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July 13th, 2017 by Paul

FGG 1031 - ACQUIRING TRIPLE NET (NNN) PROPERTIES IN A DST STRUCTURE



Triple net leased properties (NNN) are those where the tenant is responsible for paying for all taxes, insurance, maintenance for the property (the three nets). Triple net properties remain one of the most popular asset classes for real estate investors who are seeking relatively low management responsibilities and stable cash flow. We would like to share some unique perspectives that investors have shared with us that have caused many to consider other asset classes when considering a DST ownership structure for triple net properties.

Alignment of Loan Term with Lease Term - Most DSTs are financed with loans that are due in 10 years. These loans generally have steep prepayment penalties if the loan is paid off substantially before the loan maturity date. While DST loans can often be assumed with minimal cost, most DST programs project that a sale and return of capital along with any applicable appreciation will not be completed until close to the loan maturity date. Triple net properties with less than 10 years remaining on their lease term can experience a loss of value due to increased perceived buyer risks that the tenant(s) may not renew or that new financing will be more costly and difficult to obtain. Therefore, investors should review the length of the remaining lease term at the projected future sales date and determine the probability of recovering all their initial invested equity. In a worse case, even with appreciation, there may heightened risk that the exit value may not provide for a full return of invested equity.

Adjusting Rents to Meet Changing Market Conditions – Leases in most NNN properties often limit annual rent increases to amounts that are negotiated at the time that the lease was executed. In some cases, these previously negotiated increases may not be enough to cover market changes that may develop if, for example, inflationary pressures cause more rapid future market rental growth. During times of heightened inflationary expectations, investors will tend to move away from assets that have fixed rents to those assets where rents can be more rapidly adjusted e.g., residential, storage, hotels, parking lots, etc.

Maintenance Monitoring – While triple net leases require tenants to maintain their rented properties, owners nevertheless need to remain vigilant and periodically inspect properties to make sure that the lease obligations are being met. Tenants who are experiencing negative economic pressures are likely to cut corners unless they are actively monitored and compelled to honor their lease commitments.

REIT Exit Strategies – Some DST sponsors offer options for investors of NNN properties to convert their DST ownership into shares of a REIT later. A REIT or Real Estate Investment Trust is another form of group ownership that many investors find attractive. This option may be particularly appealing if the REIT ownership shares are publicly traded and if the conversion from a DST to a REIT provides an opportunity for earlier liquidity and possibly added upside due to favorable future market conditions. However, investors should understand that the conversion of DST ownership interests into REIT shares results in the loss of 1031 Exchange options going forward. That is, once the conversion to REIT shares is completed, the accumulated gain on the future sale of those shares no longer be deferred via a 1031 Exchange – and tax consequences are likely to result upon future sale.

We encourage all investors who are considering NNN leased properties to ask for our assistance to analyze pros and cons before finalizing their investments.

Article citations: nnn properties, triple net lease properties, 1031 property, nnn leased properties, exchanging real estate
triple net basis,1031 exchange reit, 1031 reits

 

Paul Getty

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