different Lease Types

If considering a Net Leased Investment what are the different Lease Types?

Absolute Net Lease

The tenant's lease is a significant risk-mitigating factor in single tenant, net leased properties. Most tenant leases are absolute "bond-net" or "absolute net" leases, which means that the tenant is responsible for all expenses and repairs and maintenance--including capital items (such as the roof, structure, and parking lot.).

Traditionally, absolute net leases range from 10 to 25 years, including option periods. And since the tenants are often strong, well-positioned companies, their leases provide for a long-term, secure investment. The landlord has no responsibilities under the absolute net lease, compared to a traditional NNN lease, whereby the landlord manages the property and is reimbursed by the tenant for operational expenses.

NN vs. NNN

The industry in general hasn't figured out the direct definitions. NNN would mean that the tenant is responsible for N-Taxes, N-Insurance, N-Common area maintenance. Based on that then if landlord was responsible for Roof & Structure, then it should read NNN with landlord responsible for roof & structure. The big but is that most agents will sell a product as NNN, the Buyer thinks it's a NNN, which to them means no landlord obligations. Therefore when a property is advertised as NNN most Buyers and or agents will perceive that to mean all expenses paid by Tenant.

Those who would like to use NNN minus roof and structure are those who try to mislead a potential Buyer. As discussed above, the three NNN's are for taxes, insurance and common area. The first two are easy to explain but the third is where the dispute is. Although the tenant maintains the common area and pays for it, there is still the exception of the roof & structure. If this were a true NNN, then the tenant would be responsible to pay for roof replacement but they are not.

The industry in general (those who deal in single tenant properties) use NN on a lease that has any potential for landlord responsibilities therefore when reviewing a property and seeing NN, at least you know that more information is required to find out exactly what the landlord responsibilities are.
Credit Rating

Credit Rating is the result of credit information interchange. The exchange is made through the direct interchange of ledger experience by individual firms, trade group interchange, and retail credit bureaus. The information usually includes how long business has been done, the greatest amount of credit recently given, the amount owing, amount past due, terms of sale, and method of payment. Credit instruments are cost, bonds, notes and all negotiable instruments. A credit limit is the maximum amount of credit a business (typically a lender) will give to a customer. This may be based on past experience, or on the customer's general credit rating.

Usually, a credit bureau makes an evaluation based on past payments and current finances, then uses the information in credit reports to businesses that are considering making a loan or offering other credit. Credit rating also helps determine an organization's ability to sell its bonds. This credit rating translates into a rating for each issue, which in turn determines the level of interest the organization must pay to entice buyers. The two major bond-rating services are Standard and Poor's Corporation and Moody's Investors Services.

Bond

A bond is debt owned by a company or a government. A bond, unlike a stock, does not give the holder ownership rights in the company. Bond ratings are the appraisal of soundness and value given to bonds by one of several rating companies such as Standard and Poor and Moody's. Rating systems differ, but the highest rating given is often AAA and the lowest rating of an "investment-speculative" bond is often C. A fallen angel is an investment-grade bond whose rating has fallen to speculative grade.

Investment Grade Tenants

With the growing market of 1031 transactions, many buyers are turning their attention to single-tenant, triple-net properties for their replacement assets. One of the main reasons is the security of an investment-grade, single-tenant asset.

Because of the security inherent in the tenants, we usually encourage investors to focus primarily on investment-grade tenants, as defined by the ratings agencies - Standard & Poor's and Moody's. The ratings range from B- to AAA for Standard & Poor's and B3 to AAA for Moody's. Anything above BBB- for S&P and Baa3 for Moody's is considered investment grade (please see ratings chart).
I try to concentrate on investment-grade companies because their financial strength and the benefits the investor. As one might speculate, the stronger the tenant, the less likelihood of default or bankruptcy (please see the chart below). The credit of the tenant affects many different aspects of an investment, including long-term lease security, possible financing, and asset liquidity. These topics are covered in the following sections.

What Type of Tenants to Look for

Secure Range: AAA to BBB

AAA. Superior financial security on an absolute and relative basis. Capacity to meet lease obligations is overwhelming under a variety of economic and underwriting conditions.

AA. Excellent financial security. Capacity to meet lease obligations is strong under a variety of economic and underwriting conditions.

A. Good financial security, but capacity to meet lease obligations is somewhat susceptible to adverse economic and underwriting conditions.
BBB. Adequate financial security, but capacity to meet lease obligations is susceptible to adverse economic and underwriting conditions.

Vulnerable Range: BB TO CCC

BB Financial security may be adequate, but capacity to meet lease obligations, particularly with respect to very long-term leases, is vulnerable to adverse economic and underwriting conditions.

B. Vulnerable financial security. Currently able to meet lease obligations, but capacity to meet future lease obligations is particularly vulnerable to adverse economic and underwriting conditions.

CCC. Extremely vulnerable financial security. Continued capacity to meet lease obligations is highly questionable unless favorable economic and underwriting conditions prevail.

*** Moody's ratings use numbers with their ratings between AAA & C, while S&P use positive and negative symbols with their alphabetical codes.

Loan Terms

Investment-grade quality tenants also affect the loan terms in ways that benefit the investor. There is a positive correlation between the credit of the tenant and the loan terms achieved. Typically, interest rates are based on the U.S. Treasury rates plus a "spread," which is based on a premium above the trading of a company's corporate debentures. The higher the quality of tenant, the lower the spread will be, producing a more desirable interest rate for the investor.

The financial standing will affect the loan-to-value percentage, the debt service coverage ratio (DCR) and the amortization of the loan, as well. Many lenders will not require as much equity from the borrower, nor expect a higher DCR, if the tenant has a good credit rating. A borrower may also be able to attain a longer amortization period with an investment-grade tenant. The lower equity requirement will allow the owner to acquire the property with fewer dollars up front, while the lower DCR and longer amortization will increase the net cash flow over the life of the investment.