Tuesday, November 21, 2006

Local NNN investments - valuable or overpriced?

It's amazing how the vast amount of wealth in the Bay Area keeps capitalization (cap) rates so low. Everyone wants their investment property to be brand new, fully occupied and ideally within a couple miles of their home. The age of the property around here will almost never be as new as you would want. So people settle for 40 and 50 year old product. Fully occupied - not too difficult as the cost to build keeps inventory down and tenants have fewer choices. But location has always been the key (ever heard location, location, location?). And with so much capital created in Silicon Valley over the last few decades, this has made the demand for local investments huge.
Some opt for it and others look past the horizon to the East. Would you buy a $2,000,000 single tenant Burger King on El Camino in Sunnyvale for a 5.5% cap rate. A rate, mind you, less than the cost of the money you would borrow? This is called negative leverage - not something most would do with the normal investment guidelines as a model.
But the cap rate is only one part of the return on investment. Rent growth, appreciation, cash flow, cost recovery (depreciation) and the all-so-important pride of ownership play equally important roles. Land value and the use of a property are also very critical here. Talk to a company like In & Out Burger as to what it takes to open a new site, especially the difficulty of getting a drive-thru approved. So, the older, established locations are very valuable in that they face very little future competition.
It may take a large capital infusion to own a single tenant commercial property in the Bay Area, but its future value is very secure. This tends to be purchased by investors selling a well-appreciated asset and looking for better cash flow and stability. Many passive investors leaving the headaches of destructive tenants, leaky toilets and rent control ordinances find comfort in a 10 year lease with few, if any, landlord obligations.
I truly believe that opting for the better location & lower cash flow property which has great stability will keep you comfortable (and traveling for the right reasons) years in to the future.

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