Feature

by Terrence Jones

I recently received a call from a client who owns an apartment building in San Francisco. He is a retired electrician who bought the building as a fixer-upper and put in his sweat equity over the years to create a nicely running, well-maintained building. He has significant equity in the building because the property has dramatically increased in value and his loan is relatively small. But he does have a concern. "I am at a point where I can no longer manage the building, but I don't know what to do if I sell it," he said.

He's not alone. Many apartment owners reach a point where they are exhausted from managing their buildings, but feel like their only alternatives are to sell the property and pay taxes on the profit, or hire a property manager to take over. About the latter option my client added, “Many of my contractor friends who have used property managers have not been happy. Property managers don't treat the property in the same way the owner does.” He also noted that selling the property and paying taxes did not appeal to him because he needs the cash flow to live on. This is a common situation in San Francisco.

But for many owners there is another option. They can sell their apartment buildings and, through the use of an IRC 1031 tax-deferred exchange, trade the profits into a single-tenant triple-net property. Many of our clients have used this strategy.

What is a single-tenant triple-net, or NNN property? Triple net means that the property owner has little or no responsibility for the property operations or maintenance of the property. The one, or "single," tenant takes care of all or almost all property expenses, except the mortgage.

Bob Tuller, director of the Triple Net Investment Group at BT Commercial, has over 45 years experience selling NNN properties. "There are a wide variety of properties and tenants that can be described as single-tenant, triple-net," he said. I asked Tuller to describe for me some typical NNN properties, and he replied with the following examples:

• Walgreens Drug Store
  Walgreens leases are for 25 years. As the tenant, Walgreens is responsible for all maintenance, utilities, insurance and real-estate taxes. Because Walgreens is an A+ rated tenant, most owners are confident that the rent will arrive on the first of every month. In many instances the owner does little more than receive a rent check and send a loan-payment check. It sounds pretty good doesn't it?
• Jack in the Box Fast-food Restaurant
  Jack in the Box is one of the largest hamburger chains in the United States, with over 2,000 restaurants located primarily in the western and southern states. Jack in the Box leases typically run for 15 years or more with rent increases every 5 years. The company's sales topped $2 billion in 2003, with a net income of $73 million. These strong numbers give many investors great confidence in Jack in the Box NNN properties.
• Tractor Supply Company
  This new and growing company (NASDAQ: "TSCO") operates 500 stores in 32 states, focusing on supplying the lifestyle needs of recreational farmers and ranchers. TSCO leases are usually 15 years in length and have rent increases every 5 years.

Other examples include cafés such as Starbucks, auto-parts stores like Advanced Auto, or convenience stores such as 7-Eleven, Inc.

There are, of course, several key factors that must be considered in evaluating single-tenant triple-net investments, including:

Strength of the Tenant
Since there is only one tenant, commercial strength and credit rating are extremely important.

Length of the Lease
Generally, a lease of 15 years or longer is best with NNN properties.

Location of the Property 
Many NNN investments with strong tenants and long leases are located outside of California.

Rent Increases of the Lease
A rent increase every few years will help your investment fight off inflation. A 5% increase every five years is generally considered appealing to most NNN investors.

BT Commercial recently sold an apartment building for a San Francisco seller who then purchased a Walgreen's drug store in another state. He wanted a no-management real-estate investment with a high-quality tenant. His monthly cash flow went up, his new depreciation allowed him to keep more of this income and, with a 25-year lease, he feels confident that his situation is stable for a long time.

Too good to be true? Risky? Every real-estate investment has some risk. But risk in a NNN investment can be minimized by choosing a good tenant with a long lease, along with taking advantage of today's low interest rates by obtaining a long-term, fixed-rate loan.

All told, selling a highly appreciated apartment building and trading into a single-tenant NNN investment is a strategy that can be a good alternative to paying taxes on a sale or handing the property over to a property manager.

---

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or the San Francisco Apartment Magazine. The information contained in this article is general in nature. Consult the advice of an attorney or tax advisor for any specific questions or concerns. Terrence Jones is with NAIBT Commercial, 415-677-0428. Copyright © 2005 by San Francisco Apartment Magazine. All rights reserved.