NNN Industrial Investment One-Liners

Don’t lose sight of the fundamentals:

• The length remaining on the lease term may not be as important as the location and the use of the property. An opportunity to renew or release could be a benefit to investors, especially if the underlying real estate meets the long term requirements of the tenant or use group.

• All things being equal, should the investment value of a property with a stable, high quality industrial tenant, who is operating with a short lease term, be overlooked or discounted? If the business model of the tenant shows creditable future growth and the site and location are critical to their operation, the investment has value beyond the initial lease term.

• Should the real estate be as equally important to the equation, as lease term and financial strength? All attributes of a NNN investment play a critical role in determining the true value if the asset and in some special cases, the value of the real estate may be as important as the strength of the tenant and the uniqueness of the location.

• The location, zoning and uniqueness of the property will always add to the real estate value. The tenant’s use of the real estate and their special requirements can make a case for a much higher value of the intrinsic real estate.

• Spending the time to quantify the real estate value with special consideration put on permitted use requirements and necessary equipment in place, can make or break a NNN deal even if the financial fundamentals say differently.

• Should savvy NNN industrial investors consider the real estate as just one factor of a NNN investment or the most critical component of the equation? In a NNN transaction, real estate having necessary site specific requirements to the Tenant’s business operation, it should disproportionately add value to unattractive real estate.

2010 4th Quarter Cap Rate Report

The story of cap rate movement in 2010 is a tale of two trends. Beginning with promise and an increase in NNN deal making, the year quickly faded in the wake of poor global economic news – only to rebound and rally around mid-year in select markets (headlined by New York and Washington D.C.). Overall, cap rates in the second half of the year were lower than the first. In fact, sellers of credit rated NNN properties in core markets closed at cap rates rivaling the 2007 peak of the market. Numerous reasons have been offered as the cause but chief among these were a lack of quality supply, a more positive lending environment and improving market fundamentals.

It is no secret that there was dramatic contraction in development over the past two years. The pause in expansion by national retailers coupled with stagnant retail sales and the tight debt market all but encouraged already wary developers to halt or slow projects slated for development. Those eager to invest quickly discovered that NNN properties were in short supply and properties of real quality in strong primary markets were even rarer still. In early summer, these factors created a dwindling pool of quality investment grade NNN assets.

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Separate Trends Benefit Net Leases

Two recent developments should push investors towards net lease properties. A new rule from the Small Business Jobs Act demands rental properties be treated as other businesses – requiring 1099 forms to be submitted to all service providers for costs $600.00 or over in one year. Furthermore, municipal bonds are on thin ice and many cities are posting billions in debt. These developments make both active real estate management and passive municipal bonds less attractive. Those who have invested in either should see net leases as a safe harbor.

The Small Business Jobs Act, like all bills, naturally contains things many would think anti-productive to its intended nature. Its provision requiring 1099’s lives up to this by issuing heavy amounts of busywork where none was required. Specifically:

The act subjects recipients of rental income from real estate to the same information-reporting requirements as taxpayers engaged in a trade or business. Thus, rental income recipients making payments of $600 or more to a service provider in the course of earning rental income are required to provide an information return (typically, Form 1099-MISC, Miscellaneous Income) to the IRS and to the service provider. This provision will apply to payments made after Dec. 31, 2010, and will cover, for example, payments made to plumbers, painters or accountants in the course of earning the rental income.

Thus, private real estate owner/operators will be saddled with new paperwork. As owners grow older – which the advancing baby boomer population assures – the time and effort required to actively manage a property will simply not be worth it. For this reason, net lease properties become very attractive. They offer a passive asset which real estate owners can trade into via a 1031 tax free exchange.

Municipal bonds, long seen as a stable investment, are looking less secure everyday. Just to name a few, Chicago as $7.4 billion in debt, Detroit has $billion and New York has $60 billion. These are major metropolises in major debt. Though the idea of a bankruptcy or default may seem impossible – these cities cannot print their own money and many have guaranteed millions in lifelong pensions. At the very least – municipal bond owners should be wary. Those heavily invested should also look for a more stable source of income. The credit ratings of top-notch net lease tenant such as McDonalds and Walgreens would put many cities to shame and still deliver guaranteed passive returns.

The market is constantly changing and as it has proven recently – can be treacherous. Many so called “safe” investments were shown to be completely unsound. Net leases offer a secure asset with dependable returns. Of all the real estate segments – few to none offered more staying power during the recession. With actively managed real estate encumbered by paperwork and municipal bonds looking shaky – the migration to net lease assets should be natural.

State of Medical Office Market

Calkain interviewed Michael Abrams - President of Foulger Pratt Rockledge Medical Properties - concerning the medical office market.

Calkain: As a developer, what is your prediction of demand for new medical condominiums in the Washington Metro area for the next year or two?

Michael Abrams: There are several conflicting forces impacting the medical condo market over the immediate and near term. On the positive front, certain financing markets are becoming very attractive with practices able to borrow funds at about 5% and up to 90% of the project cost. This compares favorably with the cost to lease. Physician practices have also experienced generally good conditions compared to other aspects of the economy which have suffered worse over the past few years. For example you don’t hear about large layoffs by hospitals or physician groups. However, healthcare uncertainty - while better since the passage of the 2010 healthcare bill - still permeates the decision making process for individual practitioners.

Calkain: As you know, there are significant shifts impacting medical delivery systems: outsourced medical services from hospitals, the advancing age of the baby boomer generation, the recent healthcare legislation. Can you comment on the impact of these trends on developing medical buildings?

Michael Abrams: We see a trend toward consolidating practice groups into larger sizes and toward greater hospital employment of physicians. Both of these trends point away from the condo model as a vehicle for physician occupancy. Larger groups tend not to own in this manner and hospitals tend to own entire buildings or lease space. We anticipate a greater orientation by health care systems to delivering services off campus in integrated settings where a variety of medical services are provided in a more unified way rather than a building with a collection of unrelated physicians who may or may not be part of an integrated approach to care.

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Michael Abrams is President of Foulger Pratt Rockledge Medical Properties, LLC, Rockville MD