In this guide
- The three underwrites
- 1. The tenant: who actually signs
- Rent coverage: the number nobody shows you
- 2. The lease: clauses that cost money
- 3. The dirt: what you own empty
- The numbers, worked
- Financing reality: 30–40% down
- The document checklist
- Buying NNN inside a 1031 exchange
- When to walk
- Frequently asked questions
The three underwrites
A single-tenant net-lease building is sold as one asset and should be analyzed as three. The tenant determines whether the rent arrives. The lease determines what the rent costs you to collect. The dirt determines what you're holding on the day the lease ends. Marketing packages blend all three into a cap rate, which is exactly why the cap rate is the last number you should look at rather than the first. Every failure mode in this asset class traces back to a buyer who priced one of the three and assumed the other two. The order below is deliberate: the cheapest diligence comes first, so that most bad deals die before you spend money on a third-party report.
1. The tenant: who actually signs
Open the lease's signature page before anything else. The question is not “which brand is on the building” but which legal entity owes the rent, and what stands behind it. A corporate guarantee from an investment-grade parent is the instrument the “bond-like” pitch is describing. A franchisee LLC operating a handful of units is small-business credit wearing a national logo — frequently a fine risk, but a different one, and one the market prices roughly 100 basis points wider. The distinction is routinely blurred in listings: the logo is national, the signer is not.
What to verify, in order: the exact guarantor entity and whether the guarantee is full, limited, or capped; whether it survives assignment (a guarantee that evaporates when the tenant sells the unit is a guarantee for as long as you don't need it); the guarantor's credit rating and, for private franchisees, financial statements and unit count; the chain's closure history and any announced footprint reductions; and whether the lease is one of a cross-defaulted pool or stands alone. For public tenants, read the parent's own risk disclosures — store-closing programs are announced in filings long before they reach your corner.
Rent coverage: the number nobody shows you
Credit ratings describe the parent; rent-to-sales describes your building. A chain can be perfectly solvent and still close your specific unit, because renewal decisions are made store by store on store economics. Where obtainable — and for franchisee deals it often is — get unit-level sales and divide the annual rent into them.
As rough working bands: rent at or under roughly 8% of unit sales is comfortable and renews easily; 8–12% is normal-to-watchful; above roughly 12–15% the unit is a candidate for closure at the first renewal, whatever the parent's balance sheet says. These are rules of thumb that vary by format — quick-service restaurants, dollar stores, and pharmacies each carry different sustainable ratios — so use them as a screen, not a verdict. The underwriting insight that follows is the one this whole page turns on: rent below market is hidden safety (the tenant renews because leaving costs more), while rent above market is hidden risk (the tenant leaves because staying costs more), regardless of what the current income statement shows.
2. The lease: clauses that cost money
“NNN” in a listing means almost nothing; the lease document is the investment. Read these articles and write down the dollar consequence of each:
| Clause | What to look for | Why it costs money |
|---|---|---|
| Maintenance & repair | Roof, structure, foundation, parking lot, capital HVAC — landlord or tenant? | A 19-year-old roof on a landlord-responsibility lease is a five- or six-figure item you just bought |
| Term & options | Remaining base term vs. option term; who holds the options | Options belong to the tenant — they are not term, they are the tenant's choice |
| Rent escalations | Fixed %, CPI-linked, or flat until an option | Flat-to-option leases lose real income every year of high inflation |
| Assignment & subletting | Landlord consent required? Guarantee survival on assignment? | Determines whether you keep the credit you underwrote |
| Continuous operation / go-dark | Must the tenant operate, or merely pay? | A go-dark right converts your asset into a countdown while rent still arrives |
| Casualty & condemnation | Rebuild obligation; termination rights; who keeps proceeds | Decides whether a fire or a road widening ends the lease on the tenant's terms |
| Estoppel & SNDA | Tenant's written confirmation of terms and defaults | The only evidence the lease you were shown is the lease that exists |
Two habits pay for themselves here. First, insist on the complete lease with every amendment — side letters and amendments are where landlord obligations get added years after the original signing. Second, have a commercial real estate attorney abstract it; the fee is a rounding error against a mis-read roof clause, and this is the single highest-return dollar in the process.
3. The dirt: what you own empty
Assume the tenant leaves at expiry and ask what you're holding. That question has a price, and it is the floor under the whole investment. Work through: the corner (traffic counts, access, signalization, visibility, ingress/egress) on its own merits; whether the building is generic or purpose-built — a rectangular 9,000 sq ft shell re-tenants, a drive-thru pharmacy floor plate with a drop-ceiling pharmacy core does not; market rent for comparable space versus your contract rent; zoning flexibility and permitted alternate uses; land value as a percentage of purchase price, which is the genuine residual; and replacement cost, because if you're paying materially above it, you are paying for a lease rather than a building.
The dark store scenario is not exotic, it is the base case eventually. Purpose-built boxes in markets a chain has exited have sold for a fraction of leased value, and the cost of re-tenanting includes demolition of the last tenant's improvements, broker commissions, free rent, and months or years of carry. If the numbers only work assuming renewal, you have not bought a bond — you have bought an option the tenant owns and you paid for.
The numbers, worked
An illustration with round figures, not a projection. A freestanding retail building offered at $2,800,000 at a 6.75% cap rate produces NOI of $189,000. Finance 60% — $1,680,000 — at 6.5% on a 25-year amortization and annual debt service runs about $136,100. That leaves roughly $52,900 of pre-tax cash flow on about $1,180,000 of equity including closing costs: a 4.5% cash-on-cash return, with DSCR near 1.39x.
Now stress it, which is the actual exercise. If the unit's sales are $2.4M, rent-to-sales is 7.9% — comfortable. If sales are $1.4M, it is 13.5% — and that same deal is now a lease that probably ends at expiry. If market rent for the space is $150,000 rather than $189,000, you are collecting 26% above market, which means the renewal is unlikely and the reversion is a re-lease at lower rent, not a renewal at higher. Run the same two sensitivities on every deal — rent versus sales, contract rent versus market rent — and most of the category's disasters screen out before the inspection period. Method and definitions for NOI, DSCR, and cap rate live in the underwriting guide.
Financing reality: 30–40% down
Residential intuition badly misprices this step, and the forums are full of the resulting surprise. Expect 30–40% equity on a conventional commercial loan; DSCR requirements of roughly 1.25–1.40x; five-to-ten-year terms with 20–25-year amortization; and a constraint peculiar to net lease: many lenders will not amortize past lease expiry, so remaining term drives loan term, which drives proceeds. Short remaining term is therefore expensive twice — once in the cap rate you should demand, and again in the financing you can get.
The trap worth naming: when the loan constant (annual debt service divided by loan amount) exceeds the cap rate, leverage is negative — borrowing lowers your cash-on-cash return rather than raising it. In a higher-rate environment that inverts the reflex to maximize debt. For exchangers this collides with debt matching: if you need a specific loan size to avoid mortgage boot, get the lender's written sizing before the property goes on your identification list, because the identification deadline does not move for an underwriting surprise.
The document checklist
Before the inspection period expires, have all of it in hand: the complete lease with all amendments; a tenant estoppel certificate; the guarantor's entity documents and financials or public filings; unit-level sales where obtainable; the current property-tax bill and any pending reassessment; insurance certificates and loss history; a property condition assessment with a roof and HVAC age and remaining-life opinion; a Phase I environmental report (non-negotiable on anything with a fuel, dry-cleaning, or automotive history); ALTA survey and title commitment with every exception read; zoning confirmation and certificate of occupancy; service contracts; and the rent roll and payment history, which on a single-tenant deal is simply proof the tenant actually pays on time. Anything the seller declines to provide is itself a finding.
Buying NNN inside a 1031 exchange
Net lease is the standard landing spot for exchangers leaving management-heavy property, and mechanically it fits: single-tenant net-lease assets are openly listed, they close on predictable timelines inside the 180-day window, and they're unquestionably like-kind real property under IRC §1031. The friction is that exchange deadlines and honest diligence pull against each other. The 45-day identification deadline arrives well before a Phase I, a PCA, an estoppel, and a lender's written sizing can all be completed on a property you found in week three.
Three adjustments keep the tail from wagging the dog. Start the property search before the relinquished sale closes, so day one of 45 isn't day one of looking. Use the three-property rule deliberately — identify a primary plus genuine backups, since an identification is not a commitment and a failed diligence on your only identified property is a failed exchange. And write the diligence period into the purchase contract so the lease abstract and third-party reports land before your deposit goes hard. The deadline structure is fixed by regulation, not negotiable with your intermediary: see Treas. Reg. §1.1031(k)-1. If the calendar forces a choice between a rushed net-lease purchase and a structured alternative, a DST exists partly to be the backup identification that prevents a blown exchange.
When to walk
Patterns that should end a deal rather than adjust its price: a franchisee guarantee priced like corporate credit; rent materially above market with a renewal-dependent exit; remaining base term shorter than your hold, dressed up with option periods the tenant controls; a purpose-built building whose land value is a small fraction of price; a seller who won't deliver an estoppel; roof or HVAC at end of life on a lease that leaves them with you; and a cap rate materially above the comparable set with no explanation you can find — because someone else already found it. None of these is unpriceable in principle. All of them are frequently unpriced in practice, and the discipline that protects you is the boring one: underwrite the tenant, the lease, and the dirt separately, and let any one of them fail the deal.