Investing In My 1st Triple-Net Leaseback Rental Property
Most investors have never heard of the terms “triple-net” or “leaseback.” For me, my 1st time investing in this niche area of real estate yielded a 58% return on investment (ROI) in just 2 years! So what are they, and why did I invest in such a deal?
A triple-net lease (NNN) is an agreement where the tenant usually pays for the property’s taxes, insurance, and maintenance (outside of regular wear-and-tear) on top of monthly rent. In my case, my triple-net lease agreement also required my tenant to pay for HOA dues, too.
A leaseback is a real estate transaction where the seller of a property becomes the tenant of the property after their property is sold to a buyer. To clarify, the buyer becomes the seller’s landlord. The lease agreement between the seller and buyer is agreed upon as part of the sale transaction. In my case, my lease agreement happened to be a triple-net lease as described above.
There are a few reasons why a seller would enter into a leaseback agreement:
They may need to free up some cash tied up in a particular property. Once they sell the property, they can repurpose it for other business.
A leaseback agreement is usually quite enticing for an investor/landlord. By entering into one, the seller gets an immediate buyer, as opposed to listing on the MLS and waiting to find a typical buyer.
By selling the property, they’re no longer liable for it.
If the seller is a home builder, selling it means they get to lock in their profits and are no longer subject to possible depreciation in a down market.
Lastly, they likely need to use this property to run a part of their business, so they’d need to lease the property back after the sale in order to continue their operations.
For my 1st triple-net leaseback investment, the seller was a home builder. In particular, they owned several lots in a new community that they were going to build out over the next 2-3 years. Most home builders first build a model home to market their unique product, interact with interested buyers, and use it as a sales office. This home builder was no different, but they were motivated to sell their model home to free up some cash and make an early sale in this new community. Lucky for me, I was in a position to help them out and ended up entering into a 2-year triple-net leaseback agreement.
I purchased the property for $505K with just 20% down ($101K). Investors are usually required to put 25% down to qualify for a Fannie Mae-backed loan for investment properties. However, due to the unusual circumstances of this transaction, I partnered with a small, regional bank who allowed me to only put 20% down in exchange for a 5% interest rate on the loan. As you’ll soon find out, putting less cash into the property gave me a higher ROI at the end of the investment.
Per the triple-net lease agreement, the tenant paid me 9% of the purchase price in rent per year, which amounted to $45,450 in gross rent. Because I had a mortgage with a 5% interest rate, my monthly mortgage payment came out to $2,169. Multiplied by 12, my annual mortgage costs were $26,028.
The triple-net portion of the deal I consider to be a wash, because as the owner of the property, I have to pay for property taxes, HOA, and home insurance myself. Per the agreement, the tenant has to reimburse me for those expenses. So it really ends up being $0 gains/losses from my perspective.
After 2 years of solid rent, I sold the property for $565K. While I purchased the property for $505K, selling a property has lots of fees involved, so my profits from the sale were reduced by about 7% of the sale price, yielding a net profit of about $20K. $19,422 in annual profit from rent each of the 2 years of the lease, plus $20K in net profit from the sale of this property, amounted to $58,844. Because I put in $101K into the deal, my ROI was $58,844 / $101K = 58% in just 2 years! Had I put 25% down in exchange for a lower interest rate, my ROI would’ve dropped to around 46%.
58% ROI in just 2 years is amazing, of course. So what’s the catch? And is this type of real estate investing right for you? Well, as always, the answer depends on your financial situation, your investment strategy, and goals. Two of the main risks of entering into such a short-term leaseback agreement are:
The tenant’s business goes sour and they can’t pay you rent anymore.
The local real estate market flattens or depreciates. In this case, the sale of the property after 2 years of rent makes it much harder to profit or even breakeven, especially due to high costs of being a seller. In a flat or down market, it’s actually quite likely the sale would wipe out all profits from the 2 years’ worth of rental income. To make this investment strategy worthwhile, you want the property to appreciate about 6-7% by the end of the lease due to the sales costs (3% to the selling agent, 3% to the buying agent, 1% to other parties).
For me, I entered (and exited) the deal in my mid-20s, so I was willing to take on more risk. Lucky for me, the real estate market continued to rise during the 2-year deal and helped me land one of my best investments thus far with a 58% ROI! Had the market declined over that period, I’m sure I would feel more hesitant to recommend this strategy to others. Nevertheless, it’s certainly an interesting niche to have experienced; it’s certainly not for everyone.
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