I have been working on several commercial real estate projects that utilize triple-net leases (NNN). A tip out of the gate is be careful the prospective tenants possess a clear understanding of triple net leases and what is involved.
There is really not a tremendous amount of mystique behind the NNN, other than a symbol for additional expenses paid by the tenant beyond the rental or lease payments. In a triple-net, the lessee will usually pay a monthly rent along with all taxes, insurance, and operational / maintenance expenses that occur from the use of the property. The lessor (investor) is responsible for capital improvements on the building, such as roof replacement or major structural components. Again, be very clear in the terms of the lease agreement who has responsibility for majors building systems like mechanical, HVAC, Electrical, as well as major repairs.
I’m sure all of you real estate entrepreneurs looking to jump into commercial real estate development with triple-net leases are asking about financing at this point. A common method is for the investor to form a LLC to hold the real estate and use a credit tenant lease method for financing. The investor borrows money to finance the property and pledges as security the rents to be received from the tenant.
This is an excellent method for obtaining construction money if you lack assets or collateral to pledge. However, this will require a creditable tenant with an executed long-term lease in place and a bank or conventional financing institution to go along with it. Also see non-recourse debt.
One of my favorite tax-deferred vehicles for real estate is the use of like-kind 1031 exchanges. The actual law will vary from state to state so this post should be construed strictly as informational and a general rule of thumb. A 1031 Like Kind Exchange is typically used in real estate transactions although many other assets, businesses and commodities can be transferred (hence like-exchange) to a new purchase. The idea is to defer the tax burden triggered on the sale of an appreciated asset and roll the proceeds into a Like Kind purchase. The tax will have to be paid at some point in the future upon the sale of the new asset unless another 1031 exchange is used. As you can see if your not looking for liquidity the tax-deferred snowball can get quite large.
Some quick deal points to keep in mind when dealing with 1031 Like Kind Exchanges
* A qualified Intermediary needs to be elected to hold funds in escrow from the sale of the first asset and before the second is consummated.
* There are 2 time line requirements that need to be met:
1. The replacement property needs to be identified within 45 days from the sale of the first property.
2. The replacement property must close within 180 days from the sale of the first property
Be sure to consult an attorney when dealing with 1031 exchanges because of the nuisances in state law. More importantly an attorney can properly identify the intermediary and ensure the HUD statement is correctly filled out, especially if bank financing is involved. The $500 bucks you will spend will far outweigh a mistake of having to swallow your tax burden.
Forbes had a great article on entrepreneurs debating whether to start a real estate brokerage firm. The article focuses on 8 core systems that are a must review for the real estate potentials:
As a principle Broker and owner of a real estate brokerage firm, I felt compelled along with Forbes advice to offer a few suggestions for the real estate addicts. Evaluating the impetus of your startup decision should be your first question…why are you starting a real estate brokerage firm to begin with?
Like most businesses your startup will have a greater chance of success by seeking a niche or an under-served market within your industry vertical (real estate in this case). Your focus must go beyond representing just buyers and sellers. Your focus should be one of specialization:
1. Luxury or high end homes
2. Land specialization
3. Commercial specialization
4. New Construction specialization
5. Relocation services.
6. Technology focus that gives your firm a competitive advantage.
My brokerage success (and the reason I started a brokerage firm) was based on two fundamental problems I wanted to solve:
1. Corporate relocation services (employee’s coming into the state) were grossly under-served in my market area.
2. I was losing land and house sales (as a real estate developer) because not all potential customers wanted to live in new communities or subdivisions created by my real estate development business.
Solutions:
Once I got through the various educational courses, state licenses etc.. I started to put real estate brokerage to work:
I attacked the first problem by contacting the relocation companies bringing new employees into the state. I then contacted the human resource departments of expanding and mid to large sized businesses. I made sure to provide exceptional service so my new startup would be the preferred choice for relocation. This ultimately lead to a tremendous amount of inbound referrals. There is no substitute for great service when it’s needed most.
The second problem was solved by being able to offer prospective customers land and houses outside company owned communities and subdivisions. The law allows owners of real estate, developers and builders to sell their own real estate, but a real estate license is required for representing “other peoples” real estate. The real estate license afforded me the ability to show other real estate property of interest to customers. This was critical because I still controlled the sale rather than watch a customer walk out the door. It may not have been a sale for one business but a great sale for my new brokerage company. The benefit for the customer is having one point of contact and a sense of trust.
By solving both of those problems with a real estate brokerage firm it has enable the company to be cash positive within the first 6 months of inception and bring in multiple revenue streams further insulating against a down real estate market. The company is now moving on to other areas of service and actually have cash positive money for sales and marketing rather than long-term debt.
I always joke with my brother (he’s a startup addict too) about how we are industry agnostic and would bake bread if the right opportunity presented itself. The salient point to take away (if you read this far) is “what problem are you solving and how are you going to solve it better?”
You will need to flesh out your value proposition and prove it is more unique than existing competitors. Startups can be more successful than historic statistics show if we as entrepreneurs spend a little more time planning out the real focus and customer benefits.
In the seed stage (no money) try spending less on marketing and advertising and focus on a flagship customer and providing fanatical service. Network within your circle of influence (friends, family, grocery store, social networks, co-workers). This will get you cash positive faster by truly meeting a need and the rest will fall in place.
For those of you unfamiliar, a 1031 exchange gives the real estate investor the ability to sell a piece of property and parlay the proceeds into a “like-kind” property. Here is a quick lay example:
Selling 60K parcel of land that you originally purchased for 40K.
Buyer 100K parcel of land.
The 1031 exchange allows you to replace the sale of the 60K parcel toward the purchase of the 100K parcel. You obviously have to come up with the remaining 40K but the beauty of the deal is you pay no tax on the 20K of appreciation. The taxes will be deferred until the sale of the 100K parcel unless you 1031 again. Think of it as leap frogging to wealth.
One unconventional 1031 replacement property option real estate investors do no think of is converting your investment property to personal use. Impossible you say, it is not “like-kind”….ah…you rent the property for two years to satisfy the investment intent. After the rental period is up the property can be used as your residence and for personal use. Live in it for another 2 years and qualify for tax-free $250,000/$500,000 tax exemption. As long as you use the property for personal use 2 of the 5 years.
* As always this information is not a form of tax, legal advice or a recommendation to use 1031 exchanges.
Which means “drink-fest” in English is upon us. I’m off to a festive bash at my building superintendent’s McMansion in one the nice communities I developed over the last few years Sugar Brook. It was one of the first subdivisions in New Hampshire to be classified “low impact development” (LID). We are about 35% sold out and extremely pleased with sales thus far for such a small town like Newport, NH.
Located in the heart of the Lake Sunapee - Dartmouth region Sugar Brook is close to town, boating, skiing, and events but yet away from it all. Now that I finished my shameless plug for Sugar Brook, I have worked up and appetite for Mexican food. Hasta Manana.
