the property. Zero cash flow property is usually highly leveraged with a long term lease (at least 20 years) secured by the investment grade credit rating of a tenant. 

Although, prime facie, a zero cash flow property might not look lucrative  to investors, there are circumstances and reasons where such an investment makes eminent sense:

• Use as 1031 & 1033 Exchange property: The most striking advantage of Zero Cash Flow Property is that you can utilize them as 1031 (& 1033) Exchange property. A 1031 Exchange allows investors to defer capital gains and recapture taxes after the sale of foreclosure or highly leveraged assets by reinvesting the capital gains in any highly leveraged assets like a Zero cash flow NNN lease.
• Highly Predictable investment: The debt financing in zero cash property is non-recourse, predictable, fixed rate and conventionally amortizes over a term that can be shorter than the underlying lease term.
• Low equity, High Leverage investment: Investors usually purchase a zero cash NNN lease property with equity as low as 10% – 15% of the net value of the asset.
• Phantom income and tax: Zeros produce phantom income when the principal being paid down on the debt exceeds the deductions for depreciation and interest. This typically starts in years 15 -16 and is paid for with inflation-adjusted dollars (historically $.58 on the dollar). To accurately calculate the amount of phantom income, the basis and deprecation from the relinquished property must also be used.  Because leaseholds can be 100% depreciated they have less potential phantom income vs fee simple zeros, when the loan principal pay down starts to exceed the interest and depreciation deductions.
• Residual value: When the lease term expires and debt is fully amortized, the landlord investor gets to benefit from secure cash flow and enhanced residual value.
• 1031 One time Pay Down Re-Advance facility:  The pay down re-advance facility found in many zeros allows 1031 investors to satisfy their exchange requirement for replacement property then, post-closing, allows them easily and with no additional cost, take up to 92% of their cash out of the property for other uses. To use the pay down re-advance facility, investors need to post a refundable deposit with the lender with non-exchange dollars. 
• Short Closes:  Close times can be as short as ten days, further making zero cash flow property appealing for time sensitive situations.

However, in the world of commercial real estate, the term “perfect” investment is a myth.   The kind of commercial real estate property investment  that is “best” for an investor is one that is consistent with your risk tolerance and investment goals. Therefore, call your trusted commercial real estate NNN brokers and experts at Triple Net Investment Group! We can help you evaluate prospective zero cash flow property and significantly minimize risks.

NNN or Triple Net lease property is not a new concept for commercial real estate investors, brokers, landlords and tenants. Yet, it is one of the most misunderstood terms by many NNN brokers and NNN investors . To be clear about the different sorts of NNN leased properties a basic understanding of net lease properties  is proposed below: .

Types of Net leases in the United States

Commercial real estate tenants, investors, brokers, owners and landlords have a wide array of net lease property (N, NN, NNN) options available to  them. Here are some of the most common ones  :

• Single Net (N) Lease: Single or N lease is the most basic type available in the commercial real estate market. Here, the N lease tenant  is responsible for paying both the rent as well as the associated property tax. Lesser known as compared to other net lease types, it enables the commercial property landlords and owners to pass on incidental property expenses to the tenant .
  
• Double Net (NN) Lease: Double net or NN lease, is the most popular of all the options available in the market. Under this net lease contract, a tenant  needs to pay both the building insurance as well as property taxes, in addition to the rent. In this case, maintenance expenses lie entirely with the landlord/owner. In addition, the commercial property landlord or owner  also bears the costs of structural repairs. .
  
  
• Triple Net or NNN Lease: This type of net lease is the favorite of NNN Property landlords, owners and investors. s. It requires the NNN tenant  to pay both the incidental expenses as well as monthly rent. Real property tax, maintenance, regular repairs, and building insurances are some of the additional charges borne by  the NNN lease tenant .
  
  
• Bondable or Absolute Net Lease: Bondable net lease or absolute triple net NNN lease represents the extreme case of a NNN lease property. Here, the Triple Net tenant  has to completely bear  all property-related expenses. In this way, the NNN tenant  assumes responsibility all transparent and unknown  property related costs. .  Damage repair costs incurred on account of accidents, tourism or vandalism are a good example of “unknown” property costs. This type of lease needs the Triple Net tenant  to abide by stringent contractual guidelines, and hence a prospective NNN tenant  should undertake an Absolute Triple Net lease only after  considerable due diligence. .

What does it mean when someone refers to an NNN lease?

A NNN lease, also known as a triple net lease is the lease structure wherein a tenant is held responsible for making payments of rent and some or all of the costs of operating, maintaining and owning a commercial property.  Commercial real estate professionals generally refer to it as a “turnkey” investment. Property owners are absolved of  bearing  a commercial real estate property’s operating expenses in a Triple Net  lease.

Risks of NNN lease properties

Although commonly and mistakenly considered risk-free, tenant credit is the most significant risk to understand, when investing in or owning a NNN lease property.

Benefits of NNN lease properties

A NNN lease property comes with numerous advantages for landlords and offers a steady and predictable income flow for a long time. Usually, the length of an NNN lease ranges from 10 years to 15 years. Thus, landlords do not need to rush to find tenants every year! The other advantages of an NNN lease are as follows:

• Stable Cash Flow: As NNN properties are leased for a long term, landlords can get a stable flow of rental income. The leases typically span for 10 to 20 years so the Triple Net Lease Buyers are guaranteed stable, positive, cash flow until the lease expires.
  
  
• Reduced Maintenance Liabilities: Another superb advantage of NNN lease properties is the minimal maintenance and repair responsibilities on part of the landlord. In addition to the monthly rent, the tenant in an NNN lease property is also responsible for all operating expenses related to the Triple Net leased property. Starting from building insurance premiums, property taxes, to all the maintenance and repair costs – the tenant looks after all possible costs associated with operating and maintaining the property. Thus, landlords are now involved passively, rather than actively, in the management of the property, leaving them plenty of time and energy to focus on lifestyle or other projects.  .
  
• Financing Options: Whether personal or bank lender, all lenders typically give preference to investors, owners, landlords or tenants of  Triple Net properties. This is because of  predictable cash flows due to institutional grade tenants and long lease terms. Additionally, single tenant NNN lease properties provide a lot more and  varied  financing options for  Triple Net Lease Buyers.
  
• Simplicity: This is another attractive feature of a Triple Net lease property, which makes it popular among nnn lease investors. The NNN lease clarifies the responsibilities of the involved parties, whether the tenant or the property owners, right upfront. The relationship between the tenant and the landlord thus remains healthy as there are fewer issue of negotiation that are non-standard.
  
  
• Tax Benefits: An NNN Buyer can enjoy the ownership of an asset by avoiding capital gain taxes by using NNN lease and depreciation schedules under US Tax regulations as a means of lowering the property taxes. 

Please feel free to contract one of the experienced nnn brokers of Triple Net Investment Group Inc with questions before investing.

We will distinguish a Ground Lease, which is related but different, from a Triple Net NNN Lease.  A Triple Net lease or a NNN lease provides a stable income to the investor, landlord or owner, with least management responsibilities. When landlords, owners or investors choose a Triple Net lease structure, they are most likely thinking of a commercial property comprised of creditworthy, national tenants.  

What is a Ground Lease? ( Land Ownership)

A Ground lease is a long term agreement between the tenant and the owner with respect to the use and lease of the land. In this, the tenant is allowed to construct a property over the land during the lease tenure, up to 99 years. By the end of the ground lease term, the land with all the improvements is now owned by the property owner, until and unless an exception is created. By the end of the NNN lease, the ownership of any building constructed by the tenant is transferred to the owner of the land.

What is a Triple Net Lease? ( Land and Building Ownership)

On the other hand, in a Triple Net NNN lease. Landlord leases the land and the building he owns to the tenant. The tenant makes an improvement to the building and starts his business and pays for all repairs and maintenance. The biggest benefit of a NNN lease vs Ground lease is that in NNN lease landlord gets to depreciate the building vs the ground lease while the tenant gets to depreciate the building.

Ground lease vs NNN fee simple 

• A NNN fee simple property conveys the rights of owning the land outright, as well as the rights to develop and tenant the land (and building), without condition of time or any other.   
• Ground leases do not convey the rights of ownership of the land, only tenancy of the land is “sold” for a long term upto 99 years.  In the sense of unconditional ownership, it is inferior to a NNN lease fee simple, but can be better than a Triple Net lease only.   

Investing in ground Leases or Net Leased Real Estate

Technically speaking, a ground
Lease is a refined form of a Triple Net Lease. Both types of leases have
investing nuance that requires deep analysis and understanding, by contacting and engaging NNN Triple Net brokers. 

For the pursuit of happiness, investors prefer making investments in triple net lease properties to ensure solid guarantee returns on the investments with zero landlord responsibilities. Triple net lease buyers can invest in leasehold properties or ground lease properties. In this article, we will compare both options and involved pros and cons.

What is a leasehold property?  (Building Ownership)

With leasehold, you actually own the improvement, however, not the land. This agreement extends up to the duration that has been agreed upon. After the lease expires, the landlord gets its ownership back unless the lease is extended.

Important things to consider on leasehold properties

When you buy yourself a nnn leasehold property, you’ll be taking over the lease from the previous leasehold owner. So, before making any offer and coming to an agreement, you need to consider the following:

• The number of years left on the lease.
• The internal rate of return for the time you have the ownership
• How will you budget for service charges and related costs?
• The length of the lease which may affect getting a mortgage and resale value.

What is a ground lease property?  (Land Ownership)

A ground lease is an agreement in which, a tenant signs and lease a piece of land and develop it for its business and agrees to pay a certain rental rate. Tenant also agrees to maintain the property and pay for insurance, property taxes and all other charges related to the property. At end of the lease all the improvements is turned over to the owner of the property. Most leases indicate that the improvements will be owned by the property owner unless an exception has been made. Since a ground lease allows the NNN landlords to take charge of all the improvements once the lease period is over, the landlord may sell the property at a much higher rate to the tenant or other investors.

Why investors choose ground lease properties vs leasehold properties?

A tenant can build on the property in a prime location that he could not purchase. Hence, large chain stores often take advantage of ground leases in their plans of corporate expansion. Also, a tenant doesn’t have to pay any down payment for securing the land, as purchasing the property would have. Evidently, this frees up enough cash that the tenant can use for other purposes.

Furthermore, the owner of the land can gain a steady flow of outcome from the tenant while retaining ownership of the property. Normally, there is an escalation clause that guarantees an increase in rent and eviction rights that provide protection in case of default on rent or other expenses.

Hence, before making any investment, it is wise to be well aware of all available options with different types of triple net lease properties. This enables you to make best-suited choice. Triple net lease buyers should know all the involved pros and cons before proceeding with Triple Net lease properties.

Please feel free to contact one of the advisors of Triple Net Investment Group Inc with questions before investing.