We have been busy. As we barrel toward our exciting 1031 exchange, selling the Brooklyn condo we’ve owned for 20 years and funneling the sale monies into a hopefully cash flowing investment opportunity, there are still more unknowns than knowns. Yes, even this far in the process. (Want to catch up? See where we started.)
The good news? Our condo is on the market! Better news, it’s attracting interest, and we hope to be moving into contract shortly.
So what will we buy? Great (with emphasis) question.
We’ve learned a ton this past month about the kind of investment we don’t want to make. Just like anything else in life, learning what you don’t want is just as important as understanding what you do.
Deep in the Heart of Texas—or Not
We identified a seemingly great target property in Sherman, Texas, which is about an hour north of Dallas in the high-growth path-of-progress area along Interstate 75 on the way up to Oklahoma. There were two structures in the deal, including 13 apartments—a mix of studios, one-, and two-bedrooms. We did the underwriting, looked at the full financials, and saw that the vacancy rate was low and that all tenants were on a year lease.
With very little leverage, we would net about $4,000 a month from day one (with room to grow). Solid!
I knew I didn’t want to buy anything I hadn’t seen with my own eyes. (Yes, you can do this sight unseen, but we didn’t want to. This is a million-dollar investment for us and our first big apartment building.) But we had a chicken-and-egg decision next: Do we go to Sherman and see the property first? Or get an inspection done first? Each task would set us back about $2,000.
On the recommendation of our agent, we visited first. In retrospect, this wasn’t the right call, but we did have some amazing barbecue and a fun overnight in Texas.
Ultimately, what looked “fine” to us ended up with massive issues once the inspector weighed in—from a failing roof to foundation issues to cracked sewer lines. (If you smell sewage, make sure to spring for the sewer line check.)
Although we definitely could have negotiated the price down to cover these fixes, we decided they were too much for us to take on half a continent away, and we walked. Yes, it was a detour that ultimately cost us $4,000 and a few weeks’ time, but it was also one that taught us a ton.
Now What?
While we were focused on Texas, we noted in our peripheral vision that cap rates on triple net (NNN) leases were rising. If we targeted a monthly NOI of about $5,000, after debt payments, we could cash flow about $4,000 to $4,500 with a property in the $1 million-$1.2 million range. That’s pretty great for a completely passive investment.
At first, we were kind of leaning out on NNNs because we wanted to get experience actively landlording, but now that we’ve been through the Sherman, Texas, experience, we understand that we don’t actually want to do that much landlording. And wouldn’t it be nice in this pressured, time-constrained environment of the 1031 to have some mailbox money? Sure, we could probably get better returns for a more active investment. But a 6% cash-on-cash return seems pretty good to us.
What Are Triple Net (NNN) Leases Again?
NNN leases are commercial leases where the tenant pays for insurance, taxes, and all maintenance and repairs. In our price range of $1 million-$1.2 million, these tend to be fast food locations or retail like Family Dollar, etc.
The leases are usually 20 years or so in length, and they usually have built-in rent increases every few years. They operate on autopilot for most of the lease period. The danger comes at the end, when you are in the last five years of the lease, when determining whether your tenant is going to re-up. If not, it can take a while to find a new tenant (while you carry all the costs)—sometimes a couple of years.
You also need to work in a renovation budget for your new tenant (we understand this is around $100,000 to $150,000 in our range) to make the space their own. Because of this vulnerability, you often see landlords selling properties before the clock runs down to the five-year mark.
This month, we’ll hopefully jump into a contract, and then the clock starts! Got some advice for us at this stage of the game? What are your thoughts on NNN leases?
Our 1031 Journey So Far:
January: Selling our Condo, the Beginning
February: Getting the sell side situated
March: Is a 1031 Exchange Really Worth It?
April: Finding the Best Deal in the Haystack
May: Final Stretch on the Sell Side
This 1031 diary will be a monthly series through 2024, chronicling our journey to a (hopefully) successful and profitable 1031 exchange, which kicked off in May. We’ll share everything—all the numbers, the analysis, the good decisions, what we wish we’d done differently, the big mistakes (hopefully not many), and everything in between.
Have questions? Got advice? What are we missing? Share in the comments below!
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
