NNN vs. Multi-Family

[Pharmer T]

Hi all,

I'm new to the forum, but been interested in finance for awhile.

I'm extremely blessed to have a good financial situation with a steady job, well over 6 figures in retirement savings, and at least 2+ years of emergency funds in the bank (I'm 37). I inherited a property in the Bay Area that I currently have under contract to sell (selling due to family reasons). I'm looking to buy a medium sized multifamily property (10-20 units) in the area I now live, Denver, or thinking about doing a NNN deal out of state. I would hire a property manager for the multifamily property, and obviously not have too much management responsibility with the NNN deal.

I wanted to see if any other members who have done either type of deal, or both, might have some sage advice on why they choose one vs. the other and how it has turned out in the long run. I don't need the money from these deals to live on and honestly either one would probably get me very close to FI, but I have two young children and I want to put away enough for their college fund in a 529 plan. Thanks upfront for all your advice!

[Scott at MD Financial Services]

Pharmer,

I too am in Denver and it is a hot market without a doubt.  The NNN will be easier typically but it all comes down to the terms of the deal (duration of lease and rent escalations) and credit of the tenant.  I have a friend that does about 3-4 projects a year with Dollar Trees, Auto Zone, Walgreen's, and CVS all on NNN projects.  The Multi home deal is always interesting but it does come down to the management company you hire (how proactive they are, inspection schedule, and their in-house repair people), management costs as a % of rent, and their ability to comply with all of the fair housing rules.  The final thing you have to worry about is selling the projects, don't get into things without an exit strategy....

[Medikit]

I'm 2.5 years out of fellowship but don't see myself in the same place financially for another 5-6 years. Still I'm trying to learn as much as I can about commercial real estate now so I'm ready when I have the income. I'm surprised there isn't more discussion about triple net commercial real estate since it is potentially an ideal fit for physicians.

Here are some of my thoughts thus far:

Pros:

- Provide income that does not correlate with my other investments

- Special tax advantages available to small business owners and specifically to real estate investors

- Ability to leverage investment in a tax advantaged way

- Minimal upkeep and management required with triple net as compared with multifamily

 

Disadvantages:

- Loss of investment diversity

- Leveraging significantly increases risk

- Lack of skill/knowledge compared to my primary trade

- Cash on cash return for high quality tenant triple net lease is typically lower than multifamily

[Scott at MD Financial Services]

All of that is true in my opinion but the thing with NNN that I have personally found is if you want a high quality tenant (great commercial paper) on the most desirable street corners (easier to re-lease if the tenant moves out) with long leases (so you don't have to mess with it but every 10-15 years) then it drives the return down simply due to the cost of the project to acquire.  The other issue is these buildings range from $750k to over $6 million that I see so that is a lot of concentration on one investment for most individuals.

[NJDoc]

Ask yourself one question: Can you carry that NNN property for 6 months if vacant? I'm assuming there would be a mortgage on the property.

In addition cap rates and returns tend to be lower with excellent NNN locations, as mentioned above due to cost to acquire.

 

Multi family is always the easier and safer way for the small individual investor. Cap rates tend to be better, vacancy risk is mitigated and property management can be done professionally if you buy a big enough property. You could always bring in a partner or two and buy a bigger property as well.

 

[CREGuy]

There are pros and cons to each asset class:

 

Multifamily

Pros

- Typically easier to fill your vacancies

- Leases are typically short term, so in a rising rental market, you can realize higher rates on an annual basis

-Typically higher cap rates (and lower price points)

Cons

- Management - Evictions, damages, headaches, much higher maintenance responsibilities/headaches (you can hire a manager obviously, but many times you still need to manage them)

- Leases are typically short term, so in a soft rental market, you will realize lower rates on an annual basis

- Much more maintenance responsibilities and costs.   Typically you will be paying everything but utilities (and in some cases those too).  Property taxes go up?  Comes out of your pocket.  Own in a cold climate and get pounded with snow resulting in a huge snow removal/salt bill?  Out of your pocket.

 

STNL Properties

Pros

- Easy to manage

-Long term leases in place provide very predictable income for a long period of time

- Strength of credit in the tenants

- Ability to pass through rising operating expenses with little to no affect on your NOI

- Ability to look at properties located anywhere in the country (including properties located in income tax free states).  This can be done with multifamily as well but given the management intensive nature of MF, it's much more difficult.

 

Cons

- Lower cap rates (and higher price points)

- Vacancies will be harder and more expensive to fill (brokerage fees, legal fees, TI allowances, etc.) However they're also much less frequent than MF and the risk can be calculated pretty well based on readily available information (lease, tenant financials, etc.).

 

At the end of the day, my personal preference would be to go the net lease route as you will have much more stable, predictable income streams, and better credit tenants.  Look at it this way, would you rather be relying on Starbucks to pay you rent (20B in sales 60B market cap) or Judy who works at the gas station down the road ($0 net worth, $12/hr)?  That's not even getting into the headaches and work associated with each.