Tertiary market dollar stores investments
Thinking of investing in NNN/NN properties in various rural markets(say, pop &lt; 50K). How should I think about the risks?

1. Lease renewal. Do most these leases renew before the initial lease expiration, of course, assuming the store is profitable?

2. If they renew/exercise options, will they demand significant amount of TI as a condition?

3. If the tenant does not renew, I'd imagine there will be a big drop off in residual value of the property. How do we mitigate this risk? E.g., sell while there's, say, 5 yrs remaining in the initial lease?

Looking to finance using nonrecourse 10 yr IO. 35-40% equity
[{"id": "fzzmst3", "text": "What does TI and IO mean? \n\nI\u2019m assuming also that pop&lt;50k means a population of less than 50k people", "replies": [{"id": "fzzpvit", "text": "Tenant improvement and interest only. Yes, population.", "replies": [{"id": "fzzqb5y", "text": "Ok. Do you know any good commercial lenders that offer non recourse loans with a Downpayment of 20%+. I want to invest in commercial real estate in the future.", "replies": [{"id": "g01w483", "text": "You\u2019re getting downvoted bc your questions are extremely basic. You could have googled \u201cTI commercial real estate\u201d and gotten the answer.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fzznqpj", "text": "Dollar general does not give rent bumps during the initial term. Run this vs inflation....", "replies": [{"id": "fzzprot", "text": "Yes I understand inflation is a risk, but tend to look at it akin to duration risk buying a corp bond. I think this type investment is similar to buying corp debt of the tenant execept that your principal at maturity is an unknown.", "replies": [{"id": "g004n97", "text": "It\u2019s not inflation, per se. It\u2019s changes in the market lease rate, which tend to not to fluctuate or swing much in small markets.  I agree with you that it\u2019s similar to a corporate bond. We used to work with Dollar General (and Family Dollar) developers. We preferred to be on the front end (locate sites, develop stores and then flip them as NNN investments), even though that\u2019s not our MO. Our position was we didn\u2019t like the potential residual value of a shuttered build-to-suit Dollar General store in a small market with few prospects and no likelihood of market rent appreciation. So, it made more since to us to flip them to investors. I\u2019d get real comfortable with Dollar General\u2019s financials, because that\u2019s what you\u2019re really buying.", "replies": [{"id": "g012vvi", "text": "Right, the biggest risk really is the residual value if the lease is not renewed or the tenants demands onerous terms.  Land is just too plentiful in these kind of markets.\n\nSeems to me, the greatest profit potential is in development, but that's not an area that I have an expertise in.  Can small time developers even do this? Why wouldn't, say, DG just develop themselves and do a sale-leaseback and make bank?", "replies": [{"id": "g01505e", "text": "&gt; Land is just too plentiful in these kind of markets\n\nyes.  \n\n&gt;the greatest profit potential is in development    \n\nThat's exactly what my buddy does FT for dollar general type clients.", "replies": [], "depth": 5}, {"id": "g01navu", "text": "Yeah, development is certainly more profitable. Any CRE property is going to be vulnerable to moves in market lease rates and cap rates. The point I was trying to make is that if you look at your inflation adjusted IRR, they aren't all that attractive. Particularly if you're looking at buying one that's 7 years in and you're still paying a 6 cap. From what I've seen, you make your money on newly acquired DGs in the first extension.", "replies": [], "depth": 5}, {"id": "g01q612", "text": "When we were analyzing acquiring some of the DG deals, we looked at the primary term (they were all brand new stores), the return during the lease term, and assumed a residual value as the cost to raze the building netted from the land value. We did not assume any appreciation in the land value, because the stores we were looking at were all small markets like you mentioned.  Assuming DG was good for the lease payments during the primary lease term, you can calculate an IRR. It wasn\u2019t for us, but there are lots of investors who like single-tenant NNN deals (mailbox money). \n\nDG doesn\u2019t develop themselves because it\u2019s easier to outsource it, and it doesn\u2019t require any capital that hits their balance sheet. They just expense the rent. Also, they, like most retailers needing single-tenant, build-to-suit structures, work with preferred developers. So, for example, DG will give a preferred developer a list of 20 small towns in a specific state where they need stores, and the developer will get sites under contract (because they\u2019re already familiar with DG requirements), sign a lease using their template form that doesn\u2019t need to be negotiated again, construct the store, DG takes possession, and the developer flips all 20 stores to their preferred investor clients. The developer does very well in this transaction. One important thing to note: the best deals never get marketed. Everything you see on LoopNet are locations the developer\u2019s preferred investors passed on.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fzzrq1q", "text": "I really like this investment. I\u2019d need to know more about dollar general\u2019s lease and the market. Who is guaranteeing the lease? Is it their corporate or a shell franchise entity? That makes or breaks this IMO.\n\nSingle tenant NNN is a real estate investors dream but need to know specifics about DG. Also, when you order an appraisal make sure they give you an as-dark value to better understand downside.", "replies": [{"id": "fzzt5nd", "text": "Yup it has to be a corporate guarantor(with investment grade rating) for me to be interested.\n\nAs-dark value may be the big risk here, hence my initial post.", "replies": [{"id": "g00tydj", "text": "The very rural markets $200-500k.", "replies": [{"id": "g0138kt", "text": "$25-55 psf, really? that's doesn't even seem like half of the replacement cost.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "g01nmxh", "text": "They are typically 15 year initial terms, with several 5 year extensions. Rents don't bump or have CPI adjustments. The tenant is typically a national holdco and the lease is secured by the investment grade parent co. So there is real wherewithal behind the lease. The problem is that you have to pay a 5 cap on a 15 year income stream that has zero escalations.\n\nIf you're looking for exposure to CRE that smells like a corporate bond, and you're ok with returns that may not end up being that great, but you'd rather have mailbox money than higher yields, then NNN leasing may be for you.", "replies": [], "depth": 2}], "depth": 1}, {"id": "fzzxcqi", "text": "Look at the building. A lot of these are just super cheap metal boxes that cost nothing and when the lease runs out, instead of renewing they\u2019ll just throw up another one a few blocks away. If you get an actual structure at least (in theory) you have a chance at another tenant.", "replies": [{"id": "g00u1ot", "text": "Not true.  Steel structures commercially built.  \n\nFacade, yes,cheap as you can build.", "replies": [{"id": "g013j4v", "text": "I agree, some of the recent builds aren't terrible.  not that different from typical strip retail.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fzzyeu3", "text": "During your diligence request the tenants sales per square foot. Analyze how they\u2019re trending. That should give you an indication of their likelihood to sign an accretive renewal. Retailers usually make vacate decisions based on that, along w general company performance. Yes you will pay TI but ask your lender to provide funding for \u201cgood news money\u201d to finance it 100% so you don\u2019t come out of pocket. Maybe hire someone to do a trade area study. How are the demographics? Growing for your target demo, or not? \n\nIn stocks or bonds you are a price taker. You buy these instruments at a fixed yield. In CRE, you can dictate the outcome of your yield. Sign a renewal w Dollar store, have the lender fund TI/LC, study their sales psf and most importantly know the market.", "replies": [{"id": "g004y1k", "text": "Listen to this advice.", "replies": [], "depth": 2}, {"id": "g00ttmd", "text": "The dollar stores rarely report sales.  I\u2019ve owned about 100, and less than 5 report.", "replies": [], "depth": 2}, {"id": "g01hrmg", "text": "Thanks for the advice. Yes, market, demographic, sales psf analysis and will be key parts of my due dilly.\n\nI love the ability to control that comes with private CRE ownership.  But given the discrepancy between where public net lease REITs are trading vs private market, I'm also tempted to look there as well.", "replies": [{"id": "g0449q6", "text": "REITS are attractive in some respects given they\u2019re trading below NAV. If you\u2019re bullish on retail and have limited experience operating buildings yourself, taking a position in REITs offers lower risk to you personally. \n\nTo #3 in your Q: I\u2019d make sure to run an alternate valuation where dollar store leaves and you need to carry (insurance, CAM, RET) the property 12-24 months before finding a new tenant. Make sure you can stomach the risk, and collect enough cash from the tenant over the initial lease term to cover you so you don\u2019t need to come out of pocket. That\u2019s you\u2019re main risk, if you sell vacant you\u2019ll get crushed on residual. \n\nAre there enough tenants in the market to backfill? How does dollar stores in place rent compare to market? IMO there is a lot of uncertainty in retail, e-commerce disruption is only accelerating due to covid. Dollar store is viewed as resistant since it\u2019s demos aren\u2019t big into e-commerce (yet). \n\nMaybe skier94 has some insight on how best to anticipate dollar stores renewal probability. You should also float this to a lender to see if it\u2019s even financable", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "g00k3hu", "text": "If you are investing, part of the due diligence/conditions phase will include a review of the leases.\n\nI suspect that the leases will have a renewal clause that notice not be given more than x months in advance and not less y months in advance to excerise the renewal option, with rents set to market in renewal.\n\nIt really depends on the leases themselves so those need to be reviewed.", "replies": [], "depth": 1}, {"id": "g00nzt2", "text": "We had a client (prior to working with our company) who 1031 exchanged in to a DG in Arizona. \n\nHe had sold his previous business property and used his listing broker to represent him on the buy side of this DG.\n\nWith 9 months left on the lease, DG offered to extend the lease for 5 years at a 35% rent reduction. There were plenty of vacant lots in the surrounding area.\n\nHe sold the DG, and we represented him on the buy side of a NNN, credit rated, national auto repair in a well developed area of Indiana. \n\nThe buyer of his DG purchased it at a 9% Cap and more than likely did a blend/extend with DG at a 6.5% Cap, flipped it with a +\\- 20% profit. \n\nBeware of tertiary markets.", "replies": [{"id": "g01gy8z", "text": "That sucks, how long did your client hold it for? did he take a bath?  This is the exact kind of scenario I'm afraid of.\n\nNot sure how the buyer made a profit if rent dropped anything close to what DG offered, even at 9% initial cap.", "replies": [{"id": "g01lj0o", "text": "He had the DG for 6-7 years. He sold it for a loss. \n\nNew owner lowered the rent, DG extended the lease 8+ years. 6.5% cap/8 years/decent tenant/average location combined with everyone chasing yields = nice profit. New owner took the risk of DG not extending or possibly he had a contact inside the DG RE Dept.", "replies": [], "depth": 3}], "depth": 2}, {"id": "g01jlus", "text": "tertiary market is the fatal flaw to this discussion.  too much risk/no control of tenant renewal without knowing sales on the way in, (which you won't)", "replies": [{"id": "g01nu1h", "text": " It's a mixed bag in my view. Some of these towns hardly have a grocery and the DG is the only game", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "g01486p", "text": "This is probably THE most crowded space of the NNN market because of how many have ben built over the last 5 to 10 years and are still in their initial lease.\n\n1) most of these have an initial 20 year term followed by between 2 and 10 five year rent options.  So the question if they renew is almost entirely in the hands of the tenant... store is doing well they will exercise.  Store is doing poorly expect a renegotiation.\n\n2) I have not seen much TI on this type of property.   They build what they want and its pretty simple; a steel box with shelves. \n\n3) Would you buy a steel box, rural retailer, NNN property with less than 5 years left on the lease at a decent CAP rate?  Good luck selling one.  There is limited adaptive reuse of these type of building because of the location and demographics. Try looking for one that have gone dark and see what they are worth even with time left on the lease.\n\nSorry, I don't know any financing available the terms you indicated. The value of the remaining rents decreasing across time &amp; the initial term.  Why any lender would give you that IO non-recourse is beyond me.", "replies": [{"id": "g0165e0", "text": "Thanks for your input.  I'm not arguing there's aren't risks here.  Just trying to assess risk/reward and see if this can be an asset class worth having in one's portfolio.\n\n3. Probably, not at 6% cap, but if the store is doing well, i can see 7-8% cap.  who know where the rates will be in 5 years! \n\nWell, I don't underwrite these loans so I don't know, but I know CMBS originators routinely do these kind of deals. The chase for yield!", "replies": [{"id": "g01863f", "text": "On tertiary properties?   I understood the long IO periods in places where appreciation is probably covering the lack of amortization but in a rural market...", "replies": [{"id": "g019em2", "text": "Just one example -\n\n[https://www.gspartners.com/financings/14950000-non-recourse-financing-acquisition-17-property-single-tenant-dollar-general-portfolio/](https://www.gspartners.com/financings/14950000-non-recourse-financing-acquisition-17-property-single-tenant-dollar-general-portfolio/) \n\n\"The individual assets have 15-year lease terms and are located primarily in tertiary Upper Midwest states.\"\n\nGranted they did a 5-yr IO period, but at 75% LTV, which is a lot higher than my contemplated leverage.", "replies": [{"id": "g02dmvm", "text": "I\u2019m a commercial mortgage broker akin to GSP. Just to look at this link on face value isn\u2019t really the right way to just assume you\u2019ll be able to get the same financing. The CMBS market completely stopped in March/April and restarted itself in end of May/June. At this point in the market, full term IO is available for deals &lt;65% LTV. You\u2019re going to have to bring a strong balance sheet and track record as well to qualify. If these are high cap rate deals then I would say the leverage will get cut down to 50%-55% because since the cash on cash return will be so high, the lender doesn\u2019t want you to be cashed out completely on a nonrecourse loan going into a recession within years 1-4. I\u2019ve run into this on 10% caps on my own deals. Another poster is also correct, you have an easier time achieving aggressive financing with scale. I suggest accumulating a bunch of the assets separately and then pooling them together to refinance. One thing no one mentioned are the collections, make sure you ask the seller for collection reports, arrears and proof from bank statements because you bet your lender will certainty ask you. Happy to answer any more questions.\n\nEdit: also I\u2019m currently financing the acquisition of a dollar general retail strip in a market with 20k population five or take.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "g014s16", "text": "A buddy of mine builds these props in the NE for dollar general type tenants.  PM me if you want to talk to him.", "replies": [], "depth": 1}, {"id": "g01wehy", "text": "Don\u2019t think you will get that kind of leverage post covid. You will likely need a crossed pool to even get a CMBS loan. You better assume no financing for your return projections. Most lenders don\u2019t even touch strong multi-tenant retail these days.", "replies": [], "depth": 1}, {"id": "g01z490", "text": "I assume you\u2019re planning to take down a portfolio? Just confirming because you\u2019ll need to go CMBS to get those kind of loan terms and the min loan amount for CMBS is $3MM-$5MM.", "replies": [], "depth": 1}]