The Triple Net Lease Market Has Finally Busted

Triple net leases have long been the most straightforward answer for high-net-worth buyers looking to park cash or execute a 1031 exchange.  

A triple net lease is typically defined as a commercial lease where the lessee pays all the expenses, including taxes and utilities. The owner collects a monthly check for the rent and has little to no management effort. When interest rates were in the 3% range, solid credit tenants like Chipotle or Walgreens, even a 4% capitalization rate had positive leverage. Investors were able to take comfort in the tenant’s ability to perform and stay long-term, rendering the investment an effective cash flow strategy.

Now that debt interest rates are in the 6% range, a 4% or 5% cap doesn't look so good. Why not? A cap rate is determined by dividing the Net Operating Income (NOI) by the Current Market Value. If you buy a 4% cap with 6% debt, you have negative leverage, the opposite of how you want to use debt to juice your returns.  The debt is dragging down the returns. Even if the lease has rent escalators, it could take years to achieve positive leverage. This is why for-sale listings for triple net leases hit an all-time high, at 5,883 listings in 2023, according to Globe St. This is up 48% from the previous year.

Many real estate assets have gaps between what sellers will pay and the number at which buyers will agree to sell.  In today’s market, this gap is significant and highly noticeable with triple net leases. Looking at the first 20 triple net leases listed for sale on Net Lease Finder, the average sale cap rate was 5.1% for credit ranging from BBB- (Walgreens) to AAA (Exxon) with an average lease term of 8.5 years. Prior to the Fed’s rate increases, triple net leases might have been one of the safest commercial real estate investment options, now they are one of the dumbest.