The net lease industry is sought after for its attractive after tax yields compared with other passive investments such as mutual funds and bonds.
Things to consider with net lease investments.
Yield on investment, security of investment, required liquidity, and management responsibilities are critical factors to consider prior to purchasing – and throughout the ownership of – your net lease asset.
Most investors possess the wherewithal to analyze their net lease investments at the time of purchase and ensure they fit their desired investment factors. However, the majority of net lease investors do not have the support structure in place to reach their desired return on capital.
I outline below a key investment factor to consider, and a simple method to assess it throughout ownership.
Yield on investment.
This factor seems the most straightforward to determine at face value. The cash on cash analysis is commonly used to determine yield on investment. Take pre-tax cash flow and divide by initial cash investment and – BAM! – you have your cash-on-cash return.
Purchase Price: $2,500,000.00
Debt: 70% ($1,750,000.00)
Investor Equity: 30% ($750,000.00)
Net Income (6.5% Cap Rate): 6.50% ($162,500.00)
Annual Debt Service (Mortgage Payment): 4.50% ($107,435.20)
Cash to Investor: $55,064.80
Cash on Cash Return: 7.34%
This analysis should be accompanied by depreciation expense and other deductible expenses granted to commercial real estate owners to determine tax savings from net lease property ownership – and thus “true” annual yield.
Hold period and residual value.
Other key factors in determining the yield on an investment are the hold period and residual value. These factors are much more difficult to determine, and require extensive and focused knowledge of the local market, the national market, and the tenant leasing your property. (The determination of your hold period and projected residual value will be discussed in a subsequent post.)
Word of caution.
The yield on your net lease investment has an inverse relationship to the security, liquidity, and passivity of the investment, and investors must be prepared for lowered security, lowered liquidity, and less passivity should they seek investments with higher yield. Security, liquidity, and passivity decrease exponentially as the term remaining on the lease disappears.
The yield on the investment does not increase commensurately as the term progresses, and investors should pay close attention to all aspects of their property to ensure they are not left witha dilapidated vacant building with no residual value at the end of the lease.
Net lease investors often get to the end of the lease term without the proper information to combat a rent reduction request. Brokers are useful when gathering this information, but are not focused on gathering the information proactively during the lease term. Investors should consider hiring a firm to pro-actively manage their asset.An asset manager focused on the client’s goals and properties will ensure their portfolio maintains the desired return on investment.