It is important when looking at buying a NNN STNL property that a purchaser can analyze the strength of the tenant for security of the passive cash flow stream over time. The purchaser wants to feel comfortable that their investment is sound and will be successful over the long term.
You have 3 main rating agencies that underwrite public companies for businesses: Standard & Poor’s, Moody’s, and Fitch’s.
Most NNN lenders look at Standard & Poor’s ratings. Statistically the higher the credit grade and rating the less of a chance of possible default by the company being evaluated.
There is credit grade and then investment grade. Credit grade can be rated but be junk status by Standard & Poor’s. Most lenders like to see investment grade credit and for Standard & Poor’s that is a rating of BBB- or higher.
Here is a Standard and Poor’s chart and what the default percentages run on average based on rating. Standard & Poor’s constantly monitors the varying businesses to assess how they are currently performing, their debt ratios, and what the outlook is for the future.
As you can see by this chart, historically the BBB rating or higher is a very safe tenant grade because of their low-to-zero default rating.
The best loan terms are typically available for the investment grade tenants for interest rate and lowest down payment percentage (usually around 30% down). It is important to note that a for sale flyer or offering memorandum might mention an investment grade credit parent company but they may not be backing the lease. Since they are not backing the lease, mentioning the parent company is irrelevant. In addition sometimes a subsidiary of the parent company is backing the lease with a regional area of stores – e.g. multiple states, instead of all the stores nationally — which can be a weaker guarantee.
There are also larger private companies that are not credit rated or public companies. Some private companies still disclose financials and lenders know them as strong performers so can give good loan terms even though not credit rated. Those typically are 35% down minimum versus 30% for investment grade tenants.
Generally the strength of the lease guarantee is based on what I call the 5 Levels.
Highest guarantee whether Public or Private company:
Parent corporation covering all stores and locations nationally
Subsidiary of the national company covering so many states
Large franchisee with hundreds of units operating in the brand system for decades
Small franchisee with just a few stores.
Non-franchise tenant small mom and pop business local to the area
As the size of the company and years in business gets smaller the risk factor can go up. The chance of tenant default and the property the buyer purchased going dark can increase.
You have to look at the size of the company.
- Are they doing well with physical stores or are they moving to an online model?
- Who is leading the company?
- How old are their stores?
- Can they handle the in-place rent to drive profitable sales per sq. ft., etc.?
When the company is national in nature, financials can be easier to come by with stock reports to shareholders.
With a smaller company you need to see if they disclose financials, both business and personal, per the lease, to see the overall health of the business. If it’s a single LLC backing the lease, the tenant
can remote bankrupt that one location and walk away keeping their other stores going. With a personal guarantee you want to analyze if their liquidity and net worth is tied up into hard-to- reach retirement accounts or general funds that can be more easily recovered from if the tenant defaults.
Along with credit grade of the tenants we want to be looking at the location itself. I like to call it Dirt First. The next chapter will be going over location in depth.