The 1031 Net Lease Broker Conundrum

Contributing Author: Sean O’Shea

As a Net Lease Investment Advisor and Buyer’s Broker, we face a number of practical challenges in the recent and current Net Lease Market.

Challenge #1:  Accessing net lease ‘product’ or properties that match a Buyer’s stated criteria.  Reproducing the cash flow of their existing asset is a point of departure, only. Then, we need to establish “What is a risk-adjusted return?”  OK, you say, you want a limited risk new investment.  No problem; but since the Great Recession with most compressed cap rates in memory (Higher prices), we have to sort through the “Net Lease Wheat from the Net Lease Chaff”.

We have, by necessity, cultivated trusted relationships with other net lease investment professionals from every credible Net Lease Brokerage source, both large and small; both regional and national; both on market and off-market sources in order to afford a 1031 Investor the maximum exposure to the Net Lease inventories from all available sources.   Constructing and updating an 80,000+ NNN database has been essential.  Since a Buyer must make a timely ID decision within 45 days of their ‘down leg’ closing; and another 3 ½ months to complete their purchase.  180 days in total timeline. Time is of the Essence at each stage of the review, selection and execution of successful IRC 1031 Exchanges.

Challenge #2:  In the highly competitive Net Lease market, it is more probable that a buyer will be compelled to, not only identify their Trade Replacement Properties, pursuant to IRC 1031 Provisions in 45 days; but, actually, complete their “up leg”; within a 45-60 day period, subject to whether there is a new debt required which may add to the timelines, as you compete with all cash buyers, if prior sold property is under the $2,500,000- $5,000,000. Cash is king in these negotiations.

Often a 1031 Buyer is in a trade, having experienced substantial value accretion of their existing property; and they are wishing to defer their capital gain liability; and to redeploy those resources in a safe investment, a coupon clipper.  Their investment goals are a NNN asset, that requires less or, preferably, no management with all operational responsibilities on the commercial Tenant…a  Multi-family Apartment Investor can be a typical case study.

They have enjoyed pretty consistent investment returns over their ownership holding period; and, now, want less headaches and more predictable, stable cash flows. This is a reasonable request and assignment on the face of it, a Bond-equivalent asset.

But, we often inform them, that “ Not all Net Lease properties are the same”.

Challenge #3:  So, 1031 Trade Requirements come in as many ‘shapes and sizes’ as there are properties sold.  If we are establishing the investment goals for that Buyer Client, then, we must, also,  “Size-the-Deal”.   What does that mean?  What is the most appropriate properties that match the trade, reward and risks to be balanced.

If your relinquished property is anywhere from $1m-$3m, we may direct a client to “QSR’s”, that is to say “Quick Service Restaurants” I. e. fast foods: Wendy’s; Taco Bell; Burger King; Carl’s Jr. McDonalds and other concepts like Chick-fil-A; Bob Evans.

• Next item is the lease term: Many sign10 year Base term lease; some 15-20 years;
• Next item is the Guarantor of the tenant responsibilities: Is it a Public Corporation?; (or a Subsidiary)?; most often a Franchisee, (can we secure credible financials?); Is the guarantor an individual personal Guarantor?
• Is the Lease form a true absolute triple NNN with no landlord responsibilities, whatsoever?
• Many Listing Brokers in this current NNN market will, literally, state in their paperwork and Offering Memorandums: “NNN lease”; then upon investigation, re-state “NNN” except for limited landlord responsibilities…. We say, then you should call it out as “NN” which may require a future owner to be responsible for line items like roof and structure, foundations, parking lot and other contingent liabilities; but marketing these properties as if “NNN”…is not quite fully accurate, from our Advisory Practice viewpoint!
• Does the lease form have scheduled increases, which address possible inflationary hedges? If, so, they range from 1%-2% annually; 5-7.5% every 5 years; 10% every 5 years. Then we ask Sellers, if those provide “risk-adjusted returns” why are they priced the way they are priced?
• Of course, we never forget, “Location; Location; Location”. Is this location a solid or growing demographic after the last ten years of crawling out of the Great Recession.  Are there regional and tax-free state considerations?

This article is intended to scratch the surface of the intense process that produces successful IRC 1031 Exchanges which afford both Buyers and Sellers  “a high certainty of full execution” which serves all Parties’ best interests in a most timely and cost–effective manner.

Sean O’Shea, Managing Director