1031 Exchange into a Triple Net (NNN) Investment
Some common but completely reasonable concerns we hear from single family and multifamily sellers considering a 1031 exchange into triple net leased investments (NNN):
“If I sell, my property taxes will go up, I can’t find any high cashflowing assets in this hot market, and commercial investments sound so risky.”
Again, these are totally understandable and reasonable concerns. Everyone is comfortable with what they know, especially regarding their investment decisions.
Allow me to shed some light on my clients’ experience:
I have a wonderful relationship with some clients who were at a crossroads with comfortable income, but high levels of deferred maintenance and management issues across 40+ units. Their family’s entire portfolio was concentrated solely on single family and multifamily investments, but their properties were financially underperforming. They considered getting more proactive with their management style, but they truly wanted PASSIVE income, and furthermore, HIGHER and MORE RELIABLE income.
Even after outsourcing day-to-day management to a management company, the reality is that single family and multifamily investments will take away our attention from what we really want to do in life. A roof replacement, unforeseen vacancies and new windows could easily wipe out profits for a few months or possibly a whole year.
Anyway, my clients took some time to explore their options, consulting with their CPA, trust attorney and reviewing an extensive comparative cashflow analysis we compiled. They decided to sell one of their apartment assets and exchange into a triple net leased investment. They wanted to simplify retirement and increase income, since they were tired of vacancies, rent control, late rent and evictions.
More importantly, their decision was based on the appealing nature of NNN investments as an alternative. They considered the following benefits:
100% passive investment- total peace of mind
No management responsibilities- tenant manages property
Corporate tenants- professional 24/7 management by a publicly traded company
Tenant pays for ALL property taxes AND insurance
Long term 10, 15 or 20 year leases- guaranteed income
Built-in rent increases every 1-5 years
So, to them it seemed like a no-brainer and made a lot of financial sense. We listed their apartment complex for sale, created a bidding war between competing buyers, got it in contract with a qualified buyer, and closed escrow within 30 days.
Here’s a breakdown of the low yield, low income apartment numbers:
Sale Price: $1.6 million
Cap Rate: 3.5%
Net Operating Income: $56,000/year
Gross Rent Multiplier: 18.6
After the sale of the apartment complex, we searched and analyzed 100s of potential replacement properties to fulfill their exchange criteria. They ultimately decided to purchase a building leased to one of the largest Burger King franchisees in the country. The property had low rents compared to neighboring commercial property, which is HUGELY beneficial because in the unlikely event the tenant decides to leave, you will likely be able to replace the tenant fairly quickly with similar or higher rent. The tenant was operating profitably, with a low rent-to-sales ratio (only 6%!). It was located in a growing area on a busy street with ~35,000 vehicles passing by everyday; in other words, LOCATION, LOCATION, LOCATION.
Here’s the breakdown of the higher yield, higher income NNN numbers:
Purchase Price: $1,500,000
Cap Rate: 6.5%
Net Operating Income: $97,500- 43% increase in income
Long term 15-year lease
2% rent increases every year
Stepped up depreciation schedule- increased tax write-offs
This transaction occurred 5 years ago. Since then, these same clients have sold 4 other assets and exchanged into 5 other NNN investments. Their income NEARLY doubled, and they now spend more time doing things they love in retirement, like visiting their grandchildren, traveling the world and volunteering.
This can be a nerve racking experience for apartment owners comfortable with properties they’ve owned for years. If you’re considering an exchange, you should consult with your trusted advisors, including CPAs, attorneys, and real estate agents/brokers. More importantly, you need to ask yourself:
What are my goals and priorities in life?
What are my financial and investment goals?
How can I structure my investments to provide the freedom to achieve my life goals?
NNN investments aren’t for everyone. But in this highly inflated single family and multifamily market, it seems in many cases a NNN exchange makes sound financial sense.