Net-Lease Funds: These funds acquire assets subject to long-term leases on properties with single or multiple corporate tenants, where the lessee typically pays all of the operating expenses. Such funds generate current income and could see some capital appreciation. The success of a net-lease fund relies on the predictability of the lease payments to generate distributable cash for investors.
These are income-oriented investments, generally considered to be in the core-plus category, with moderate risk and moderate return. A net-lease fund with the following characteristics, however, can reduce investor risk and increase the certainty of current returns:
1. If it acquires only operationally significant assets net leased on a long-term basis (usually 12 to 15 years) to investment-grade or creditworthy companies.
2. If it acquires only assets leased to single tenants.
3. If almost all of its acquisitions are off-market, private transactions. This acquisition technique enables a fund to buy assets at lower-than-market prices.
4. If many of the acquisitions are "build-to-suit" transactions, where the investment manager is often contacted directly by the corporation and thus is involved from the outset, negotiating the lease with the corporate tenant, finding a suitable developer, and arranging construction financing. Funds that do this can share in the developer's profit for an even greater acquisition price advantage.
The creditworthiness of the corporate tenants in this type of fund sets it apart from the other real estate investment strategies because there is virtually no risk that a corporate tenant would jeopardize its credit rating by walking away from the lease. In that respect, a net lease is much like a corporate bond: An investor can buy a Federal Express ("BBB" credit) corporate bond maturing in 2014 with a yield to maturity of 2.53%, or a Federal Express net lease, backed by the same credit, that generates 6%-8% annual cash flow, depending on the amount of leverage used, and also has the potential for capital appreciation.
Again, a well-structured, well-managed net-lease fund has the risk profile of a core investment (low risk) combined with the return profile of a core-plus investment (moderate return). Primarily because of the investment-grade nature of the lessees, these factors significantly mitigate investment risk:
1. There is no lease-up risk. The corporate tenant has executed the lease before the acquisition.
2. There is no vacancy risk. These properties are operationally significant and mission-critical to the lessee.
3. Because the operating expenses are borne by the tenant, there is no expense risk.
4. Because of the tenants' creditworthiness, construction and mortgage financing are readily available at favorable terms.
5. Investment holding periods are usually shorter than they are in other real estate investments.
6. For the family office or a similar investor, there is a certainty of cash flow from the outset.
A properly structured net-lease fund offers investors the best risk-adjusted returns available in real estate today. Family offices and similar investors looking for a conservative, income-producing investment with low risk but moderate returns, one with no correlation to the performance of the stock market, ought to consider income-producing net-lease funds for a portion of their assets.
David Wrubel has been involved in real estate and financial services for over 27 years. His company, D2 Advisors, provides consulting and capital markets advisory services to both national and regional real estate fund managers, operating companies and developers.