3 Tips for Conducting Due Diligence in Net Lease Investing

Along with face masks, hand sanitizers and social distancing, there is one more phrase that we’ve heard almost ad-nauseam throughout the course of the COVID-19 pandemic: Essential business. In the world of net lease, that phrase boils down to essential retail, and the list of contenders in this arena are up for serious consideration by investors looking for relative safe havens in an economy rocked by the pandemic.

But qualifying in a category in and of itself doesn’t amount to stability, and pre-investment due diligence, always a hallmark of smart investment, becomes even more critical today in the midst of the national pandemic-induced retail slowdown.

First, let’s look at the retail types suggested to the Trump Administration as essential by the National Retail Federation as quoted in Chain Store Age:

• Grocery stores, convenience stores and other retailers providing food and pet supplies. Also big box stores, wholesale clubs and any other retailer of household consumer products;
• Transportation and delivery services;
• Facilities supporting interstate delivery of goods;
• Pharmacy and healthcare services;
• Convenience stores;Agricultural and farm retail stores;
• Gas stations, auto supply stores and auto facilities;
• Hardware and home improvement stores;
• Restaurants and other facilities that prepare and serve food; and
• Retailers that supply other essential businesses products.

So, armed with potential retail types that dodged the shutdown bullet, investors can drill down to questions of the stability of specific retailers. Here are just a few of the essential questions investors have to lead with at the start of what is hoped will be a long-lasting relationship: Needless to say, the first order of business is the creditworthiness of the tenant. Its bond rating is a good litmus test here. As Beth Mattson-Teig stated a while back in an article for Real Assets Adviser, there is little difference between the obligation to pay rent and the obligation to pay down unsecured debt. Another critical consideration is the tenant’s renewal track record. History tends to repeat itself, and ongoing commitments are the Golden Ticket in a net-lease agreement. Remember, part of the benefit of net-lease deals comes in the tendency toward long-term and stable income. The underlying real estate should also be a concern. The generally accepted principle is that retail sits on the best real estate in town. But check out things such as transportation access and the condition and economic direction of the surrounding community. This is especially true in an age when so many parts of older communities are being revitalized for a new generation of occupants.

There you have three important aspects of due diligence, but needless to say, in all aspects of due diligence, remember that the deeper you dig, the more light you shed on the subject. We don’t know what tomorrow will bring as we fight our way up and out of the hole of COVID-19. It may be that the worst is over. But that doesn’t mean you should drop your guard.