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How Is Cap Rate Calculated on NNN Lease?

Cap rate is the very first thing investors pay attention to while considering various commercial realty options. The decisive meaning it also has within the NNN lease frame market. The cap rate is the correlation between a property’s net income produced and the capital cost or its actual market price. Shortly put, the cap rate is yearly net income divided by the asset’s cost.

What is the essence of the NNN lease? It is a loan kind according to which the tenant should cover all the property expenses together with insurance, maintenance and realty taxes. This amount is added to the rental and utility costs. So, it’s obvious why the NNN lease provides such a low rent charge compared to typical lease terms. Despite the profitable property fee, the leaser has a lot to care about. Still, the NNN lease remains a win-win situation for both the leaser and landlord.

Let’s explore step by step how is cap rate calculated on NNN lease?

  • First, define annual gross property profit. It is usually money produced by the rent, but don’t forget about other property earnings sources.

  • Count out from the gross income yearly operating costs. They have to include insurance, maintenance, utilities and taxes and any other costs for the property. You shouldn’t sum up the money spent on the business to the total. Besides, mortgage fees and other payments don’t belong to the operating expenses. Subtracting the overall operating costs amount from the gross income sum and you will get the net profit.

  • The cap rate will appear by dividing the given profit by the purchased property price.

For instance, if the building put on sale for $2 million has a net profit of 200 000, the cap rate will form 10 percent ($20 000 / $2 million).

What Is the Hottest Cap Rate?

A 10 percent cap rate is considered pretty good. But, overall, there are some essential points influencing cap rate figures.

  • Property Sitting. Depending on the area development, locations are of three tiers. The first tier involves highly developed cities, the second location type is with areas still in growth progress and the third one is full of unbuilt realty plots. That’s why secondary and tertiary commercial markets gain high popularity.

  • Property Age and Classification. There is a peculiar division of A, B and C property classes. Class A represents the perfect condition and deluxe location buildings. The interior and exterior are renovated and look awe-inspiring. Class B has fewer brand new and gorgeous options than the previous one but is still attractive enough. You may find such properties usually in the suburbs. Class C offers poor placement and aged buildings that need renovation.

  • Credit Reliability of Tenant. The tenant credit trust is of crucial meaning since it is related to your investment costs. For instance, a lasting loan with a well-known and vast company may ensure a considerably better cap rate than a lease with a local operating one.

  • Lease Duration. The principle is very plain: the longer the lease term, the more beneficial the cap rate. The onliest risk is connected with the tenant’s lease expiring and what will happen afterward.

The benefits of NNN lease investments

The main NNN lease pro is that the leaser is entirely property-keeping responsible. So the owner has no management duties and may redirect free time to the right channel or look for new agreements. Still, you can find many more priceless opportunities.

  • Long-term Possession. Each triple net lease has its peculiarities, but the one thing echoes almost everywhere – lasting lease terms. Some can ensure agreements even for 25-year. Due to the leaser will use the property for an extensive-time period, lessors may feel a high comfort level and confidence in tomorrow.

  • Stable Income. The tenant’s trustworthiness may differ depending on the lease and its conditions, but NNN lease tenants are in most cases reliable and have high credit grades. That way, non-payment risks are equal to zero and stable income flow from lease fees is guaranteed.

  • Build Capital. Some NNN lease fees go for the property mortgage fees consisting of the major amount and monthly interest. The loan’s main balance gets reduced with each such payment, creating equity for the building owner. The realization of this capital is possible while selling and may drive the investor a significant profit.

  • Lease Transfer Upon Selling. Since properties with NNN leases are in high demand among realty depositors, their purchasing and selling are quite frequent. Luckily, the lease agreement remains with the new owner after the sale, which may profit from lease fees further.

  • Prevention from Operating Expenses Increase. After the NNN lease signing, operating costs are no more owners’ worries. So, in the case property taxes or insurance services rise, the realty investments won’t suffer.

  • Rental Income and Expense Refund Streams are Separate. The principal rental payment goes separately from the expense refund. Regarding accounting, such an agreement is extremely convenient as it aids in tracking income streams apart and agreeing on the costs to refund income with the actual expenses paid off.

  • Rental Fees Go Up. With time NNN lease performs a periodic rent rise. For instance, lease terms indicate that the rental fee will increase by 2% yearly. Being an investor, you will only win since the rent income flow grows over time and wealth multiplies consequently.

  • Both Parties Have Equal Audit Rights. The NNN lease tenants refund costs directly to property owners, not vendors. So, the owner names the exact cost for each item. To make sure must-paid expenses are true, each party can check the actual costs compared to the amount to charge from the tenant.

Final Thoughts

If you decide to invest in real estate, the NNN lease is just the job. Review all the offered options and don’t fixate only on a low cap rate. Sometimes slight savings today may cost you a fortune in the future. So, be reasonable, consider all the benefits and risks and the wishful NNN lease will become a fateful investment.

Related Articles:

What is the Cap Rate on a Triple Net Lease?

Realized vs Recognized Gain in 1031 Exchange

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