Today, I’m talking with Dan Lewkowicz, a seasoned real estate veteran with over 15 years of experience in many facets of the industry.

He is also the Senior Director of Encore Real Estate Investment Services and specializes in shopping centers, medical office buildings, pharmacies, quick service restaurants, automotive, and more.

I wanted to get Dan on the podcast because he’s an expert in a fascinating investing strategy. It’s called the triple net lease, and it’s been on my short list of strategies to pursue.

In this conversation, we'll cover everything from what this strategy is, why it's so appealing, who it is and isn't for, and some of the biggest advantages and drawbacks to consider.

Links and Resources

Key Takeaways

In this episode, you will:

  • Discover what makes triple net lease properties such an attractive passive investment vehicle.
  • Learn how to evaluate triple net lease deals and ensure strong, predictable income streams.
  • Gain insight into finding promising triple net lease opportunities nationwide.
  • Understand how to mitigate risks when investing in commercial properties.
  • Hear strategies for buying and holding commercial real estate across long distances.
  • Explore how technology enables passive investment in physical commercial assets.

Episode Transcription

Editor's note: This transcript has been lightly edited for clarity.

Seth: Hey, everybody, how's it going? This is Seth Williams. You're listening to the REtipster podcast. And today I'm talking with Dan Lewkowicz.

Dan is a seasoned real estate veteran with over 15 years of experience in many facets of the industry. And currently, Dan is the Senior Director of Encore Real Estate Investment Services and specializes in shopping centers, medical office buildings, pharmacies, quick quick service restaurants, that kind of thing.

And I wanted to get Dan on the podcast because he's an expert in an investing strategy that I think is just fascinating. It's something I've had on my short list of strategies to pursue, and it's triple net lease properties.

And I've actually got a video and a couple of blog posts I spent a bunch of time putting together explaining what this is all about. I'll be sure to link to those in the show notes for this episode at, so be sure to check that out.

But in this conversation, Dan and I are going to do a deep dive into this strategy to help you understand all the benefits and some of the drawbacks associated with it, how to find these deals, how to know when you've got a good one, and a lot more.

So Dan, welcome to the show. How are you doing?

Dan: I'm great. Thanks for having me. I appreciated getting to know you in the meantime and kind of the build up for this. So I'm excited to be here and hope to add as much value as possible.

Seth: Yeah, absolutely.

So for those who aren't going to go to the show notes and watch the video I put together, what is triple net lease investing or just the net lease in general?

Dan: Yeah, great question. So net lease, I would do my best at describing net lease, not by telling you what it is, but telling you what it isn't.

A lot of people are familiar with multifamily investing. So I'll often make the juxtaposition between a multifamily deal and a net lease deal just to show you how different they are and illustrate some points that you get a good understanding of what net lease really is.

So for our example, let's say we've got a small apartment building, okay? It's, again, just making it up, keeping it simple. Small apartment building, got 10 apartments in this apartment building. Each one is paying $12,500 a year, I should say, so a little over a grand a month. So the gross collected rents, the gross income, the top line number on the balance sheet, is going to be $125,000, right? 10 times $12,500.

Now, you take another building. This is now a Wendy's building, okay? This Wendy's building also brings in $125,000 in base rent. So the number at the top of the line is $125,000. They look exactly the same right now.

However, if we go back to the multifamily building, you'll know that in multifamily, you have to pay for things. There's a lot of expenses, right? As the owner of the property, you have to pay the taxes, you have to pay the insurance, you have to pay for any maintenance. You have to pay for interior maintenance, you got to pay to shovel the snow outside, you got to pay for the landscaping to cut the grass. You got to pay for things like roof and structure, windows. You got to pay for a property manager, bookkeeper, all these different things.

You'll be lucky at the end of the day if your $125,000 isn't $65,000 or $60,000, maybe half of what the gross collected rents were. And by the way, those expenses, most of them are not fixed. They go up. Well, they don't normally go down, but they go up. If gasoline goes up, if salt goes up, boom, your snow plowing is more expensive. Cost of construction goes up, your roof replacement is more expensive.

Now, flashback over to the Wendy's property. Again, $125,000 gross collected rent. Let's look at the numbers below the line. Let's look at the expenses.

So you may be surprised to learn that in the Wendy's property, which is known as an absolute triple net property, which we'll define in a minute, you have no expenses because the tenant pays for your taxes. The tenant pays for your insurance. The tenant pays for things like roof, structure, parking, landscaping, grass cutting, snow plowing, management, et cetera.

So at the end of the day, whereas in your multifamily property, your $125,000 of gross collected rent became maybe $60,000, $65,000 in net operating income, in your absolute triple net Wendy's property, your $125,000 of gross collected rent, your base rent is your net operating income.

So these properties are very predictable. You know exactly what you're going to be collecting. And in fact, the leases have, when there is a rental escalation built into the lease—it's spelled out in the lease—you know not only what your NOI is going to be today, but you know it's going to be in five years, in 10 years, in 15 years, in 20 years.

So in a nutshell, that's what net lease is.

We described an absolute triple net lease because there's three ends here. Your taxes and insurance are your first end. We said those are paid for by the tenant. Then you've got your common area maintenance, again, paid for by the tenant. And then you've got things like roof structure and parking.

That's an absolute triple net lease. Those are all paid for by the tenant. Landlord has zero responsibilities.

Now, you do have kind of a step down from there, which is called a double net lease. Still the same thing. Tenant takes care of taxes, insurance, and common area maintenance. However, they don't take care of things like roof and structure, and in some cases, parking lot.

Most of the deals we deal with are absolute triple net. Some are double net. There are other types of leases, like a gross modified, where the tenant—very similar to the multifamily—isn't paying any expenses (or maybe just a few), and the landlord is absorbing those. Much less common.

We try to stay away from those and we try to steer our clients to modify their leases to be more like double net or absolute triple net leases.

Seth: And just to make sure we're clear on this, the reason that people invest in these type of properties is because they're very hands-off, right? I mean, is this essentially a passive stream of income or is there any work that the property owner has to do on an ongoing basis to manage anything?

Dan: Up until now, we've talked only about single tenant net lease assets, right? One tenant, one building. I also specialize in shopping centers, as you and I were discussing before. Ironically, the majority of my shopping centers that I sell are actually in your backyard, relatively speaking.

So for shopping centers, okay, you're going to have things like management. You need a property manager. That could be yourself or for 3% to 4%, that could be somebody else. Highly recommend it being somebody else.

Depending on how the leases are structured. In some shopping centers, the leases are structured as gross leases where the tenant pays rent and then you have to pay for all the expenses. I don't like that. I advise against it whenever the owner has an opportunity to negotiate the lease. I like triple net leases with what is called CAM reimbursements, which stands for Common Area Maintenance.

So in these leases, for example, a tenant might pay, let's say, $12.50 a square foot for their base rent. But they're also going to pay a specific amount for those CAM charges. And at the end of the year, the owner is going to go through and see how much he or she spent on things like management, administrative, (if it's in the lease) parking lot, sweeping and shoveling, grass mowing, and different expenditures.

And they're going to make sure and do reconciliation, make sure that they're whole. If not, they're going to bill it back to the tenant so that at the end of the day—it doesn't always work perfectly, but in theory, the landlord has no expenses.

Now, that type of an asset to your question is going to have a certain level of, you know, hands-on experience if you're the one managing it. Now, I've got clients that buy shopping centers. They live on the other side of the country. I help them up with a local manager or they maybe visit the property once every year or two, but they're not hands-on at all.

Now that's the most potentially hands-on type of product that we really deal with. With the absolute triple net lease, they're 100% hands-off. They're what's known as a “coupon clipper.”

As an aside, I will give some advice on this and I'll give an example. I recently sold a CVS. It was at the end of CVS's term and we knew that they were not gonna be renewing. The buyer knew that as well and was gonna be redeveloping the property. The owner actually lived local, but hadn't visited the property in over 20 years. This had been in the family since 1997. So you're talking about what? Almost 30 years.

So unfortunately what happened was we got to due diligence and the buyer had an inspector go and do a property condition assessment. And he came back with $275,000 of items that needed repair. And the seller really had no choice but to do a price reduction.

So what I tell all of my clients is every year, every two years, every three years, if you want to stretch it to every five years, is spend the $750 or $1,000, get a property condition assessment. Because even if it's CVS's responsibility to repair that parking lot, who says they are? Even if it's CVS's responsibility to repair that roof or replace it, who says they are? If you get that property condition assessment, you don't have to go there. You can pay somebody to go there.

And you see that there are problems. Well, guess what? A simple one-page letter from your attorney saying that per this section of the lease, you, the tenant, are responsible for X, Y, and Z. Here's a report showing you're not doing your job. Get it done. You got 30 days. That could save you so much money when it comes to sell the property or if the tenant vacates.

So that's just a little aside. They are a hundred percent hands-off and passive. However, I just like to give people that advice because it's so simple, so cost-effective, and it can save you so much money.

Seth: So what if the attorney sends that demand letter or whatever it's called saying, hey, tenant, fix this thing. And then the tenant doesn't do it. Like, does the property owner have any hammers that they can use to say, hey, you better do it or this is going to happen? How does that work?

Dan: Yeah, great question. So they are then in default of the lease, which is in the contract, right? So if you and I sign a contract that I'm gonna do X and you're gonna provide Y or vice versa, and I don't do that, or you don't do that, we're in breach of contract.

So it becomes a more serious matter because now not only have they just kind of shirked their responsibility, but they're in breach of contract. And, you know, it's been pointed out they were given 30 days to cure. They didn't. It's definitely a lawsuit waiting to happen. I'm not an attorney, but I think that in situations like that, you may even be able to recoup some of your legal fees.

Again, I'm not an attorney, but I’ve really never seen it get to that. A notice is enough. No tenant wants to be sued by their landlord and no landlord really wants to be suing their tenant, frankly.

Seth: Now, you live in Detroit, but you deal with a lot of properties over here in Grand Rapids, which is like three hours away from Detroit.

And somebody on your team, you mentioned it did something in Sun Prairie, Wisconsin. It makes you wonder, like, how far of a footprint do you cover? It’s clearly not just the eastern part of Michigan, right?

Dan: I am a national net lease broker. So as we speak, I've got a Wendy's, a former Wendy's for sale or lease in Kennett, Missouri. I've got a Walgreens in St. Louis, Missouri. I've got a Walgreens in Fulham v. Arkansas. I've got a CVS for lease in Southgate, Michigan. I've got a few shopping centers that are coming to market in Grand Rapids, Michigan. I've got a medical office building in Iowa. I did close a deal recently in Texas, a couple of deals in Texas, two deals in Virginia. So yeah, we're all over the country.

What we do doesn't require us necessarily to ever visit the buildings, because, if you think about it, I'm not a residential realtor. I don't have to make sure that you like the color of pink that's in the bathroom, right? It doesn't work like that. People are not buying these properties because they think they're pretty. They're buying them for the income stream. And the income stream is defined in the lease, right?

Obviously, they want things like good demographics, strong population density, high average household income, strong traffic counts, good visibility, good ingress, good egress, easy to get in and out of those things. But, you know, they might want to go there, but for me to analyze an underrated property, I can do it all from the comfort of my office. If need be, obviously, I'll go and visit a property or meet a client.

But ironically enough, the majority of what I do is definitely not face-to-face at this time.

Seth: That's really fascinating because normally, as a land investor, that's one thing I always kind of figured was sort of unique about land is that a lot of the information you need, you never have to leave your office for. At the most, you could send somebody to drive by and get some pictures or maybe do a wetland delineation or something. But I don't ever have to go there personally if I don't want to.

And it sounds like that's kind of how your business works too.

Dan: Yeah.

Seth: It almost reminds me of… I've got a few friends who are pilots and as part of their pilot training, they have to be able to take off and land the plane without ever looking out the window.

And it almost kind of reminds me of that. Is this the kind of thing where it's similar, where, like, if you just have the right stuff on your computer screen, you don't really have to use your eyes to ever go see that property?

Dan: Yeah. I mean, there's so much… Look, there's a value to being at an intersection and seeing the energy, seeing the cars, seeing the visibility. I can go online and I can see, oh, wow, 53,000 vehicles. I know what that feels like because I've been in a 53,000 intersection, you know, in other properties.

I'm not going to try to completely sugarcoat it and say that there's things that are missed because being in person at a property does give you a better feel. And whenever possible, we will go to the property, right?

However, the vast majority? First of all, what's going on with this asset isn't really the property. It's the lease, right? That's the first thing we're looking at.

And then the other factors, like I said, like traffic counts, we can get down to one vehicle per day, knowing how many are going across on average. We order drone photos. We get a good feel of what's going on in the area. You know, put a drone in the sky and you're going to see more than I would see on my feet or in my car, right?

So there's a lot of technology today. Even something as simple as Google Maps makes our job, it just gives us a lot more information. Which is really what we're doing is, when I'm putting together, the first thing I do when I get a property that I'm working on for a client, whether they just want to know what it's worth, or they say, “Dan, sell this thing,” I'm trying to grab as much data as possible and put that together into a compelling story for why this is a good investment.

So we have so much data at our fingertips. And some of this is not at the general public's fingertips, right? It's proprietary information. It's information we spend tons of money every year paying for. But nonetheless, it's information that allows us to help the market see whether this is in fact a good investment or not.

Seth: Yeah. So maybe the commercial world works differently than the residential world, but how does that work where you can work all over the country? Do you have to get licensed in each of the states where you work, or is there some super license you can get where it authorizes you to do stuff everywhere?

Dan: It's a great question. I get it a lot. So we have built a network of what's called broker of records. So essentially, what we do is, as an agent, I need a broker to be on my listing. So what we do is we partner with a broker of record in a specific state.

So, for example, let's go with Virginia. And we actually, so to speak, in a certain sense, are kind of co-brokering this listing together. They're using their license. We're using our license and they get paid a fee out of closing for what they do, which enables us to transact in a space that without them, we wouldn't be able to.

Seth: So curious, just looking at this from, maybe somebody who's a new investor in commercial, maybe they've done rental properties for years, or maybe they've been a land investor for a long time and they want to get into this commercial space and start with a triple net lease type property, is there a minimum amount of cash they should have ready to go?

What is the least expensive commercial building that would make sense for this? Where it's like, basically, don't even think about doing this until you have this amount of money ready to go.

Dan: It's a good question, because my background is actually in single-family house flipping here in Metro Detroit, which, especially when I was doing it during the last recession, did not require a huge amount of capital to get into.

As it pertains to your question about net lease, so typically, if you're using leverage right now, I mean, you may be able to find 70% loan-to-value. But just to keep things round and conservative, I like to just divide it into thirds and say that in order to determine how much cash you need, we have to look at what you want to buy.

So if you want to buy a shopping center, there are shopping centers out there under a million bucks. I've sold shopping centers for as little as 500 grand in your neighborhoods. Now, they may or may not have their issues, right? It's important to look into that.

So a million-dollar property, you'd need roughly $300,000, $350,000 for down payment. If you're looking at a half-million property would be half that. The shopping center space really opens up more after $1,250,000 or $1.5 million. If you can get to $2 million, now you've got even more products. $2.5 million, it's just really opening up.

So at $2 million, you need about $600,000 roughly. For a single tenant deal, you could get a low rent ground lease, really great credit, corporate credit, Valvoline or something like that. If they're paying $55,000 at a five and a half cap, you might be in right around a million bucks, million-and-one, something like that. I'd have to pull out a calculator.

But a low rent deal, let's say, $55,000 at a five and a half cap, that's a million bucks on the nose. There you go. So if you did that, that's an opportunity.

You can get great terms. Now, the problem there is that if you leverage a deal like that at a five and a half cap today with today's interest rates at like six and a quarter, six and a half, six, seven, five, you're going to have some negative leverage. It's a whole other discussion.

If you want to go into the dollar store space, it starts around a million bucks. So similar answer. That's all if you want to have sole ownership of this property, right? There's a whole ‘nother world of syndications and joint ventures where you can contribute small amounts of capital, usually about $50,000 as a minimum. I've seen people take 20 or 25.

I'll give you a great example. This isn't exactly what you're talking about because it's not ownership of a property, but I'm involved in a joint venture in Ohio. It's very interesting. I'm self-employed, so I have a SEP IRA that I can contribute to.So I decided that I wanted to take some of the money in my SEP IRA and invest it in this joint venture.

Now, this joint venture is a group of people, a group of investors, who have decided to give a bridge loan to an individual who owns an office building and some land in a great corridor in Ohio and is working with Starbucks to develop a Starbucks on that site. So we have a very low loan-to-value, like under 30%. And we're secured by a building that's cash flowing significantly, as well as this new construction that's going up and the lease that's already signed by Starbucks.

So that's not ownership. That's me being a private lender. But it allows me to have a higher return and feel comfortable knowing that I'm investing my money in a smart way.

Aside from that, there are the syndications that I mentioned where you could contribute $20,000, $50,000, $100,000 and have ownership. I've got a client, for example, that has a fund where he does exactly that. He solicits capital from people. I'd be happy to make an introduction.

He then takes that money, puts it into a fund, talks to me. We go buy shopping centers for his fund. You can have fractional ownership of a shopping center where you participate in the upside. You get distributions, all those things. So there are definitely opportunities even if you don't have that, you know, $300,000, $500,000 for a down payment for actual ownership.

Seth: So, like, it's interesting, that idea of, you know, working with Starbucks. Starbucks makes me wonder if I wanted to build to lease a single tenant building that something like Starbucks would go into, how do you find those kinds of tenants who want to do that? And how much money would I want to have together? Is it similar, like maybe half a million or more than that, since I'm building something new?

Dan: Well, so there's two ways to do it. I mean, I was involved in exactly what you're referring to in a different state at the end of last year, where a former quick service restaurant—that was vacant—was being purchased.

And the purchaser, it was kind of complicated, but he had hired leasing agents to go to all the tenants and their broker representatives to see if they would want to lease the property. And Starbucks’s broker, on behalf of Starbucks, presented a letter of intent.

And there was some negotiation going forward about taking the existing QSR, quick service service restaurant, doing some modifications, moving the drive-through and converting it to a Starbucks.

Now on that deal. I mean, I could go through all the specifics, but I think for the purpose of our discussion, Starbucks is willing to pay $153,000 in good rent.

Seth: Is that per year?

Dan: Yep. And that deal probably would have traded at about a 575 cap, maybe a six cap conservatively. If I bring out my calculator and I try to be conservative, which I've learned to do in this business, $153,000 at a six cap, $2,550,000. So that's easy to remember.

So Starbucks was actually requiring this guy to contribute, not upfront, but after Starbucks did the renovations, $800,000 of what's called TI, tenant improvement. That's a big number, but they were also going to put in another 1.2 million of their own money into the building itself. So they'd be in for 2 million with a 10-year lease.

The deal made a lot of sense, but in the end, Starbucks kind of went sideways on us because they said that in order to make make it work with the number of cars they need in their stack, right in their drive-thru, they would need to demolish the entire building. This owner would have to rebuild them something from scratch. Wouldn't make sense.

The reason I'm bringing this up as an example is because it shows you that this guy was under contract to buy the building for under a million bucks. He would have to put in about $800,000. He'd have costs. He'd have brokerage fees, but he'd clearly be in for under $2 million. He'd have a building that's worth $2.55 million. Good deal.

Now, when Starbucks said, I'm sorry, we're going a different direction, you have to scrape the building and build this new one, that would have cost him at least $3 million in addition to the million bucks that he was spending to buy the actual property.

So a lot of times, the retrofits can be a lot cheaper. If you're going to build something ground up, I mean, I was joking with somebody earlier today, because if you look at all the quick service restaurant companies out there, they've pretty much over the last three to five years, all gone toward a smaller footprint.

And I was joking, like, who do you think benefits from that the most? And the answer is the developers, right? Because the developers can still sell for about the same price because the price of the asset is not really based on the square footage, it's based on the rent.

Okay. So same rent. Rent's not going down, but their cost of construction is going down because they're building a 2,200-square-foot building instead of a 3,750-square-foot building.

So, I think that you have to make sure the numbers really work. If you've got a tenant paying big rent and your cap rate is low, it'll often work. If those factors are in the other directions, you may not be able to make the deal pencil out.

Seth: How much of a return should I expect from, say, a triple-night lease investment in a single-tenant building?

And I know this probably ranges depending on the location, the market, and all this stuff. But if I'm looking at a deal like this, how do I ascertain if this is a good deal or a bad deal? How much income should I be making based on the dollars I'm investing in it?

Dan: So first, right off the bat, we're not going to be able to determine if it's a good deal or bad deal just based on the cap rate because there are so many other variables.

So I would say you determine whether it's a good deal or a bad deal through experience. Just like anything, the more deals you underwrite, the more you're going to be an expert. In the beginning, reach out to someone like me who can give you a second set of eyes, maybe show you a few things that you might have missed. That's very important.

But in terms of the actual cap rates, what to expect, we can start at the bottom and go to the top. So starting at the bottom, I mean, one might argue this is the top, but the bottom cap rate number-wise, maybe the most trophy assets are going to be your trophy. Generational, like a Chick-fil-A. That's in a major market, in a major corner, and they're just going to be destroying it in business. They're making $8 million a year in sales. They're never leaving. It's a gold standard, just A+ real estate. You're looking in the forest still, believe it or not, four, four and a quarter. These used to be three, seven, five deals, but now they're more like four, four and a quarter, maybe four and a half.

If you kind of move back from that, and you look at like your quick service restaurant deals that are on incredible corners, high traffic counts, they're doing very high sales volume, their rent to sales ratio is below, let's say 7%. Very important, their lease is guaranteed by their operator who is either corporate that has thousands of locations, or a huge operator with 2,000, 3,000, 4,000 locations.

Because, keep in mind, as an aside, not all Wendy's are created equal, right? Some of them are paying higher rent, some of them have more terms left, some of them have better sales. Some of them have a guarantor that has three units, very weak guarantor. Some have a guarantor that's 300 units, much stronger.

So if you have a very strong guarantor and all the other factors I mentioned, and you've got a brand new 20- or 25-year lease, you're probably in the low fives, five, five and a quarter, maybe five and a half. As that term gets burned off, maybe you're at 15 years or 12 years, you might get closer to six.

There is some QSR, good QSRs are available in the high fives, low sixes. It kind of trails off from there. Once you're in the sevens, there's usually some issues, shorter term lease, or there's clauses in the lease that can make the rent variable because it's based on the percentage of sales, things like that.

Dollar stores, which were trading at their height, brand new dollar store in a tertiary market, 15-year deal, built a suit, was trading at around five and a quarter cap. Today, it's probably six and a quarter, six and a half. If there's some term burned off, it's going to be in the sevens maybe seven and a half depending on how much term is burned off.

Pharmacies today are all over the board. We've had a massive shakeup in the pharmacy space. Anything from mid fives, if it's the best of the best, most of the product is six and a quarter to eight cap today. A lot more eight cap deals in the pharmacy space than there were before.

If we were to switch over to shopping centers, again, you've got trophy A+ real estate at five, seven, five, six, six and a quarter, but that's kind of like the outliers.

If you take those out of the equation, most of the shopping center space right now trades between six and a half and eight and a half cap.

I have clients that I am constantly fishing for. They're looking specifically in the seven to nine cap space. There's a lot of stuff available. And in that case, it makes a lot of sense to leverage because you can still get interest rates significantly below what your cap rate is.

Seth: Now, just to make sure I understand, I know people in the land business, we don't deal with cap rates that often because usually it's just a different type of business and we're not borrowing a lot of time for the properties that we're buying, at least in the land flipping space.

And just to make sure I understand, so the reason a person would invest in a lower cap rate property is because it's more of a guaranteed-ish source of income, right? Like, it's less risky. Whereas the higher cap rate properties might come with more risk or uncertainty about the lease, the property, or the market. Is that accurate?

Dan: That would be exactly what it is. High risk, high return; low risk, low return. That's 100% what it boils down to.

Seth: In the self-storage industry, I've heard this thing like, if you buy a property that's kind of out in the boonies, where there's lots of other vacant lots around, it'd be very easy for somebody else to build up a new property next door and kind of change the dynamics of the market. So those kinds of properties would have a higher cap rate.

Whereas, if you buy a huge multi-story place in downtown Chicago or something and no other competitors are going to come in at any point, it's just a much more certain thing in terms of what you can expect. And that might have a much lower cap rate, but you know what you're getting and it's probably not going to change anytime soon.

Dan: Exactly. Yeah. And that can go for location or tenant, right? If there's a tenant in bankruptcy or potentially in bankruptcy, there's higher risk, higher return. But it can also go for lease term, right?

So if I have, let's say, a Taco Bell that has 20 years left on the lease, that's pretty much a guaranteed income stream for 20 years. Obviously, if that tenant files bankruptcy, I could lose that. That's why it's important to have a very strong guarantor on the lease.

But that deal has significantly less risk than if there's six months left on the lease or 12 months left on the lease, because I could be left with an empty building. In fact, oftentimes, when we're pricing very short term deals, I don't price it as a cap rate. Like, normally, I'm looking at a deal and I'm like, okay, based on the comps and information and my knowledge, this is a six and a quarter cap, right? Let's take the rent, put it at six and a quarter cap. That's the price.

For a lot of short-term deals, what I'm doing is I'm saying, okay, this tenant is paying $125,000 a year. There's one year left on the lease. We have no indication whether or not they will renew. If they renew, that's great, but we have to assume they're not renewing. This building is worth a million bucks. Let's take it and price it at $1,125,000, right? The person's going to collect that 125,000 income stream, then they've got a million-dollar-building.

That's one way to price it because I can't really put a cap rate on that. The level of uncertainty is so high that it's not really fair to put a value, put a cap rate, on a property like that.

Seth: It's interesting hearing you talk about guarantors for leases. In my past life, I used to do SBA 504 loans and we always had to get unsecured, unconditional guarantees on the borrowers personally.

And so, in my mind, I think of a guarantee in association with a commercial loan or something like that. But a lease is almost like a loan alternative, where the difference is that at the end of the term of the lease, you don't own anything, you just pay for your time?

But if that lease, you know, if something happens to it, there's a guarantor standing behind it to support those payments, right?

Dan: Yeah. I mean, it's like leasing a vehicle, right? You know, at the end of the day, you're responsible, you're signing the dotted line.

You know, balance sheets, in terms of how things have been reported in the quick service restaurant industry, have changed in a way that's kind of odd. But some people prefer to take their lease liabilities off of their balance sheet, because if you're a large operator, a lease liability on a 20-year lease, even at 100 grand, that's two million bucks, right? So, if you've got 100 of those, that's $200 million on your balance sheet.

The reason I bring that up is that the lease is a liability for the tenant. It's something that they're obligated to pay until it's over. And if not, you know, people can go after them.

And that's why that guarantor is so important because, you know, don't put it past corporations. You might think you're buying a CVS with a corporate guarantee, but maybe… I've seen guarantees on that CVS I mentioned earlier in our show. So the guarantor was, I think it was like CVS Metro Detroit. So they might have taken their three worst performing stores in Metro Detroit, put them in this entity, sign these leases, and then now that they're doing poorly, they can say, okay, you know what? Big deal. We're going to bankrupt the entity. We're not bankrupting the corporation. We're bankrupting the entity.

That's why it's so important to know who your guarantor is.

Seth: Sure. Is the guarantor always the same as the tenant? Or could the guarantor be some other party for some reason?

Dan: Well, I'll give you an example. Wendy's is a national chain, right? That's the name on the building. But the guarantor on the lease is going to be the franchisee or corporate. It could be corporate. But in the case of Meritage, they're a large franchisee I've worked with over and over again.

Seth: That's Wendy's, right?

Dan: They’re not Wendy’s, they’re a franchisee of Wendy’s. They’re actually located in, headquartered in, Grand Rapids. They have about 345 locations, so they’re a very strong guarantor.

So the tenant, Is it Wendy's? Is it Meritage? It's a little bit of both. Wendy's is the corporation that's operating there, but the real tenant is Meritage.

So yeah, the answer is that sometimes yes, sometimes no. I mean, you could have a corporate Walgreens where Walgreens has the name on the sign and Walgreens, the tenant and Walgreens is signing, right? You know, and then it can go different ways. It can even go in a better direction.

You can have like The Learning Care Group signs on their leases and they've got like seven or or eight different children companies that they're the parent of, but oddly enough, they're signing. So the guarantee is the whole company, which is that's what you want, right? You want as big of a guarantee as possible.

Even though the other direction as well, I've got a medical office that the name on the sign is the largest healthcare system in the state, but the guarantor is a sub-entity, right? So they want to protect their assets, which as a broker, I don't want that. I want the most assets possible on the line to secure that property and that lease for the owner.

Seth: So a little while back, we were talking about that Starbucks example, how they were coming to the table, investing a bunch of money, I think 800,000 or something like that.

Dan: They were going to put a $1,200,000, but the owner would have had to put $800,000 as a reimbursement.

Seth: So that makes me wonder, what condition does the empty building need to be in to find a new tenant? Like, if the tenant is going to come and do their own stuff, make their own leasehold improvements, what are they going to expect to have in place when they show up to do that? If I just have a completely trashed out building, but the walls on the roof are there, is that enough? Or does it have to meet some minimum threshold to be leaseable?

Dan: Listen, even for commercial real estate professionals, I think it still applies.

I believe that, you know, perception and psychology is very important. The moment you walk into a trashed building, you know, it just hits you in a way that you can never really erase. So definitely spend the money to do a trash out and clean it up.

But this particular building was your classic 1998, you know, green roof, green tile Burger King. It needed a lot of work. It had the four walls. The roof was in decent condition. It was relatively clean. But it was old. It was very, very old.

And, you know, unfortunately, in the quick service restaurant space, we're seeing that all over. I mean, Restaurant Brands International, the parent company of Burger King, announced last week that they're going to spend a billion dollars buying their largest franchisee, which is Carol's. Carol's has a thousand units.

And one of the reasons they're doing it, they feel that Carol's can't handle remodeling all these units that need to be remodeled. So they're breaking them up, giving them to other franchisees and having them be remodeled. So, I mean...

It's a big issue because these quick service restaurants, if they get behind on the remodel, their sales usually go down, right? Because as humans, we are magnetically attracted to something nicer, newer, and shinier. And we'd rather go to the nicer, newer, shinier alternative next door than the tired, old-looking one.

So if they get behind on that remodel, then the sales start going a little lower. Then they can't justify the remodel. And then they're in this very bad cycle. So that is a problem that a lot of large restaurants are trying to avoid. I think that Burger King is doing everything that they can to keep that brand alive.

Here's a scenario for you. Let's say I wake up tomorrow morning and I own a single tenant, Starbucks-like building in a decent location, but it's empty. What should be my first step to find a good tenant to occupy that?

I realize I could hire somebody like you to do it for me, but if I was trying to do this by myself, where would I even start looking to find these people? Am I calling up corporate offices or something? Is there some website where I can advertise this or what would you do?

I mean, I definitely would not do it myself. First of all, as much as, you know, I'm an investment sales broker, so I sell buildings and I help investors buy buildings.

Listen, I've got a bunch of deals on the market right now that are for lease. Most of them are for sale or for lease. But if you've got a building and it's not in my market, I'm going to be doing you a disservice. And I'm going to be honest with you about that. I'll find you the right person who's the local person in your market, and I will highly or strongly advise you not to do it yourself.

What they're going to do, first of all, is they already have the relationships. They already know who's where. They already know how far away the locations are from their next closest locations. They have the software. They've got the team that can make the cold calls. They can be out there doing the property showings. I would never, even me personally, I wouldn't do it myself. I would hire somebody to do it. They're going to run what's called a void analysis or a a gap analysis to see what tenants are the most likely fit in that location.

And they're going to start shopping your space around. Eventually, you know, those tenants are going to start presenting LOIs through their, you know, brokers to let you know, like, what can be done.

But the leasing process is a long process. You need to figure at least a year, at least. If you do it in a year, good for you. That's amazing. But at least a year, it's so important because people can get drowned in the carrying costs for properties like this.

So it's important to keep in mind. And then keep in mind also that you're going to get a variety of different offers. I mean, you might get an offer of $100,000 a square foot. I'm sorry, $100,000 a year from a tenant. But they might ask you for $500,000 in tenant improvement allowance. You might get an offer for $89,000 a year with no tenant improvement allowance. You got to run your numbers and know that it's not as straightforward as typical sales are. are.

Seth: So like if I were to hire you to find this tenant for me and you find one, is there some fee you take from that or how much does it cost for me to get your help to do that?

Dan: Yeah. So there is no fee to get the help. And again, if it was, unless it was in my market or there was some extenuating circumstance, I would refer you to the best person locally. Leasing brokers usually have to be local.

But the way that it works, it's similar to a sale. So, you'll sign as, let's say, let's just make an example. So you were hiring me and you're saying, we're going to agree for, I would say a year, 18 months, maybe to represent you and find you a tenant.

So the way that it works is that there's a certain percentage of commission that's agreed upon upfront. Normally it's 5% or 6%. And it's for the entire duration of the lease.

So for example, if it's a hundred thousand dollars a year rent at 10 years, right? That's $60,000 at 6%. And that commission, I would split with if there there was a broker that came in and brought the tenant, which is very likely because a lot of these tenants have their own in-house brokers and then those are the only ones they'll use.

Now, if it was a 20-year lease, $100,000, 20 years, 2 mil, that'd be $120,000 that we would somehow split. So, you know, that's how it would look in terms of the arrangement. You know, as a broker, I'm going to want to get paid at least execution as a seller.

You're probably going to say, Dan, I'll give you half at least execution and half when they start occupying the property. You know, it's all a negotiation, but that's really how it would work.

Seth: So, you mentioned that you kind of work all over the country. So it sounds like there's really no reason I need to be worried about geographic location as long as there is a property that fits what I'm looking for.

Or like, I want to see at least this much income. It should cost this much. Just kind of give you the profile of what I'm looking for and say, go, Dan, and you can find it. It doesn't necessarily need to be anywhere near me as long as I can send out a person every so often to check on the status of it.

Is that accurate? Or like, would you say, no, Seth, we're going to start in Michigan for some reason? Or is that not really how it works? As long as you know the specifics I'm looking for, you can go anywhere?

Dan: I mean, it's going to be to your comfort. First of all, experienced investors invest all over the country, but they also invest invest in markets that they like.

If it's an absolute triple net deal, unless you want to get the pleasure of driving by it, I don't really see any difference at all. Because you're not responsible for anything. If it's a shopping center and you're managing it, yeah, it gotta be close. But again, I wouldn't recommend you to manage it.

So shopping centers maybe would be a little more reason to be close to you. You know, just in case, because shopping centers are a lot more owner hands-on. That's not necessarily your hands, but the hands of whoever you're hiring. So that might make more sense.

But again, I have clients that are buying shopping centers all over the country, even though they're not there and they really never visit. So I don't think you have to be constrained to your own, you know, farm market, so to speak.

Seth: So I've got a really oversimplified question here, but I'm just going to ask it anyway.

So if I want a hundred thousand dollars of annual net income from triple not lease properties like this, how much do I need to buy in real estate?

Dan: You said $100,000 of income?

Seth: Yeah.

Dan: Well, that's very simple. Because if we say that the cap rate you're going to be targeting is 6%, okay? Right? So if I want to have $100,000 of income, all I need to know is what price of property is going to get me $100,000 annual income at a 6% return.

And the answer is $1.666 million.

Seth: Okay. So I just have to… and to do that, say if I needed, is it like a 20% down payment or more than that?

Dan: I mean, no, typically you're looking in today's market. They want to see like 30%+.

Seth: Okay. So 30% of 1.666 million, whatever that is. I need that amount of cash. And then the banks that are willing to work with me, essentially.

Dan: Yeah. And I find that a lot of my clients have success with local community credit unions and local community banks in the area that the property is in.

Now, if you're in the area and the property's in the area, it's going to be maybe even a little easier to get a loan. But I wouldn't say that that's a deal breaker if it's a property outside of your farm area. But I definitely would go with a local lender.

Seth: And in terms of what lenders are looking for, I know when I did SBA 504 loans, it was always owner-occupied small businesses, which is kind of different from what we're talking about. This is like, I'm not occupying it. I'm not the small business running the place. Somebody else is doing that.

So, what do banks want to see in terms of, what should my personal financial situation be like? Does it matter what my annual income is from whatever that source is? Or are they just looking at the property itself and using that as the basis to approve the deal?

Dan: You know, I would say that (I can answer this to my understanding, but being that I'm not not in the underwriter's seat at the bank, because that's not what I do), I can't give you full certainty on this.

But from what I've seen, they like to see your personal financial statements. Well, not like, typically they need to. They want to see some liquidity, some experience, some real estate holdings. That's all helpful.

At the end of the day, what's important for the lender is a few things. Obviously, your debt-to-income ratio is very important. It has to be on the side of a certain threshold. You know, typically they're looking at, they don't want to loan more than 70% of the value of the property. Which, by the way, in the future, if you refinance, the property goes down in value, that could potentially be a problem.

Now, the other thing is what's called the DSCR, the debt service coverage ratio, which is essentially the ratio between what income the property brings in after all expenses and what the debt service is.

So if the property brings in $125,000 of NOI, net operating income, and the debt service is 100 grand, you now have a 1.25% DSCR, debt service coverage ratio, which is pretty healthy.

Depends on the deal, depends on the lender, but I've seen them go as low as 1.1, which is kind of crazy, or 1.08 for certain deals. But you want to make sure that you're able to cover your debt service.

Seth: Yeah, it's probably a conversation I have to have directly with a lender. But I appreciate you sharing what you kind of have ascertained from your time working with this stuff.

Dan: Sure.

Seth: It almost sounded like you were saying triple net lease and absolute net lease interchangeably. But I had thought that there was a difference where like the absolute net lease is where the parking lot and the roof and that kind of stuff is the tenant's responsibility. Whereas the triple net lease, that stuff is more of the property owner's responsibility.

Is there a difference between those two?

Dan: So I don't know who did this, who put this little nomenclature change, because this is exactly why I said it the way that I did.

In certain parts of the country, primarily in the western side of the country, sometimes brokers and investors, mostly brokers, will say absolute triple net lease, which is zero landlord responsibilities, and then triple net lease means the landlord is responsible for roof and structure. That is wrong. So that's what we call a double net lease.

So for me, in order to avoid that ambiguity, because some people call a triple net lease what I would call an absolute triple net lease (meaning no landlord responsibilities), and some people call that a double net lease, meaning roof and structure is a landlord responsibility, so to avoid that ambiguity, I just take that out of my lexicon.

And I say, absolute triple net lease: landlord responsible for nothing; double net lease: landlord responsible for roof and structure, or sometimes parking lot as well.

Seth: And I know like with the single and double net lease stuff, how like some of it's on the landlord, some of it's on the tenant. Does that ever change? Say, if I were to just say single net lease, are you jumping to the conclusion that, okay, we're talking about property taxes. That's what's the tenant's problem. Or is it?

Dan: First of all, it's not very common. Like double net lease is, really, in terms of that word, that's it goes in most cases from a double net lease, which again, roof structure and maybe parking lot on the landlord, everything everything else on the tenant, to a modified gross lease, which can be anything you want it to be. It just means that you get a gross rent and then the expenses are divided however they are.

Single net lease, that term almost never comes up, but typically that does refer to taxes and insurance being paid by the tenant or at least taxes. But again, it's not very common.

It won't change unless there's an amendment. Right now, Rite-Aid is going through bankruptcy. One of the things they're doing is they're reaching out to their owners and they're saying, we want to slash your rent. We want a couple months free rent, and we want to go from a double net lease or whatever we were, an absolute triple net lease to a gross lease where you pay for the taxes, insurance, and maintenance, which is like, that's a crazy expense hit.

But that is a very rare situation. It's because they're in bankruptcy. Were they not to be in bankruptcy, they wouldn't even be able to do that or propose that unless a new lease amendment was signed.

Seth: And you mentioned earlier how there is some property management involved, say if there's like a shopping center or a strip mall or something like that.

Dan: Yeah.

Seth: So I'm wondering, what is that? What is involved with that kind of management? And how much does that cost to hire a property manager to do that stuff?

Dan: Yeah, great question. So typically, when I underwrite a deal, I always put in a management fee, even if it's being seller-managed, because I don't assume that the new buyer is going to owner manage it. And furthermore, even if they are, they should get paid for that, so to speak.

So I'm typically underwriting 4%, unless it's some huge number, but 4% typically of the gross income. So that includes the the base rent, as well as any CAM charges or triple net reimbursements that the owner is receiving.

So the owner might get 200 grand in base rent and 100 grand in expense reimbursements. My 4% is off of the 300,000, so that would be 12 grand a year.

So they're responsible for managing everything in the plaza. They're responsible for getting the grass cut. They're responsible for getting the parking lot swept and sealed and fixed and replaced and all that stuff. They're responsible for plowing the snow and doing the landscaping. They're responsible for roof repairs and anything that goes wrong with the sewer or plumbing or any tenant complaints like that. So that's really what they're doing.

Now, in addition, you may have another expense which people often overlook, which is lease up expenses. So if you've got 10 tenants in a center, it's very uncommon for them to be 100% occupied forever. So anytime you have a vacancy, you now have to have a leasing broker, unless you do it yourself, lease that space out, which is going to cost you money in brokerage commissions.

Not a lot, because normally in shopping centers, the annual rent is a lot lower. But you also potentially have what's called “fit out expenses” or “tenant improvement allowance expenses.”

So you might sign a tenant who says, I'll stay here for 10 years. But in exchange, I need you to either give me a rent abatement, get rid of my rent for a few months, or credit me some rent or diminish my rent. Or I'm going to put $60,000 into this space to build it out and make it the way I want. I want you to contribute half of that.

So those expenses are real expenses that come up for shopping center owners once they purchase a property.

Seth: You had mentioned a little bit earlier, this idea of it can take a year for a property to lease up and find a tenant. It makes me think, how much cash should I have set aside for holding costs when a property goes vacant?

I realize it probably doesn't happen that often if you have like a 15-year lease or something, but when that day comes, assuming it's going to take a year, maybe longer, is there like a rule of thumb, like whatever the property's worth or whatever your normal lease payment is, have this much set aside, ready to go? Any thoughts on that?

Dan: It's a little different for shopping centers, multi-tenant properties versus single tenant. Because with shopping centers, it's like multifamily versus single family. Single family, vacancy, it's zero income and some expenses. Multifamily, there's one vacancy, you still have income.

So same thing with multi-tenant, right? If one of your tenants or two tenants leave, you still have that income stream.

Now, obviously, you have to keep in mind that sometimes your debt service might be a certain amount and you need to be at a certain occupancy even just to pay your bills, right? That's important.

So the answer to your question is there's not really a rule of thumb. I will say that with single tenant deals, your know, your expenses are going to be taxes, insurance, as well as the cost to maintain the property. Because if that was an absolute triple net property, you never had that expense, right? That was always on the tenant.

So, you know, I can tell you this, you know, taxes, pretty easy to look up. Insurance on a vacant building can be high. So you have to factor that and insurance costs have gone up. And then, you know, typically, in general, we tell people to to put away a replacement reserve. This is not exactly for your question, but it would help.

So we tell people to put away a replacement reserve, depending on the condition of their building or their center, anywhere between 10 and 35 cents a foot, just take that out of your income and put it in an account.

Now, if you have a roof, for example, that's on its way out, has five years left, you can do the math pretty easily on how much it will cost to replace the roof, divide that by five, put that in that replacement reserve account, pull that out every every month, that's really important.

You can help offset your vacancy costs in terms of your improvement of the building or repair, replacement of the building by having that vacancy, that repair allowance, so to speak. So that's important.

I can't give you a rule of thumb as to how much money you're going to need to have, but for a year of a Walgreens sitting vacant, you're going to need a year of taxes, a year of insurance, and you're going to need enough money to keep the property in good repair for the entire time that it's vacant.

So, you know, I know it's not exactly a cut-and-dry answer, but I think pretty easily you can calculate taxes and insurance and then I can help you put aside a certain amount of money per square foot, depending on the condition of the building, to help account for any of those repairs that might happen.

Seth: Do you have any examples off the top of your head? Like, yeah, we dealt with the Walgreens or a Starbucks or this or that, and it was this amount. Realizing, like, this is not a cut-and-paste answer for everything, but just to get a vague idea of what it might be.

Dan: Yeah, listen, you could be looking at it depends. It really depends on municipality. But I've seen quick service restaurants that have taxes as low as $10,000 or $15,000 a year, right? And insurance could be three to five grand a year. So you know, you might be looking at $20,000 to $25,000 in taxes and insurance.

I've helped my clients secure an individual who would be paid about 200 to 500 hours a month to cut the grass and plow the snow and you know, secure the building. And do showings and make sure people can get in and get out and winterize it and de-winterize it and all that stuff.

Most of the time, when people have vacant buildings, they don't really continue to repair them at the same level that they would. And they just kind of let things go a little bit. So in that example of a small Burger King, you're looking at, I don't know, I would say 30 to 40 grand a year to have just to keep it the way that it is.

If it's a larger, 15,000-square-foot former pharmacy, that number could easily be $80,000 to $100,000 in a worst case scenario, let's say.

Seth: I'm curious, is there any particular way to find motivated sellers or below market deals on this type of property? I mean, I know how to do this with land. It's not particularly difficult, but when I started getting into self-storage, I found it was a completely different world in terms of just the way everybody thinks about these things and finding motivated sellers and that kind of stuff.

But off the top of your head, if I wanted to find a below market deal on a commercial building that could be used for this, like, is there even a way to do that? And if so, like, how would you find those people?

Dan: I mean, the best way to do it is to network with great brokers. You can do what I do if you want. It's not a lot of fun and not easy, but I mean, the way to do it is to get on the phone and make 300, 400 cold calls a week and tell people what you're willing to pay for their building. But you might as well just be on a broker shortlist and get those great deals before they hit market and let them or their team be the ones that are looking for the motivated sellers.

You can do it if you want, but I just think it's not an efficient usage of your time.

Seth: Yeah. Well on that, say if you're going to do cold calls and tell people what you're willing to pay for their building, is there a quick back of the napkin way to come up with an emotion-free data-driven number that you could offer for people?

I'm dealing with a number of self-storage facilities right now where, not surprisingly, the sellers want more than they're worth. And it's kind of interesting. I've talked to a number of people about, like, how do you come up with a number that's just objectively what the property is worth? Doesn’t matter what the seller is asking, like, you need it to cash flow on day one and it just needs to be a no-brainer decision. Even if they say no to it, that's fine. At least you need your objective way to do this.

So how do you do it? Do you just figure out, okay, when is the lease coming in? And what are the most likely expenses with this property, property taxes and all that stuff, and then do it that way? Or I don't know. How would you do it?

Dan: There really is no accurate back of the napkin if I'm sitting with you and you give me the a napkin and you want it back in the same sitting, right? I mean, I can pretty quickly, I already know relatively what it's worth.

But if somebody wants back of a napkin now, it's a mistake. Because why don't you let me use my tools to see what's really going on so that I can tell you what it's worth?

But essentially, you know, what we do is we get a copy of the lease or leases if it's a shopping center. If it's a shopping center, we also need the rent roll and the profit and loss report. So we then will go through that. We're going to alter it because there's almost not Not always.

In most cases, there's going to be things on there that don't belong on there or things that are not on there that do belong on there. So we're going to do that. We're going to create an accurate rent roll, an accurate income and expense report. And then we're going to do our demographic research, look at traffic counts, look at nearby national and local retailers. We're going to look at the market, look at trends like demographics, population density, average household income.

I think I already mentioned traffic counts, ingress, egress, visibility, tenant profile, duration of leases. All of these are variables. Annual increases in leases, if they are, how many options do they have? What's the condition of the center? What's the historical occupancy been here? here.

And then based on that, we're going to look at some comps. We're going to come up with a cap rate number, apply that to the price, and it's going to be pretty darn accurate.

Now, a single tenant, it's a lot easier because single tenant, I just need the lease. I don't need the profit and loss report. Rent roll, there isn't one of those, right? It's all profit. There's no loss, especially with an absolute triple net deal.

But I'm going to do the same things. Traffic counts, ingress, egress, national retailers. How's this corporation doing? What's the guarantor like? How are they doing? How many units do they have? Is there a personal guarantee? What's their net worth? What kind of real estate holdings do they have? I'm going to look at the area just like I did with the shopping center.

And again, pretty quickly, I can give full report that is pretty accurate as to what the real value of the property is.

Seth: Going back to this issue of a tenant vacating a property and the property sits vacant for a while, does this ever happen where a property sits vacant for years and years on end or the tenant unexpectedly leaves?

And if so, how do do you avoid that situation? How could you just buy a property that won't sit vacant for that long? Is it just a matter of looking for those lower cap rate properties where they're going to fill up faster? Or is there any trick to make sure you don't get in a bad position?

Dan: Yeah, absolutely. It essentially boils down to the fact that, you know, we listed a property last year, it was a former gas station that was vacant for 20 years. It had some environmental concerns and it just was completely dilapidated. We weren't able to move it at the price that the seller had asked.

But something like that, it was in a little bit of a remote area, it had the potential environmental issue, just things that would scare buyers away. So that was, I'd say an anomaly.

Normally, properties go dark for a long time, because there's a problem, maybe there's an environmental problem, maybe there's a problem with the ownership, maybe there's a problem with the real estate.

But the answer to your question in terms of how do you find properties that are not going to go vacant. Yeah, cap rate is part of the play, right? Because lower cap rate is lower risk. But really, at the end of the day, you want to look at the fundamentals of the underlying real estate. Because if the fundamentals of the underlying real estate are good, then even if your tenant leaves, you can backfill with another tenant.

Now, another very, very important part of this is market rents. So what I mean by that is, you know, if you're you're looking at a tenant that's paying $40 a square foot, but the market is $18, that's not a deal I like because if they leave, you're going to put an $18 tenant in there.

And that means if you have a loan, you're not going to meet your debt service coverage ratios, and you're not going to meet your loan to value, and you're going to be in big trouble, which is not something that we want.

So that's very important. You want to look at the underlying fundamentals of the real estate, but you also want to make sure that they have replaceable rent. That's very, very important.

Seth: No, that's great. It makes me think of some of the gotchas and things that people might not think about, especially if it's their first triple net lease property that they're getting into.

Can you think of any other gotchas or risks associated with these deals or maybe examples of people who got into this and then it was like, oh, shoot, I didn't realize this was going to happen, and they ended up in a bad spot?

Dan: Yeah, here's an obscure one.

There's a guy that I was working with that had a PetSmart. And he had just bought it not too long ago for a certain cap rate. And his broker didn't really show him the lease. He never really went through it. And he was considering selling it. And I was underwriting it. And I uncovered what we call a wrinkle in the lease, right?

Which, for anybody who doesn't know what that means, it's metaphorically speaking, let's say the lease had a wrinkle. It covered up this little part. Nobody saw it. Opened it up. Uh-oh, there was a wrinkle in the lease.

So, this wrinkle in the lease was what's called a co-tenancy clause. And what that is, is that in this case, this PetSmart was part of a shopping center that had, I believe, a Lowe's in it. A co-tenancy clause said that if at any point Lowe's went dark or vacated, PetSmart could immediately reduce their rent by 50% and vacate at any point.

So had this guy not had this clause, his property would have been worth X. But that co-tenancy clause cost him close to a million dollars in value. So that was definitely a big oops.

I advise him not to sell because it just didn't make sense. And he's held on to it. I check in with him every now and then. And I drive by the PetSmart because it's not too far from me. And he's lucky. The Lowe's is still there. But it's just, it was unnecessary.

And had he had a better broker or had he had his reading glasses on, so to speak, maybe he would have come across that wrinkle in the lease. That, I think, is a good example.

I sold a shopping center to an individual in your neck of the woods. He was in a 1031 exchange from California. And he struck me as someone who was a little bit cheap.

So he decided to self-manage the property from California, even though the property was in Grand Rapids. I kept in touch with him. You know, he looked at some of my other deals that I was selling. And within two or three years, you know, we were on the phone and he, I asked him to see his rent roll, and he was at 50% occupancy. I sold him a 100% occupied center, and he had mismanaged it all the way down to 50%.

So, you know, thankfully, I was able to help him get it back to full occupancy, and I'm actually going to be listing it for sale again. But that's a good example.

I mean, it wasn’t worth it, right? He could have spent thousands of dollars a year to save himself 50% of his income stream indefinitely.

Seth: Well, I'm curious, what kind of property would you look at and just say, no, don't do it. This is a bad deal. What would be the cause for you to say something like that? Is it a bad location or the bad building or a bad tenant or the bad lease or what kind of problems aren't fixable about a deal?

Dan: Good question. So a wrinkle in the lease like like that is not fixable about the deal. That's for sure.

This is something that's overlooked, but ingress and egress. I had a deal I sold where the city just put one, like pedestrian islands, so you don't have to cross the whole street. You just cross half the street, stand there, wait for the traffic and then go.

So they put this pedestrian Island legitimately right in front of my client's drive-through. And we were both talking and we're like, this isn’t good. This property is going to go downhill. and he ended up selling it. We found a buyer who didn't care, but that was an issue that wasn't going to change. And that was very important. So a wrinkle in the lease, ingress, egress.

Seth: I've seen the weird stuff from my days in the 504 world, where there might be a strip center or something like that, and Subway is a tenant in one of those local units. And something in the lease says like landlord you can't have any other restaurants here.

Dan: Oh, that's very common.

Seth: Really? Wow. You would never know that unless you knew to look for it or had seen it before.

Dan: Very common in shopping centers that there's restrictions without question. It's very important to look into that.

I would not buy a property today that I couldn't replace the rent. I'm not interested in buying, unless there's some extenuating circumstance, but I'm not interested in buying something, like I said, that is paying $450,000 in rent and I can replace it with a dollar store at $125,000. So that would definitely be, for me, a deal breaker.

And then, occasionally I come across these multi-tenant properties that were like clearly flipped and put together in a sloppy way with like, tenants signing weird leases or it just looks like somebody grabbed something that was garbage and then like put a bunch of band-aids all over it and then said, here, it's worth more.

So those things I stay away from because those are definitely problems. And I mean, yeah, everything's going to be on a case-by-case basis, obviously. I think that if you're, pharmacies without drive-thrus, Starbucks without drive-thrus, those I would definitely, I'd second guess without question.

Seth: Yeah, what you're saying kind of reminds me of, I was talking with my friend, Eric Scharaga, who is a note investor for vacant land. And you're saying kind of a similar thing. Like I can buy a note where the property was sold for way more than it's worth. And then the loan is way higher than the property's value.

But, if I ever have to repossess that thing, I can't assume I'm going to resell it for that high price again. Like it's got to make sense for what it's actually worth.

Dan: Oh yeah, exactly. Yeah, that makes sense.

Seth: Does seller financing ever get involved in these kind of deals? And if so, and if you're involved, how would you get paid your commission if it's a seller financing deal? Does the borrower just basically have to cough up enough cash to cover that and the seller's down payment requirement?

Dan: So it's not that common. I would say some of the funds, they're doing this thing recently where they make an offer and they say, we want to ask the seller to lower the price by 20% and then we'll give them 20% equity in this particular fund. Most of my sellers don't go for that. They don't want to jump in bed with somebody that they don't know.

One of the benefits of selling these properties is you're selling to somebody and you're cutting ties, right ? So that's a form, I guess, of seller financing.

It comes up, some people offer it, you know, it's not as common. In the event that there would be seller financing, my brokerage commission would be paid exactly the same.

The seller is still selling the building, right? Let's just make up numbers, selling it for $10 million. There's a million dollar seller hold. So the $10 million purchase price is what the commission is based off of. Yeah, he's lending this guy money, but it's independent in a certain sense of the transaction.

Actually, in fact, I did do a rather large, almost $50 million transaction that had a $5 million seller financing component in it. They were carrying a second mortgage behind the bank and it was paid off. I think it was a five- or seven-year mortgage. But that was because we needed to make the deal work because the borrower couldn't get enough from the bank based on his cash position.

Seth: Yeah. I've seen that in the past if the property doesn't appraise high enough, but the buyer still wants it. And so they come up with a under the table deal or something, not really under the table, but just something to make the deal work.

Dan: So yeah, this was… this was a hundred percent over the table. It just was that the seller, the buyer needed to contribute extra equity. This offer was contingent and this was a huge deal for all parties. So they felt that if they could execute and provide that seller financing, that the deal would go through. And it did. And everyone was happy, including me.

Seth: Now, when interest rates go up, as they have over the past year, does that have a direct impact on the property value and what these properties can sell for? Should it have a direct value on that?

Dan: It does. You would think it would have more of an impact because, you know, we saw a 550 roughly basis point swing in about 17 or 18 months in the federal funds rate.

And the asset class within net lease that was hit the hardest was probably dollar stores because they had been churning out for a decade and the cap rates kept going lower and lower. But they were only affected by like 100, 125 basis points, quick service restaurant, most of them 50 basis points.

So yeah, they were affected, but net lease is sticky. That's another value of net lease is that it's the cap rates and the values are sticky and they don't change much or quickly.

And even though we had this incredible, huge surge in interest rates, the cap rates didn't go up that much, which by the way, made my job a lot harder and made buying deals a lot harder because, you know, if I look at one variable, there's really two variables I think that are most impactful in what I do and in the net lease market.

Number one is the VX, right? The volatility index. The more volatility there is, the more transactions there are, the better it is for a broker and just the more volume there is.

But in addition, the spread, the delta, if you will, between borrowing costs and cap rate, that's the biggest driver in net lease volume and transactional volume. And that has gotten squeezed tremendously to a point where it's very difficult to transact on a lot of properties.

We are hopeful that as interest rates are relaxed over the next 12 to 36 months, that spread is going to increase and that velocity in the market is going to come back.

Seth: Now, suppose a property owner signs a 15- to 20-year lease with the tenant and it includes a rent escalation clause so the rent automatically goes up each year. But then if the rate resets on the property owner, their interest rate or inflation goes crazy or both.

Is it feasible that that rent escalation isn't enough to cover it and the property owner ends up in the red anyway? Does that ever happen?

Dan: When you say the rate resets or the property owner isn't able to cover it, give me more context as to what you mean.

Seth: Yeah. So say if I bought a property four years ago and my rate was like 3.5% or something like that. And then at five years it renews and now my rate is 8% or something crazy like that. And inflation is going nuts and the increasing rent isn't enough to make it okay. Does it ever ever happen?

Dan: Yeah. So first of all, some leases have rental increases that are tied to CPI, the consumer pricing index. So maybe with a floor or with a ceiling, you know, or maybe they'll say 3% or CPI, whichever is lower, things like that.

You're bringing up a very interesting point. So as this cascade of people who need to refinance, that starts happening. Because in commercial, most commercial loans have a five-, seven-, maybe 10-year balloon, right? So those people that got those great rates in 18, 19, 20, they're starting to have to think about refinancing.

And, you know, I mentioned those two factors earlier—loan-to-value and debt service coverage ratio.

Well, when your lender goes to refinance you, he or she is going to be looking at exactly those figures and the loan-to-value might not work because if they reappraise your building and it's worth less. And now you're refinancing, you might not be able to take out as much of a loan. And if your loan payment is going up, which it will because interest rates went up, now your debt service coverage ratio is not going to work.

So there's a lot of issues there. And that's why a lot of people are faced with the predicament of having to either do what we would call a cash-in refi. You have to bring cash to closing or just selling the property. And it's definitely motivating a lot of our transactions right now without question.

Seth: Yeah, I know that even in the storage industry, that's a big way that people look for deals is try to figure out, okay, who got a loan like four and a half years ago and it's about to reset now? Because they're probably going to want to sell because their rate is higher and just targeting those people specifically. So interesting.

Dan: Yeah, exactly. In your experience of dealing with people who buy these types of properties, what kind of person should not be investing in this type of strategy? Is there a type of person who thinks it's a good idea, but it's not really because of their situation or how much money they have or what they're trying to get out of their investment portfolio?

Dan: Well, if you're not able to cover those things, like I said, like if you're buying a shopping center and you're not able to put away some replacement reserves, that's a problem. You're going to get hosed.

If you're buying the first deal or a few deals you see, that's a problem. You could get hosed, right? You want to sharpen that muscle and see as many deals as you can.

I just did a presentation on underwriting shopping centers on Friday that I can share with people. There's so much resources out there. Reach out to someone like me who can help and help you train yourself to be able to underwrite because it's not as simple as it looks. So that's that for sure.

Again, somebody who thinks, oh, I don't care, $450,000 rent, I'll take it. It's a great cap rate. And they don't realize that or they're closing their eyes to the fact that your only replacement tenants are paying you $150,000 or less, right?

That's someone who shouldn't do it. So I mean, these are all examples of people that I think are looking at things in a short-sighted manner. And I think that's why it's so important to network, reach out to me or someone like me who can help you.

And even if you have an outside deal, even if it's not mine, I'm happy to put some eyes on it and tell you, oh, wait a second, you got to look at this. And the next time you're going to say, oh, wait a minute, I remember that. I have to look for that.

So that's what it is. It's about training yourself. And you only do that by being around good people and doing those, exercising those muscles.

Seth: Yeah, it's interesting.

So you kind of mentioned earlier this idea of, what if you get a tenant who's paying over market rent? That's not necessarily a good thing because if you have to release it, you can't get that same price.

But if you go the other way, say if you have a tenant that's paying significantly under market rent, would it make sense to intentionally buy that kind of property if you know the lease is coming up in a year? Because maybe based on the rent today, it's not worth that much, but I know it's going to be.

Dan: When I'm marketing a property, one of the things that, if it's true, I put in an offering memorandum is below market rents. Because, this is going to appeal to an investor who says, okay, today, seven and a half cap, but 18 months from now, when two tenants roll, I can make this into a nine cap.

And I love checking with my clients who are like, Dan, this is amazing, because I was able to, you know, turn this property into a significant cash cow. That's awesome. I love that. So, yeah, without a question, buying under market rent is great.

And in many cases, in these deals, you know, people are just, you know, they're collecting their money and just waiting for the tenant to leave. That that's what they want.

Seth: I know people who are in like the residential real estate space and flip houses and have rental properties. They'll have plenty of horror stories from tenants they've dealt with.

I'm curious, do those horror stories ever happen with triple net lease properties or are they less common? And if they do happen, do you have any fun stories or interesting examples to talk about there?

Dan: So you can have shopping centers that have, essentially, have a declaration that basically is like the bylaws of the shopping center. And you can have out parcels like small, like freestanding single tenant deals. And everyone's under the bylaws.

So the bylaws might say, for example, you can't build a restaurant more than 2,500 square feet or two stories without the permission of Family Dollar, as an example, right?

So there's all kinds of things like that. Very important as a broker to know those, especially if you're dealing with somebody who's trying to redevelop something.

There's also a clause in this declaration for the CAM charges of what's called the egress and ingress parcel. So what that means, loosely, is that the shopping center has a huge parking lot and everyone benefits from the parking lot, not just the shopping center owner.

Because keep in mind, in this example, the shopping center is owned by one person. The out parcels are owned by two different people.

So what this clause says is that every quarter, the shopping center owner can reconcile and take all of the bills specifically from the parking lot and ingress, egress, landscaping, all that, and divvy it up as follows:

80% to the shopping center owner, 10% to parcel A, 10% to parcel B.

Parcel A had an absolute triple net fast food restaurant on it. So the tenant actually was responsible for those charges, the 10%, right?

Really, it's the landlord, but in the landlord's lease, it says the tenant pays for everything. So for years, for decades, that's exactly how this went on.

Shopping center billed the tenant. They never even sent the bill to the landlord. Tenant paid it because it was their passed down responsibility. Landlord didn't even think about it. Everything's great.

So what happens is five years ago, tenant decides not to pay it anymore. Shopping center doesn't do anything about it. Then tenant files for bankruptcy.

Then parcel A owner calls Dan, says, I've got a vacant former restaurant. I need you to sell it. We get it on the market, tons of offers, get it sold. Before we got it sold, I reached out to the a shopping center owner. And I said, hey, I need what's called an estoppel certificate, very common in our transactions.

And they said, well, wait a minute. Do you know who owns that property? And I said, yeah, of course I know. It's my client. They said, send them this bill. It's for about 15 grand, not a ton of money, but not a small amount.

I sent it to them and they're like, what do you mean? This is not our responsibility. We've never seen this. We didn't know about it. They were responsible, but it was going to their tenant.

Shopping center owner kept sending it to the tenant. Tenant stopped paying. Landlord didn't know about it. Now tenant, the shopping center owner, wants to get paid. That's how it went. Transaction proceeded, it was unclear how this $15,000 was going to get paid. Would it get paid before closing? Would it be paid in through escrow? Would it be paid after who knows?

Long story short, title company did not take an escrow for this. Seller didn't pay it. It never got paid.

Fast forward a couple months, buyer who I worked with directly is reaching out to me saying the shopping center owner wants the money. I said, well, you're the buyer. He says, I don't know what to tell you.

Next step, I call my clients. My clients don't want to pay it. It's going back and forth. Now we're at a point where the shopping center owner is ready to sue the buyer and my client. So I'm telling my client, hey, just pay the money, don't get sued by two people and have to pay the money.

So, you know, for me, I hate having to deal with things post-closing because the deal's already done. To me, I mean, that's a horror story I'm dealing with right now. It doesn't really have to do with investors, but it does. The lesson there is like, you need to know what's going on. Just because a bill is going to your tenant it’s not your responsibility. If it's your responsibility, you should make sure it's getting paid.

That's the lesson.

Seth: Yeah, for sure.

Well, Dan, thank you you so much for talking with me. It's been fascinating.

People want to get ahold of you or work with you in some way. What's the best way to do that?

Dan: So first of all, you can catch me on LinkedIn. I'm very active there. I put out content every single day of the week. My first name is Dan. My last name is Lewkowicz.

Also, if you want to reach out, if you have property, you want to sell property, you want to know what it's worth, you want to talk real estate, you've got a deal you want to look at, whatever, you can give me a call directly on my cell phone. That's 248-943-2838. Again, 248-943-2838.

If there's anything I can do to be of assistance, it would be my pleasure.

Seth: I will also have links to all of Dan's stuff in the show notes, So be sure to check that out and hopefully we'll talk again soon.

Dan: My pleasure. Thanks so much for having me.

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Seth Williams is the Founder of - an online community that offers real-world guidance for real estate investors.

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