I recently had the opportunity to catch up with Michael Murphy, EVP and Associate Real Estate Broker with Douglas Elliman Real Estate. Mike is an industry colleague and a professional whom I’ve long respected for his knowledge and insight. Our discussion highlights the NNN (Triple Net) lease property investment and some of the challenges owners are experiencing today. We also discuss the increasing interest in Delaware Statutory Trusts.

Dan Raupp: Mike, you’ve had extensive experience with triple net lease investments for years. Are they still as attractive to investors today as they have been in the past?

Mike Murphy: They can be. Remember, triple net properties are generally of interest to investors looking for a passive potential income stream. Their lower-risk, management-free profile may offer an effective way for investors to diversify their holdings and provide what may be a source of income potential.

As with any investment, due diligence is essential, and since the strength of a triple net investment is largely dependent on the quality of the tenant and the lease, these are two areas that warrant special consideration.

Dan: Regarding tenant quality, talk about the issue of creditworthiness.

Mike: The value of commercial properties is influenced by the strength of the tenant.

I believe the best way to explore this is to evaluate tenants’ creditworthiness using a standard rating system such as Standard and Poor’s (S&P), Moody’s, and Fitch. For triple net lease properties, tenants with a minimum of BBB (with any combination of pluses or minuses) provide the least risk of default and are the preferred tenant.

Dan: You’ve mentioned that in some instances, even high quality tenants are having a hard time today. What’s going on?

Mike: We especially see this in the retail sector where you have national brands like Gap, Pier 1, Chico’s and Walgreens closing hundreds of stores. The last time I looked, I believe over 2200 store closures had already been announced for this year in the U.S. And that is just what’s been announced. I’ve heard estimates that by the end of the year, we may see a total count of 12,000 store closures, eclipsing the 9300 that closed last year. That’s a lot of vacancy.

What’s causing all this? Buyer behavior. At ever-increasing levels, consumers are simply choosing to purchase online. Retailers who haven’t figured out how to effectively combine a brick & mortar strategy with an online approach as a compliment, are in danger.

Dan: How is this impacting property owners?

Mike: There is some real pain going on. As you know Dan, I believe one of the advantages of this type of investment is that the leases are often written for terms of 20 years or longer. Now you see national brands closing stores and they may simply choose to vacate properties of break their leases. This is unprecedented for well-known creditworthy tenants.

And if these types of tenants aren’t just walking away, we are certainly seeing them use their influence to ask for, or even demand, rate reductions from owners.

So what’s happening is that owners are either forced to reduce rental rates or they are getting stuck with all the expenses that come with a vacant building. In addition to the costs they incur for marketing the property to find new tenants, they now have to pay all the expenses that were the previous tenant’s responsibility.

This is causing many investors to reconsider the triple net lease as a preferred type of real estate investment.

Dan: That’s not surprising, hearing the environment you’ve just described. What other types of investments are of interest to these owners?

Mike: Primarily the DST (Delaware Statutory Trust), which you and your team at Fortitude are deeply experienced with Dan.

I’m certainly not telling you something you don’t already know, but for your readers, the DST structure continues to grow year-after-year as a preferred real estate investment option.

Dan: For a triple net lease owner, what do you think is the most intriguing aspect of the DST?

Mike: Well, for owners who are dealing with struggling tenants, I believe the most appealing aspect of the DST structure is the professional management that oversees the investment property. Most quality DSTs have hired seasoned professional management teams to oversee every aspect of property management, including vetting and due diligence of tenants as well as the ability to market and effectively secure new tenants.

For owners who are fatigued with these responsibilities, the passive nature of the DST is extremely attractive.

Dan: Any other potential benefits of the DST that stand out for you?

Mike: As you know Dan, there are a handful of very high quality sponsors offering DSTs today and these are teams that have been in the industry for a long time and have made it through all types of market cycles. Their skill at identifying and securing institutional quality properties of all different asset types provides a significant degree of confidence to potential investors today.

Markets are dynamic and certain geographic areas can rise and fall in value as can certain asset types. When you have experts who go to extraordinary levels of due diligence to evaluate the properties they are considering for a DST, that is simply something individual triple net lease investors have neither the time, experience or expertise to do.

That’s another big reason for investor interest in DSTs.

Dan: Mike, as always, it’s great to catch up with you and thanks for your thoughts on these two popular types of real estate investments. We’ll plan to revisit this conversation later this year.

Mike: My pleasure, Dan. I look forward to our next discussion.

For more information on this topic, please feel free to contact Dan Raupp and the Fortitude team.