Fundamentals of Absolute Net Lease Appraisals
Over the last 20 years, a new sector of the retail industry has emerged, which has taken the investment real estate market by storm. The absolute net lease market has become a sought-after sector by small investors on up to the institutional investor. As this sector has evolved, a certified general appraiser might find themselves challenged with valuing an absolute net lease property.
A gross lease is one where the landlord pays all the expenses associated with a property and a triple net lease is where the tenants pay operating utilities, taxes and common area maintenance (CAM) on top of normal operating expenses. Often times the triple net lease is confused with its big brother, the absolute net lease. An absolute net lease is where the tenants basically pay all the expenses of a property, including management, and the landlord is only responsible for the finite expenses associated with record keeping and bookkeeping.
The absolute net lease market is relegated to the national or regional tenant with a corporate credit rating and a definitive presence in at least a regional market. The trend in retail real estate has shifted toward the absolute net lease model over the past 20 years. One of the primary reasons for this shift is the desire of the retail tenant to be located in standalone locations along primary roadways or intersections, instead of inline in a shopping center. Innovations in construction and shopping center designs have also supported the growth of this market as well.
Valuing properties in the net lease market is a matter of taking a consistent approach. You need to be confident you are comparing apples to apples. The value of a net lease property is mostly the differences in the term of the lease, credit ratings and surrounding demographic of the site. The surrounding demographics and the business model of the tenant are important in valuing an absolute net lease property, as a tenant will pay a premium for a site that includes strong demographics that support their business model.
To value an absolute net lease properly, your data will most likely be more regional and sometimes even be on a national basis, instead of within the immediate market of the subject property. This is because the differences in the dynamics of the tenant (lease term, rate and credit rating) of net lease properties require you to capture a larger amount of sales. And sales activity in this sector is such a finite market. Therefore you have to go further out to get truly comparable properties in your analysis.
Comparables in this sector would include tenants with similar credit ratings, lease terms and similarities in their demographic business model. Having comps with these similarities will allow for fewer refinements in the valuation process.
When you start out to appraise an absolute net lease property, you should be well armed with demographic data about the subject property and each of the comps, traffic counts for the subject, and access to a corporate credit rating source such as Dun& Bradstreet or Standard and Poors.