NNN Landlord Dilemma in COVID’s Uncharted Territory

By Betty Friant, CCIM – Senior Vice President, Kay Properties and Investments

QUESTION: There are some really big companies announcing that they won’t pay rents. What is going on?

Even some of the biggest companies in the United States are asking for or “requiring” rent reductions during the Covid 19 pandemic. Well known companies like Starbucks, The Gap, Cheesecake Factory, Chipotle, Shake Shack, and Ruth’s Chris Steakhouse are among the large tenants who are looking for help during these trying times.

QUESTION: What does that mean for the landlords?

It can potentially be devastating. If investors have a loan on their triple net lease (NNN) property and the tenant stops paying rent, that means that the landlords will have pay the mortgage payment themselves out of their own funds. The banks still expect the mortgage to be paid. Landlords could lose all their equity in the property if they can’t make the mortgage payments and the bank forecloses on the property. It can get even worse. If the landlord signed personally for the loan, there may be additional money due to the lender if the property ends up being sold for less than the mortgage amount on the building at the foreclosure sale.

QUESTION: Most investors think NNNs mean no landlord responsibility. How is that changing?

NNN typically means that the tenant is paying rent PLUS taxes, insurance, and maintenance so the investor can sit back and receive “mailbox money”. Although there are other actions a landlord needs to take when owning NNNs like making sure the building is properly cared for, making sure that the tenant has adequate insurance and has named the landlord on their insurance policies, and making sure that rents and any common area maintenance (CAM) fees are being prorated/paid and adjusted as laid out in the lease. With Covid and the many tenants asking for rent relief, it is bringing a whole new layer of responsibility to the landlords, many of whom have never owned commercial real estate before.

QUESTION: How can investors protect their interests?

It’s complicated. In order to negotiate with a multi-million or multi-billion dollar company, the landlord will want to consider hiring an experienced (and perhaps expensive) real estate lawyer to sue for the rents due or to help negotiate the new terms of the lease for any reduction in rent. Usually the landlord’s family lawyer won’t know enough about commercial real estate to be effective in these negotiations. The landlords and their lawyers will be up against attorneys for the tenants who handle this type of negotiation every day and know all the ins and outs of the market and what the long lasting terms can mean to the transaction.

QUESTION: What are some of the types of arrangements being made for unpaid rents?

In some cases, the landlords refuse to negotiate and demand payment in full. However, there are many agreements being worked out as tenants and landlords try to come to some sort of acceptable compromise. If the landlord is willing to work with the tenant instead of suing for the rents, the negotiations can become very complex involving percentages of the rents due now versus the amount deferred and any amounts that might be totally forgiven. Then there are the questions about how and when the collections of the deferred rents might come into play. There are also questions about how to handle any common area maintenance fees and the upkeep of the building during the time that the tenant might have closed the business. If an agreement is finally reached and the new addendum to the lease contract is signed by all parties, then comes the managing and tracking of the delayed and deferred payments. This may be more difficult and time consuming than the NNN investors planned or can do on their own and so another layer of property or asset management might be warranted. In the end, all this negotiation might be for naught if the tenant ends up not being able to pay and the landlord has to start over with hiring an attorney to start the process to sue to try to get some relief and collect some of the funds due them.

QUESTION: That sounds like a lot for most investors to handle. Is there another alternative to this type of NNN investing?

Yes. Delaware Statutory Trust DST 1031 properties offer a way to invest in real estate where you own a piece of the property instead of the whole property. In a DST, there is an experienced Asset Manager who will be attending to all the issues mentioned above. That Asset Manager should be very familiar with this type of negotiating and has the experience to potentially achieve the best outcome for the investors all the while keeping the investors informed about what is going on and how the negotiations are progressing. At some point, many investors want to be hands off and leave this type of managing to a professional. That is why the DST market has grown to a multi-billion-dollar size. You can learn more about DST and 1031 Properties at the Kay Properties Marketplace at www.kpi1031.com or call 1-(855) 899-4597.

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