Net Lease Trend Gains Ground in Receding Economy

NEW YORK CITY-Net leases are gaining most-favored-deal status among building owners eager to minimize their risks in a volatile economy. Many a multifamily or multi-tenant office property has been sold over the past two years in order to finance a net lease acquisition that puts the fees, and most of the headaches associated with ownership, firmly in the tenant’s hands.

According to Andrew Oliver, a managing director at real estate investment banking firm Sonnenblick-Goldman Co. who specializes in arranging financing and sales for single-tenant net lease properties, the uptick in net lease deals is being driven by a combination of buyer insecurity, favorable interest rates and the plug-and-play convenience of owning a building in which the tenant has to fix the plumbing and pay the taxes.

“There’s a flight to quality in a market like the one we have today,” Oliver tells GlobeSt.com. “People are looking toward highly rated tenants. Lenders feel more comfortable when lending against a high credit-rated tenant. There’s little rollover risk, no worry about capital improvements, and you know you have cash flow for 15 years.”

A tenant who enters into a net lease, also known as a credit tenant lease, agrees to occupy the entire building listed on the lease, pay all taxes and costs associated with the building, and maintain the property just as an owner would in a multi-tenant property.

“There’s not a lot of management, Oliver says.” You don’t have to worry about a leak in the roof–the tenant’s responsible.”

Lenders like net leases because they’re low-risk. For buyers, that translates into generous terms. According to Oliver, “with a net lease you can leverage much more” than you can on a traditional loan. Lenders generally allow borrowers up to 75% of the purchase price of a multi-tenant building. But a buyer purchasing a property with a single, highly rated tenant on a 15- or 20-year net lease can borrow as much as 90 to 95%.

Don’t expect a quick return on a net-lease investment, however, Oliver says. “It’s the Rip Van Winkle theory. You go to sleep, wake up and sell at a much higher rate,” Of course, you have to sleep for 10 to 20 years, and there’s no guarantee that you’ll wake up to a seller’s market.

Nevertheless, Oliver says, even the worst-case scenario for an owner with a well-structured net-lease deal is a cakewalk compared to many higher-risk investments. Suppose your tenant’s 15-year net lease ends during a down market or there are new buildings in the area giving you some competition. You’ve been paying off your mortgage for 15 years with the rent you’ve been collecting. You may have even burned the papers already. Now you can afford to lease up your building at lower rents than your competitors can.

And that’s the worst case. At best, the neighborhood around your building is transformed from shabby to chic over the course of your tenant’s 10- or 20-year lease. Now you’re in the chips. “You can tear down and build a different kind of property,” Oliver says. “Put up a five-star hotel or an office building.”

The concept has been readily embraced by owners, with more buyers looking at net leases as jittery investors continue to step up their search for low-risk ventures. “It’s been very lucrative for us over the past two years,” Oliver says. He adds, though, that with the number of multifamily properties on the market beginning to drop, available capital for net-lease acquisitions is likely to decline as well.

Recent net-lease sales that Oliver has closed for Sonnenblick-Goldman include Three Gateway Center in Newark, which is leased to Prudential Insurance for just under 15 years; the Mellon Independent Center in Philadelphia, leased to “an A-rated tenant” for 15 years; and a New York property leased to New York Life Insurance Co.