Edward Fernandez founded 1031 Crowdfunding in 2014 and has more than 20 years of experience in sales, real estate and investments.
Investors who are interested in real estate can choose among different asset types that each offer potential pros and cons. As the founder of a real estate investment platform, I’ve noticed that the relative appeal of these options often depends on the age of the investor. Older real estate investors tend to have longer tenure in the industry, so their investment decisions can be strongly influenced by previous cycles. Younger investors are often more aggressive, partly due to their relative lack of experience with these cycles.
I believe that real estate asset types can be better understood by comparing them with bonds and dividend stocks. Generally speaking, a bond provides money back and a coupon, while a dividend stock offers the potential for growth.
In real estate investing, a single-tenant triple-net lease is a common form of commercial property lease and acts like a bond because its value diminishes over time. These properties aren’t valued based on the “sticks and bricks,” as we say in the industry, but rather on the tenant and lease term. So if one Walgreens has 10 years left on its lease and another has three years remaining, the former is more valuable due to the longer period of guaranteed cash flow, versus the possibility of an empty building in a few years.
Conversely, a residential multi-tenant type of asset (which can include apartments, senior housing, student housing, self-storage, etc.) is similar to a dividend stock. Unlike a triple-net lease, multi-tenant offers the ability to “mark to market.” By this, I mean that when a tenant moves out, the new tenant coming in will typically pay a higher rent figure. When such turnover happens frequently, cash flow for the property consistently increases. Multi-tenant property value is based on the cash flow it produces, so the value grows with greater flow.
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Given the differences between the two types of investments, I’ve noticed older investors are often more attracted to net-lease products. These investors have likely already created their wealth and are nearing or in retirement, so they’re more focused on protecting their principal while enjoying stable cash flow and potential appreciation. A triple-net lease product has an investment-grade tenant guaranteeing the lease, which essentially ensures the cash flow. This asset type would also protect investor principal if sold at the proper time.
Younger investors, meanwhile, tend to focus more on growing their wealth than trying to protect it. So they may be more likely to become involved in a multi-tenant investment since it provides greater potential for value appreciation than a single-tenant scenario.
Delving deeper into the relative attributes of each asset type, big companies like Amazon or Dollar General are sometimes responsible for single-tenant leases. I’ve found such companies can be counted on to pay their rent the vast majority of the time because they don’t want a default on their credit rating that could lead to decreased share prices.
This is very reassuring for investors seeking guaranteed cash flow, but it comes at the cost of potential principal reduction based on lease-term burning. A publicly traded company on the New York Stock Exchange or Nasdaq could also decide to claim bankruptcy, meaning you as the landlord would become a creditor and potentially not receive your rent payment.
With a multi-tenant asset, the mark-to-market ability creates net-operating-income growth that dictates value. Although this would be the best scenario for an investor trying to grow their wealth, the downside is you don’t have a guarantee. The cash flow is directly tied to your occupancy, which can decline in a softening market and decrease the investment’s value.
Investing In Each
The same investor may well try both asset types at different points in their life. Let’s say that someone becomes tired of active real estate management and decides to sell a residential property investment. Instead of having to deal with late-night phone calls because roofs are leaking or pipes are clogged, they reach a point where the idea of just collecting a rent check every month sounds very appealing. In a triple-net lease deal, the tenant is responsible for all the maintenance rather than the landlord. So the investor could elect to transition into that type of investment and no longer have to worry about the “tenants, toilets and trash.”
If someone takes the opposite approach and goes from a net-lease deal to multi-tenant, it’s typically because they’ve suffered principal loss. Many investors like the idea of owning a percentage of properties occupied by big corporate names. But the reality is, you’ll lose principal at some point with a single-tenant triple-net lease deal unless you sell at a strategic time, and a lot of people don’t realize that until they experience it. So if you’ve lost 10% or 20% of your principal, you might decide to avoid a similar investment the next time and opt instead for a multi-tenant asset.
As with investment vehicles in any other industry, real estate assets can be very attractive but entail potential downsides each investor must evaluate based on their unique circumstances. Investor age may play a significant role in these decisions because of its powerful influence on objectives, previous experiences and relative risk tolerances.