The Danger in Net Lease Investments

There is a prevalent notion that an investor can just buy a net lease property and enjoy the rent checks rolling in each month. But Noah Shaffer, senior director of asset management for Confidant Asset Management, says that isn’t always the case.

“Landlords are starting to get calls from Walgreens and others, saying, ‘Hey, Amazon is really killing us,” Shaffer says. “’We’re going to need a 25% rent reduction.’ And those landlords, who thought this was a passive investment for 15 years, aren’t prepared to make a decision on something presented by the corporate tenant. So, as a result, they make poor decisions about their investment asset.”

In some cases, retailers aren’t even offering to negotiate with their landlords. They’re just closing up shop.

“Retailers are failing,” Shaffer says. “This is a real threat to net lease landlords. Not only will landlords lose the rental income, but they will also have to service the property tax, utilities and insurance for the site. Strong retailers are using this dialogue to leverage and scare net lease landlords into rent reductions.”

Outside of a large tenant asking for a restricting, there are a lot of other ways landlords in net lease could run into problems, including difficulty collecting insurance and property taxes and deferred maintenance.

“Deferred maintenance is a real thing,” Shaffer says. “Failing to pressure wash the mold off your Walgreens and its roof could result in damage to the building structure that is much more costly than a bi-annual wash.”

Net lease investors also need to be aware of things that their tenants do. For instance, Shaffer knows of an example of a franchisee performing remodels and stiffing the contractor for millions of dollars in work. The contractor then filed a lien against the property. “The landlord was unaware of the lien and how to remove it from the property,” he says.

In other cases, retail locations may be closed before the landlord even knows. In this environment, Shaffer says landlords must be proactive. For instance, at a Pier 1 in Tallahassee, Shaffer’s team began marketing a property for lease and sale with a local broker a year in advance of the lease expiration because it noticed Pier 1 was struggling at the corporate level.

In many cases, Shaffer says these landlords aren’t planning ahead for these bad situations. “As a result, they are forced to make poor decisions regarding their investment, or take what is handed to them,” he says.

A better way to avoid problems is to buy good real estate in corners with traffic signals, Shaffer says. “When you buy it, it’s no longer buying it on the income stream,” he says. “It’s buying it with a secondary use in mind as the tenant leaves.”

Shaffer also prefers smaller locations, ranging from 1,800 to 3,000 square feet. “You can usually find another national tenant to move into that space at the right rates,” he says.