Jonathan Livi is the managing principal of Livi Kapital. Livi Kapital sources investment opportunities for family offices, UHNW individuals, and private equity funds. He could be reached at jl@livikapital.com. To receive investment opportunities, you could sign up here https://www.livikapital.com/contact-us/.

Why NNN deals are so expensive?

In a recent LinkedIn post, I discussed the curious case of NNN real estate.

(https://www.linkedin.com/posts/jonathan-livi-5a32b3b3_deals-deals-deals-activity-6980985291985588224-nqgX?utm_source=share&utm_medium=member_desktop)

What particularly interested me was the fact that cap rates on these deals have continued to remain very low, well below interest rates on any possible financing that could be secured in today’s environment.

What we’ve seen happen in commercial real estate in the past few months is that as interest rates have gone up, cap rates on purchases have gone up as well. Because buyers cannot finance their acquisitions as cheaply as before, they need more day 1 yield to make their deals work.

The curiosity is that NNN opportunities have lagged behind this trend. I’ve continued to see NNN deals sell at low 4% cap rates, even though bank loans now cost 5%+.

To explain why NNN properties continue to sell at such high prices (low cap rates) my LinkedIn network provided some of the following insight:

1. No management: NNN deals require absolutely zero management from the owner of the deal. They are real estate’s most prime example of “mailbox money.” So for high net worth individuals who have no interest in operating real estate, NNN real estate is the best option. Many of these HNW buyers are not looking to grow wealth rapidly, but rather to park cash long term. As such, they are less interested in getting a steal, and more interested in putting their money to work in whatever capacity possible.
2. No Financing: Many NNN deals are bought without financing. That’s because many of the buyers of these assets are 1031 buyers (buyers who’ve recently sold an asset, and are deferring taxes with the new acquisition.) These buyers have a lot of cash on hand, and their primary focus is to not pay capital-gains taxes, not to make a killing. Therefore, as 1031 money continues to flow, the prices on these NNN assets remain high. (It’s important to note that 1031 money is tied to high asset valuations. And as asset pricing falls, this money will dry up, which will cause NNN pricing to fall as well.)
3. Cheaper Financing: NNN deals, especially when backed by a credit rated tenant, are seen as a safe asset type. As such, many banks offer cheaper financing on these assets than for other product types. One comment expressed that this could be as much as 75 basis points, making what would be a 5.25% rate on one deal a 4.5% rate on a NNN deal.
4. Accelerated Depreciation and Cost Segregation: Besides for being able to defer taxes through a 1031 exchange, buyers of NNN assets are often more focused on potential tax savings through generating “paper” losses. Without getting into the details of how depreciation and cost segregations work, they afford the owner of such assets the ability to show heavy losses on their tax returns, thus sheltering much of their income from taxation. These tax benefits often outweigh any returns on the actual property, and causes buyers to focus very little on how much they are actually paying for the asset.

With all of the above, prices are still falling across the commercial real estate world. As of this writing (2022-10-13), deal flow in the market is very slow, and I’m beginning to see opportunities that one could only dream of 9 months ago.