I’m looking at buying a triple-net leased building occupied by Hollywood Video. There are 6 years left on the lease (with 2 5-year options after that). The cap rate is 9% and it looks like I can finance 75% of the purchase at a 7% interest rate. This would give me an ROI of about 15% which seems to compare favorably to other commercial properties and apartment buildings I’ve looked at, and this would have no management hassles.
So my question is: what am I missing? What’s the downside to NNN deals? How much should I worry that the business won’t extend the lease and that the building will sit empty for a long time?
Well the good thing is Hollywood Video is a stable company and probably will be more likely to be there long term. Many small businesses fail and therefore would leave you with a vacancy, at least with an established company your odds of that happening are greatly reduced.
That’s a decent return for a NNN. As Rich said, you have a stable tenant, as long as they are doing okay in that location their would be no reason for them to leave. It’s not a company that is going to be experiencing massive growth and will need to move into a larger location to fit more movies anytime soon either.
In the 5 year options, what kind of rent increase will take place? Would that be enough to make the tenant find another storefront? How long have they been at that location so far?
Check for deferred maintainence, typically the store manager isn’t going to know there is a problem with the roof until theres water dripping through the ceiling.
Usually it’s not a big surprise when a NNN tenant vacates the building. You will probably know far ahead of time which will give you some time to find another tenant. If your really worried than start looking now.
Biggest downside to NNN leases is that they usually offer small returns in exchange for small risk. Normally cap rates vary from 4-9% in my experience. It’s in the tenants best interest to keep the building in top condition which leaves you with no management. There are plenty of conservative investors who would love to buy a building with a 5% cap occupied by a national tenant. You have plenty of room for a relatively quick sale if you get in trouble.
Sounds almost too good to be true for a NNN on Hollywood. Is this property located in FL? If so, you may be running #'s based on a 12/31/2005 NOI, which looks great. Now the 2006 inurance numbers are comming in, they are 6 to 10 times higher than the previous year for commercial properties, which would kill your projected ROI. However, I am just guessing. Need more info.
Another concern about a video store is that changing technology could rapidly put them out of business. Video on demand, TIVO, DVR’s, full length movies on computers, and the blurring of the lines between TVs, computers, telephones, and other handheld devices may soon make video obsolete. In the near future, you will be able to order any movie from your lazy boy and immediately watch it right in your living room. When this happens, who will go to the video store?
At 6 years, try to do more of a site analysis approach. It’s really no different at this point from buying a strip, with just one tenant.
What’s the site worth, can you replace the lease rate at the site, what are the actual location’s financials, how’s Hollywood video doing in general(check their 10K).
With the ROI you are suggesting, I’m guessing that this is for 25yr financing due in 10? Can you support the loan payment if you are without a tenant come 6 yrs for about 6-9months.
If the dirt is good, it’s a hard corner, and the lease rates check out, it’s probably a good purchase. HV’s tend to be vanilla boxs so they should rent more easily than a special purpose/tenant building should it come down to it.
If HV at the site is running greater than a 10% profit to the sale price, it’s a reasonable shot that they will take the options. The better performing the location, the longer they will want to remain a tenant.
I was thinking about this a little more… and look at it just like normal retail. Take the area retail comps for caps and price per foot into consideration. 9% depending on the submarket should be pretty good.
Again the other thing that I’d look out for is that NNN leases are based upon site cash flows, either actual or projected. Typically, the lease rate per foot is very high compared to the market at the initial commencement of the lease. Verifying that the market has caught up, or looks like it will in the remaining 6 years might be the trick.
Frankly I’m amazed that these video stores still exists. Who rents vids from them anymore? With neflix, DVR, PayPer View, etc etc. I haven’t rented one in years.
All I know is the Blockbuster near me has a long line at the checkout all weekend. If it snows, is a holiday or a weekend you can forget running in quickly…see also 45+ min line. It also typically is out of all of the new releases and I generally leave empty handed and cursing. I rarely rent anymore now.