INVESTMENT GRADE CREDIT RATINGS
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Three Most Important Factors
The three (3) most important factors in successful Single-Tenant Net-Leased investing are: Location, Credit Quality (corporate guarantee) and the tenant’s Brand name strength.
A Single-Tenant Net-Lease (Net Lease or NNN) property investment has many of the characteristics of buying a bond. The “Investment Grade” (IG) ratings from Moody’s, Standard & Poor and Fitch are important factors to consider, along with the location aspects and condition of the property.
A Credit Rating Is An Assessment Of The Creditworthiness Of A Borrower
Think of it this way, a credit rating is an assessment of the creditworthiness of a borrower. As individuals, we have credit scores from credit bureaus, such as Experian and TransUnion that use a form scale from Fair Isaac (FICO). Scores range from 300 (extremely poor credit score) to 850 (extremely high credit). Hopefully, we are all familiar with our credit score and have seen the advertisements for “free credit scores.”
Rating Agencies Evaluate Corporate And Government Credit Strength
Fitch, Moody’s and Standard & Poor evaluate corporations and government entity credit strength but through a different scoring scale. Naturally, we’d want to invest in excellent or great credit scores, whether it be an individual, business or government entity.
Many investors seek to invest in Investment-Grade property assets, which are tenanted by corporations with credit ratings of at least BBB- or higher by Fitch and Standard & Poor, or Baa3 or higher by Moody’s. Likewise, certain institutional investors, such as pension funds, foundations and banks, can only invest in Investment Grade bonds and properties leased to Investment Grade tenants.
Investment Grade Credit Signifies a High Likelihood of Payment
Many Single-Tenant Net-Leased Triple Net Retail properties are leased to publicly traded companies, such as CVS, Walgreens, Autozone, 7-11, Dollar General, McDonald’s, Chick-Fil-A, Starbucks, Walmart, Whole Foods, Hobby Lobby and Kroger. In these cases, it’s easy to pull up investment research from reputable online stock analysis sources. A good site for the number of stores in a chain, sales growth trends, and same store sales is: https://retail-index.emarketer.com.
In the case of medical and dental properties, the guarantor might be a large hospital system or Dental Services Organization backed by significant private equity firms or hedge funds.
Credit Rating Agency Classification Systems
An “Investment Grade” is a rating that signifies a municipal or corporate bond presenting a relatively low risk of default. Bond rating firms like Standard & Poor’s and Moody’s use different designations, consisting of the uppercase and lowercase letters “A” and “B” to identify a bond’s credit quality rating. Scores of “AAA” and “AA” (high credit quality) and “A” and “BBB” (medium credit quality) are considered investment grade. (Source: investopedia.com March 5, 2020).
The chart below shows the different rating types from Moody’s, Standard & Poor’s, Fitch and AM Best.
Junk Bonds Are Not Investment Grade
A rating below Baa3/BBB-/bbb- is considered to be a speculative grade (or “junk bond”), which means there is a more likely chance of default. Due to this risk, investors are typically compensated with a higher yield/interest rate to compensate for the risk premium associated with a lower credit ranking. Anything below a B3/B-/b- is very risky and leaves you at an even higher risk of default, thus increasing the yield/interest rate even more. Investors should pay particular attention to Credit Rating Downgrades. Downgrades are a signal that the corporation or government entity is over-leveraged or the earning ability/revenues are decreasing.
Going back to individual credit rating example from above, Jason Ricks has developed the following comparison breakdown as an illustration:
Naturally, when investing in Single-Tenant Net Leases, it would be wise to invest in “Investment Grade” retailers or medical groups. The yields won’t be as high as the speculative “junk,” but if you’re looking for risk adjusted returns, investment grade is the less volatile investment strategy.
Net Lease Properties Versus Muni Bonds
With Net Leased properties, especially investment grade ones with credit tenants (also known as Credit Tenant Leases or CTLs), the rental income is backed by financially secure entities and you have the value of the underlying real estate. Plus, the investor has all or a portion of the income sheltered from taxes because most governments want to encourage investment and development. Net leases are Main Street investing.
Wall Street pushes conservative investors towards municipal bonds because of their tax treatment by the US government and supposed security. However, many municipal bonds are extremely risky because of out-of-control public pensions, faulty revenue projections and, most importantly, they barely keep up with inflation or lose value due to debased money. In recent years, total returns from municipal bonds were negative.
Related Article: NET LEASE PROPERTIES VERSUS MUNI BONDS
Closing Thoughts: Real Estate Has Intrinsic Value Along With Cash Flow
Real estate is a tangible, physical asset, hence the name “real” estate. Whereas bonds, stocks and derivatives are financial products backed by the issuing counterparty, a net lease is a contractual financial agreement PLUS physical property. They perform like a mix of debt and equity; the performance on the income portion is related to the financial health of the tenant and location of the property. The performance of the equity portion is related to the location and the brand image of the tenant. Net Lease (NNN) investments combine a reliable income stream (cash flow) backed by the stability of strong, financially secure tenants and the hard asset value of real estate.
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Jason Ricks, CCIM is a Concordia Equity Partners principal whose primary focus is on acquisitions, leasing, and development. Jason is a native Texan, professional real estate investor and certified commercial investment member (CCIM). Jason’s background in retail leasing and asset management make him an invaluable member of Concordia’s team for developing strategies to unlock the value of a property. Jason also has extensive experience and familiarity with south and southwestern US markets. Jason’s most recent experience is with AMLI Residential as the Vice President for Retail Asset Management where he established and has led the mixed-used Retail Asset Management team working on premier properties worth hundreds of millions across the country. Prior to that, he served as an Asset Manager for BH Properties where he oversaw a 2.2 million square foot value-add retail portfolio throughout Texas and Oklahoma. Jason broke into the commercial real estate business as a Shopping Center broker for Tarantino Properties. He received his BS in Business Management from Oklahoma State University, where he was a Team Captain for the Oklahoma State Football Team (The Cowboys). Jason is an active member of the International Shopping Counsel of Centers (ICSC). Most recently, he was featured in the #1 Amazon bestselling book: DESIRE, DISCIPLINE & DETERMINATION (2019).
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