By: Zachary Whittacre, Senior Manager – Real Estate
The realm of commercial real estate is multifaceted and complex, particularly in the niche space of leased fee sales within Triple Net Lease (NNN) properties. These transactions involve selling a property while it remains under an existing lease. This article aims to provide an in-depth understanding of the intricacies involved in leased fee sales, focusing on their valuation, commercial real estate property tax implications, and the consequent impact on lessees.
Leased fee sales in commercial real estate are exemplified by properties that are occupied by name brand freestanding retail stores. These businesses are frequently involved in transactions that highlight the distinct characteristics of leased fee interests in NNN properties. In these arrangements, tenants are responsible for expenses like property taxes, insurance, and maintenance, making these properties highly attractive to investors.
When an investor acquires such a property, they inherit not just the real property but also the existing lease terms. The stability and reputation of tenants often translate to a sales price premium compared to fee-simple sales in an open market. This premium reflects the investor’s confidence in the tenant’s ability to provide a stable, long-term income stream. In contrast to standard commercial property sales, acquiring a property with tenants of that size and classification means adhering to the existing lease terms, significantly influencing the property’s valuation and investment appeal.
Valuation of NNN properties in leased fee sales is a complex process, particularly for properties with tenants like the name brand freestanding retail stores. A critical aspect of this valuation is understanding market rental rates, drawing insights from comparable properties, such as former drugstores that have transitioned to different retail uses. These comparative rates establish a baseline for potential income in the event of a tenant change. Common occurrences of these scenarios are freestanding retail tenants, like dollar stores, filling the space of the former drug stores when the drug store permanently shuts their doors.
This broader perspective incorporates the property’s current lease conditions and its income potential under alternative uses. At the end of the day, the current tenant can leave the property, which would open the property up to the current market conditions. It is crucial to analyze the market value of the property excluding the current tenant and lease terms. The goal of commercial real estate valuation is to find the fee-simple market value which would exclude all business value of the current NNN tenant.
Investors also need to stay attuned to broader market trends and the overall health of their local retail sector, as these factors influence the perceived stability of future rental income. The rise of interest rates has had a significant impact over the past few years on the commercial real estate market. The buying power for commercial real estate has dropped significantly as interest rates have risen. The risk involved in acquiring commercial property is higher than it was two years ago, which can be portrayed in a higher cap rate derived through Band of Investment. Legal and regulatory considerations, such as zoning, property tax rates, or other relevant regulations, also play a critical role in the valuation process.
Lessees in NNN properties, such as those occupied by name brand freestanding retail stores, face significant implications when the property is sold in a leased-fee transaction. The primary concern is the potential reassessment of property taxes post-sale. Especially in states where commercial real estate is reassessed on a yearly basis.
In NNN leases, tenants are directly responsible for property taxes, and a reassessment can lead to significantly increased tax liabilities. This can affect their operational budgets and financial planning for the whole organization. The variability of property taxes introduces an element of financial uncertainty for lessees, especially in markets with rapidly changing property values.
Additionally, the approach of the new property owner to property tax matters can affect lessees, as some owners may be more proactive in appealing assessments to reduce tax burdens. Understanding the lease terms related to property tax pass-throughs and adapting to the new owner’s management style are crucial for lessees. Due to the tenant paying the property taxes, the tenant should hire a commercial property tax consultant to appeal the assessments. Having a consultant stay on top of values soon after sales is crucial to keep county values from running away.
Navigating leased fee sales in NNN properties requires a strategic approach. Buyers must engage in comprehensive due diligence including market rental research of rental rates, examining the lease agreement, assessing tenant stability, and understanding the property’s tax history with potential for future reassessments. Buyers should also try to avoid disclosing the sales price publicly, due to the potential tax implications on the lessee through property reassessments.
Lessees should stay informed about the implications of a potential sale, focusing on lease terms and the new owner’s property management approach. Consulting with legal and property tax consultants specializing in commercial real estate is advisable for all parties to navigate the complexities of these transactions. Clear and transparent communication among all stakeholders is essential to align expectations and ensure a smooth transition with the least detrimental impact on the lessee.
Leased fee sales in NNN properties, particularly those involving tenants like name brand freestanding retail stores, present a challenging yet rewarding landscape in commercial real estate. Understanding the nuances of property valuation, property tax implications, and the impact on lessees is crucial for successful management of these transactions. Property owners, investors, and lessees must be well-prepared and proactive, engaging with property tax advisors to navigate these complexities effectively. As the commercial real estate market continues to evolve yearly, staying informed and adaptable is essential for all parties involved.
