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I’ve been helping clients sell apartment buildings and buy triple net leases for almost 15 years. In almost every scenario the client is initially hesitant to get into something new. After all, the devil you know is better than the devil you don’t. With the challenges facing property owners in New York, this sentiment has started to shift. Private clients are starting to look for the exit ramp but don’t know exactly where to go or how to get there.  I wrote this article for people who are considering buying a triple net lease for the first time as a roadmap of what to look for, what to avoid, and how to weigh the risks.  I wanted to share my recent personal experience in the hopes that it inspires you to take radical action and try something new with the goal of having a better future. I’ll share with you why I started, how I ended up buying and selling what I did, and the wild ending no one saw coming!

Context & Goals

The 2017 Jobs Act allowed for certain types of real estate to qualify for accelerated or bonus depreciation. Bonus depreciation means that rather than spread out your benefits over a typical 27.5-year straight line, you can take all of the depreciation in year one! Triple net leased car washes and oil change stations are the prime candidates to take advantage of the rules. These benefits began to phase out by 20% per year starting in 2023. In 2022 you could receive 100% of the benefits, 2023 80% and so on. My goal was to buy something safe with predictable cash flow and massive tax benefits. Previous clients have shared with me the comfort they get knowing exactly how much money they make each month rather than the unpredictable cash flow of apartment buildings.

Buying The First Deal

On December 20, 2022, I closed on my purchase of a corporate guaranteed car wash in Memphis, Tennessee at a 5.6% cap rate.  This was a 20-year sale leaseback with 1.50% annual increases.  There were a ton of car washes available that met this price point but none of them had a corporate guarantee from a publicly traded company. I didn’t intend to hold onto the property for a long period of time, one, maybe two years depending on market conditions. The cost of debt at the time was around 6% so the property only covered about 50% LTV and that would suck up most of the cash flow. It would cost me roughly $30,000 to get a mortgage (brokerage fees, legal, etc.) and on a small purchase that could eat away all the resale profit especially after I paid the closings costs on a sale (transfer tax, brokerage, etc.). I decided to take out a line of credit against my stock portfolio to cover the entire cost of the purchase price. This had no closing costs, made the transaction simpler and doesn’t come with prepayment penalties, giving me ultimate flexibility to sell without worrying about proceeds. More importantly, it was an interest only loan at a rate below whatever the banks were willing to offer me. I was earning 5.6% return from the rental income, and I was paying a floating rate back to my lending institution at roughly the same rate which I could deduct as a business expense on my taxes. The cash flow was basically a wash (car wash pun intended 😊), but I received passive losses to the tune of 80% of my purchase price. (100% bonus depreciation: purchase price minus 20% for a land allocation which you cannot depreciate.)

Getting The Property Sold

Since I no longer had any deprecation left for this asset, I decided to list the property for sale in September 2023 and ultimately found a buyer at a 5.15% cap rate willing to close after I owned the property for a year and one day to avoid short term capital gains. We signed a contract in October and scheduled our closing for December 22, 2023.  This buyer was looking for the same thing that I was last year. If I played my cards right, I could also satisfy my up leg (what I will buy) in the 2023 calendar year to take advantage of the 80% bonus rather than closing on something in January for only 60% of the benefit.

Q4 2023 Market Conditions For Purchasing  

Despite the debt market being historically challenging, the net leased market was still hot. Lenders were quoting no less than 7% and cap rates for small properties (below $3 million) hadn’t moved much. Larger assets saw cap rates rise but there was still more demand than supply for small deals. Properties that used to support 60-65% financing were only servicing 50% and most quotes included a personal guarantee. Car washes in particular were impossible to finance without a personal guarantee because of the specialty use. Meaning if the tenant vacated you couldn’t replace it with a restaurant, dollar store or bank, it had to be a car wash. Anything without corporate credit and there would be a personal guarantee required on the loan. Many people are willing to do that – I am not one of those people. This was frustrating but, in a way, made my decision-making process easier. The market was making the decision for me by eliminating possibilities for my exchange. In an ideal world I would I have taken my equity and bought a new deal by leveraging up and taking out a 50% LTV loan and getting new depreciable basis. The only properties that qualified for the full 80% bonus were oil change stations and car washes and since I wasn’t willing to sign with recourse, I was left with buying something with more cash at a smaller price point.

There are four things to look at when purchasing a triple net lease. Unit economics, location, credit of the tenant, and length of the lease.

Unit Economics

By looking at store sales I determined that my car wash in Memphis was performing fine but not great. Although I’m protected by a corporate lease, I still want to have long term surety of a quality site. The property served its purpose for me, so I was willing to move on from it. The economy was coming down from an inflationary period and the average American had less disposable income in 2023 than they did in 2022. I personally do not get my car washed more than once a year – I drive in the rain and vacuum it myself if it’s dirty. I wanted to get away from a luxury experience and into something more recession proof, so I opted to change product types.  My up leg was a corporate sale leaseback oil change station where the tenant invested $300,000 in the site six months earlier. Although store sales were impossible to determine, I made the bet that if the tenant was willing to plop down 300k during 2023 in renovations alone, then it’s a site they believe will do well.  Strong store sales projection…check!

Location

Why Memphis? I know the name and it’s a city with an international airport and professional sports teams; probably not going anywhere. Much of the net leased market is in places I’ve never heard of across our nation.  As silly as that sounds I knew that if I had that mindset then someone else would too when I went to resell it. The corner was good, and it was on the main drag, but it was definitely rough. Memphis isn’t exactly the St. Regis and isn’t in an area of projected long-term growth. I was able to sell Memphis and exchange into Austin – one of the hottest markets in the country. Location upgrade…check!

Credit Of The Tenant

In August 2023 the CEO of Driven Brands made a statement that the car wash industry became oversaturated with supply. There were too many developers building them and selling them to bonus depreciation suckers like me.  The stock price went down 50% in one day and has stayed there since then. This was concerning and another piece of evidence to switch away from the car wash industry. But…Driven Brands is the only publicly traded tenant in this space, and I really valued the credit of the tenant. I had no interest in buying a lease with a 30-unit franchisee. My observation was that the franchisees, even the larger ones, held no weight with 2023 lenders and are typically private equity backed with heavy debt levels. Their business plan is to continue to acquire sites, rebrand them, pull their cash out by selling to someone like me to go buy another site, and then eventually get acquired by a larger fish in the space like Driven Brands. A payday for the suits but risky for a solo investor like me. Getting hitched to one was above my risk tolerance, so I went with the only available option. I bought the highest priced oil change station I could find (below 1,450 square feet to qualify for bonus) guaranteed by Driven Brands – the same guarantor as my car wash that I was selling. Due diligence on the company included asking my financial advisor about the health of the company and he sent me their internal memo – they rated the company as healthy and the stock as undervalued! A reassuring sign for me.  Credit of the tenant…check!

Length Of The Lease

As the length of time goes down on the lease, the value of the property tends to deteriorate. It adds additional risk to the lender and landlord. There are plenty of people who make a killing buying 8 caps with two years left on the lease, signing extensions, and then reselling at 5 caps. I am not one of those people.  When I bought my car wash in 2022, I signed a brand new 20-year lease. The buyer of my property had 19 years left which retained a lot of the value and allowed me to sell it for a well below market cap rate. Many properties I was looking at didn’t have more than 15 years left on the lease.  I did the same thing in 2023 that I did in 2022 – I negotiated a brand new 20-year sale leaseback. I assume if and when I resell this property in one to three years, I will get a similar pricing premium. Long term lease…check!

The Wild Twist No One Saw Coming

By the time December 2023 came around I was under hard contract to sell, and in my due diligence period to purchase my up leg. I was coordinating a closing to sell on the 22nd and purchase on the 27th. (I would hate to lose more than five days of cash flow😉).  Closing on the 27th gave me a cushion to own the property for a year and one day and then still be able to sell it again next year for someone to have 60% bonus rather than 40%. Not the primary goal but if I was able to do that then it would be a cherry on top and help retain some additional value.

On Thursday December 21st – the day before my scheduled closing – I got word that the title company that was holding our funds, First American, got hacked… Uh oh! Back in October, the purchaser negotiated into the sales contract a $75,000 credit if I wasn’t able to close in 2023 to take advantage of the tax benefits. We added a 12/27 TOE, and if we weren’t able to close, technically I would be in default and the buyer could back out!  At the time I saw no reason why I wouldn’t be able to close and since he was paying a low cap rate, I viewed this as an acceptable risk.

The 22nd comes and goes as does Christmas, the 26th and 27th.  My due diligence period on my Austin purchase was expiring on the 28th but I had no idea if I was even going to close on my sale, so I didn’t want to put up $100,000 of nonrefundable money. Thankfully the seller was sympathetic to the situation and granted us a diligence extension until January 5th with the understanding that we were still going to try to close before the end of the year even though no one had any clue what was happening at First American.

On the morning of the 29th which was the last business day of the year, we get word First American is opening for business and will distribute the wires to close out the Memphis site. Nothing was going according to plan, so I wasn’t going to believe it until it was done.

At 1:30PM lying in the dentist’s chair with half my face numb from Novocain, my attorney called me. I needed to get home ASAP to wire him the remaining balance for the Austin purchase! No way! At 4:30PM on the last business day of the year I successfully completed my 1031 exchange by selling and buying all on the same day – just in the nick of time. Phew!

Trying something new can be scary and nerve-racking. Your intuition is to check every box and plan to perfection, but the reality is nothing goes according to plan. The best advice I got was this: just start, it doesn’t have to be perfect; aim for 80% and that’s good enough. The rest will fall into place over time. The hardest part of a transition is starting, and if I can do this…you can too! The only things you need are the right team around you and the willingness to step outside your comfort zone and try something new.

Seth Glasser

(212) 430-5136 | sglasser@mmreis.com | Seth Glasser is a Partner at NYM Group.