Modified NNN Dollar Store in Rural South Fights for 7 Cap

Inheritances are bittersweet. Say you suddenly find yourself the landlord of a Family Dollar, for instance. It’s leased, lucrative and low maintenance. But sometimes you just don’t want to own a seemingly random, rural retail store — especially if it reminds you of a personal loss. You’d rather offload it to a hungry market while rates are low and get into cryptocurrency instead. Sounds easy enough, right?

Well, not so much. Jim Truhan inherited a fundamentally solid investment property with strong cash flow. Like most single-tenant, freestanding convenience stores on triple-net leases, Truhan’s 8,320-square-feet Family Dollar in the outskirts of Greensboro, North Carolina, had consistently netted his family solid returns since day one — when it was built to suit in 2014.

But when Truhan (name changed for privacy) gave Greensboro Commercial Properties a call earlier this year to help him get it off his hands in a hurry after his father passed away, broker Micah O’Hare eagerly accepted — and then quickly found out that the deal wasn’t going to be so straightforward.

First, O’Hare needed to figure out the financials — starting with net operating income (NOI). He called the former manager who had been operating the store for years to ask for records of the trailing 12 to 36 months. “Since it had been owned by one person, the manager provided me all the expenses dating back to when it first opened,” he told LoopNet. “So that was nice.”

But when he got into the weeds, he noticed something odd. Some of the expenses were missing from the balance sheet. He figured someone may have just omitted some of the insurance and tax costs. But before questioning the tenant, he started scouring the lease.

What he found was surprising. In most standard triple-net leases, the tenant directly pays property taxes and commercial property insurance. But in this 10-year lease, on which three years remained, the landlord is on the hook for paying those expenses and then requesting reimbursement within 180 days. “If you're late, there would be no exception for the reimbursement,” O’Hare explained. “Keep in mind, that’s not completely crazy, but it did come to bear.”

What O’Hare found when he called the manager back was that the owner had made a costly mistake. He hadn’t been requesting the reimbursements for taxes or insurance — which O’Hare clocked at around $12,000 a year — for the past six years.

"That was a bit of a blow to my seller — not just because it would have been nice to get that money previously, but because that’s a $12,000 swing in the NOI we’re marketing."

Micah O'Hare, Greensboro Commercial Properties

Another unusual lease term, according to O’Hare, was a clause that capped the tenant’s reimbursement of tax costs at 5% annual increases. If taxes went up 10% one year, for instance, the tenant would only have to pay half. When O’Hare and the tenant went back to the drawing board to figure out how to handle the most recent year’s expenses, the tenant stuck to the lease terms — offering a 5% increase over the amount of the last year they had paid them.

Since the owner hadn’t collected reimbursements, that meant the 5% increase was relative to the asset’s very first year, when it had just been assessed as raw land before the improvements had been built. “Here’s $840,” they told O’Hare. “That was a bit of a blow to my seller — not just because it would have been nice to get [the cumulative amount from all those years] previously, but because that’s a $12,000 swing in the NOI we’re marketing.”

What O’Hare found, quite simply, was that the lease wasn’t a true triple-net, and there wasn’t a whole lot they could do about it. So, he engaged an attorney to move forward. “We put together a line of reasoning,” he said, which didn’t quite get the tenant to hand over all $12,000 of the past year’s reimbursement of expenses, but at least got them to cut a check for around 70% of that amount.

“That was a win for the owner. It also made it easier to go to market with a targeted 7% cap rate,” which is a measure of risk in an investment that’s calculated by dividing the asset’s annual net operating income, before debt and capital expenditures, by its purchase price.

The nationwide average cap rate for convenience stores, which fall into “general retail,” according to data gathered by LoopNet’s parent company, CoStar, was hovering at around 7% at the time of this property’s listing — so it’s a rate buyers were eying and a number O’Hare wanted to achieve by positioning his asking price accordingly. They listed the property for $1.63 million. Ideally, O’Hare said, he’d find a way to compress the cap rate even more for his seller.

The listing attracted a ton of interest from day one, he said, with a Californian offering asking price on literally the day it hit the market. Ultimately, though, he saw that not many suitors would be able to get the deal across the finish line.

The lease’s unusual terms became a sticking point in the market, O’Hare said. “A lot of buyers were looking for an absolute triple-net. This mechanism in the lease that makes for a gap in reimbursement and a 5% increase cutoff turned a lot of people away.”

While in this lease the owner still gets paid at the end of the day, he noted, that discrepancy became an interesting case study in investors’ appetite for involvement in triple-net lease management. That sort of nuance “shouldn’t really matter,” he said, “but it can matter.”

Potential investors also inquired about the store’s sales, but getting their hands on that data wasn’t going to happen. To retain leverage, dollar stores typically don’t cough that up, O’Hare said. Some investors use other methods to surmise revenue, such as reports from companies who track the volume of cell phones entering a store and tally an approximate average sales per person, he said. In this case, O’Hare would have to put together offering materials without an idea of the store’s income.

The timeline of the lease also wasn’t ideal, he said. There were three years left on Family Dollar’s lease, and feedback from the market was that potential buyers were almost unanimously looking for leases with five years or more remaining.

This property was also competing in the market with a surge of new builds of single-tenant stores attracting long, triple-net leases that sometimes yield cap rates as low as 4.25%, he said. These developments happen to be the most prominent type of retail assets to which investors and developers are swarming, according to CoStar analysis.

“We had to adjust our strategy in response to buyer feedback to get the deal over the finish line. It led us to negotiations we never would have expected.”

Micah O'Hare, Greensboro Commercial Properties

The lease also had six extension options, though, each for five year-terms with 10% increases over the current annual base rent of $120,000. So, O’Hare went back to the tenant to negotiate. “If we could only get that first five-year extension locked in now, we could drop to as low as 5.75%,” he said. But they weren’t so lucky. “They told me to call back in two years.”

Then, something else surprising happened, O’Hare said. His representative at Family Dollar, which is owned by Dollar Tree, casually mentioned as the two were getting off the phone that Truhan’s store “had been flagged.” Due to the location’s reportedly strong sales, Dollar Tree was considering expanding the store’s footprint, likely to accommodate its new “combo store” concept, in which the two brands live equally under one roof. “So, I’m looking for an extension on the lease, and end up getting put on to a potential expansion of the actual building.”

Excited by this prospect, he went back to the drawing board. With a two-acre parcel and a floor plate of only around 8,000 square feet, an expansion would be “pretty realistic,” he thought. And his back-of-the-napkin calculations looked strong. “There was definitely enough juice for the squeeze,” he said. “With 25% more store and a new 10-year lease at a higher rate, we’re looking at a potential 10% hike in NOI, or more.” If they could get this inked before closing, Truhan would be sitting pretty, O’Hare posited.

But after crunching numbers for construction costs and considering a potentially lengthy negotiation process to get it sealed, all while the lease’s remaining 36 months or so dwindled month by month, the expansion prospect didn’t quite pencil to Truhan’s liking, and the ticking clock was exerting too much pressure on O’Hare. They scratched the idea and pressed on. This new insight at least shed light on the fact that sales were exceptionally strong, and that Family Dollar had staying power at this particular location — meaning it was likely they’d renew when the time came.

The property had been on the market for several months at this point, and despite all the twists and turns thus far, it had attracted enough interest for O’Hare to start nailing down a buyer who’d jump on what he says was still a strong proposition. “It ultimately proved to be a pretty great offering. We got good activity from the market from start to finish and I think the seven cap was just right.”

While they got offers above, below, and spot on the asking price, O’Hare and Truhan ultimately went with a local buyer and landed on a price of $1.58 million, achieving a rate just below asking and still hitting on that 7% rate.

Ending up with a local buyer for this type of investment was unusual, he said, because the property is managed by the tenant and requires potentially zero in-person nurturing. Investors’ cap rate requirements also vary depending on where they are located around the country, and for this deal, some of the best offers were from California.

But, for various reasons, the buyer they went with happened to be a Greensboro-area CPA with a broker’s license who, from what O’Hare gathered, sometimes sources deals for some of his affluent clients, sometimes in groups, in exchange for equity.

After a busy six months or so on the market, all parties walked away happy upon closing the deal last week. “We realized that if we’re going to get our most lucrative transaction while rates were moving so quickly, we’d have to adjust our strategy in response to buyer feedback to get the deal over the finish line. It led us to negotiations we never would have expected.”

LoopNet publishes a "Deal of the Month" at the first of every month. See the entire series here.