Inflation is an inevitable process. However, when its level increases, it becomes a worrying factor. It is especially true for investors because they are trying to save and increase their money, and inflation eats away at their profits. Therefore, it is essential to understand how to minimize its negative impact. In this article, we will tell you how inflation affects NNN leases.
The Impact of Inflation on Different Types of Investment Instruments
Any investor knows that a portfolio should consist of different types of assets. And they all react differently to the depreciation of money.
Company Shares
Usually, when money depreciates, large companies also suffer. This reduces their profitability and the ability to pay dividends. Buying shares at the moment of their decline and forgetting about them for a while is a strategy that can be followed in conditions of high inflation. As soon as the economic situation begins to stabilize, share prices will begin to rise again, and then they can be sold at a higher price.
Unfortunately, the inflation factor cannot be hedged (insured) 100%. In this case, the main thing is to remember that the fluctuation in the value of shares is dynamic in nature, and if the shares are falling and the company itself demonstrates the stability of other economic indicators, then this is the best time to increase the share in its shares.
Bonds
Any bonds are perceived as risky when prices go up. However, in all countries of the world, stocks and bonds on the stock market are considered the optimal and profitable investment tool during periods of high inflation. The growth of the key rate leads to the fact that the yield on deposits and bonds with a variable coupon (if it is tied to the key rate) increases, and the yield on bonds with a fixed coupon, on the contrary, decreases. As a result, the prices of the latter can decrease until the yield on them equalizes.
Despite this, bonds in conditions of inflation are a more reliable investment object than stocks. This is due to the fact that they almost always have a fixed coupon income, which depends on the period of ownership of the bond.
Gold and Precious Metals
Experts consider gold and precious metals to be stable assets suitable for investment. Buying gold is a way to add stability to a diversified portfolio in conditions of high inflation. You can invest in gold not directly (by buying metal bars) but by opening “metal” accounts. This method of investing is profitable because the interest on such accounts is tied to fluctuations in the prices of precious metals. There is also a variant of so-called bimetallic accounts when invested funds are nominated in two types of precious metals at the same time. This allows you to insure your money against fluctuations in the prices of precious metals because if the value of one metal decreases, then the value of the other will definitely increase, and thus, a balance is achieved.
Real Estate
This asset has its pros and cons. If you already have purchased real estate, it will reliably protect you from inflation. As prices rise, the value of the building increases proportionally. Thus, you save your money. However, if you plan to purchase real estate as an investment asset during a period of high inflation, then there may be pitfalls. The deal will be profitable if you do not use borrowed funds. In other words, when you have a certain amount that is enough to purchase real estate, this is the best option. However, the cost of the mortgage can negate all potential profits.
However, experts consider investments in real estate for the purpose of its subsequent sale to be the least profitable in these conditions. If you want to use this asset as efficiently as possible, then you should pay attention to renting out premises. NNN lease will be a particularly profitable option. We will dwell on it further.
What Is NNN Lease
This type of property rental assumes a fairly low rent. However, tenants assume the responsibility for the maintenance and repair of the premises. Thus, this method requires the least financial and time costs from the owner of the building.
Benefits
The main benefit is that you only spend money once on the purchase. Under normal circumstances, real estate is an asset that requires regular investment. However, with this type of rent, all expenses are borne by the tenants. Thus, in conditions of inflation, their expenses will increase, not the owner’s.
The second advantage is the long-term nature of the lease. Most often, such leases are used for offices. Therefore, it is not profitable for the owners of these companies to change their location. This can lead to the loss of some clients, so they usually rent the same premises for years.
The third advantage, which is of direct importance to the topic of our article, is preserving the value of the building. Over time, as a result of poor maintenance, the building may fall into disrepair. This will affect its value. You will not be able to sell it profitably, or you will have to spend money on repairs. With NNN lease, tenants maintain the good condition of the premises, so this outcome does not threaten you.
Downsides
Of course, there are some negative aspects, and they don’t mean you should give up on the idea of using the building for this type of rental. However, they are essential to consider:
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Low immediate income. This type of lease is a great way to invest in the long term. However, in the short term, you will receive less from one building than with other types of leases.
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Difficulty finding tenants. If a tenant decides to move, finding a replacement may be difficult. Thus, the premises may be idle. This does not apply to properties in good areas.
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The cost of a building suitable for such rent can be pretty high. Accordingly, such investments require significant initial capital.
As you can see, there are not many disadvantages. Moreover, they can be compensated with a skillful strategy.
How Inflation Affects NNN Leases
With the general increase in prices, the cost of services and rent also increases. At the same time, the costs of servicing the premises do not bother you much since they are paid by the tenants. That is, with this type of rent, you practically do not feel the impact of inflation. Sounds great, doesn’t it? However, there are pitfalls here, too.
All this only works under ideal conditions. In reality, tenants can close and end the lease, and you will suffer losses. In addition, they can protest against the increase in rent, refusing to renew the contract. The apparent advantage of this asset is its stability and reliability. Even if you have problems with tenants, you can always sell the building, recouping your costs.
Best Strategies
In conditions of high inflation, the most profitable strategy will be to use your existing real estate for NNN lease. In this scenario, you get the maximum benefit. If you are just planning to buy a building, it is best to use the funds you have available for this. In this case, the deal will be profitable. You will be able to cover the investment fairly quickly and start making a profit.
The most unprofitable option is to purchase real estate using a loan. In conditions of high inflation, the interest rate will be high, and the benefit from rent will not be able to quickly compensate for the costs.
How to Minimize the Negative Impact of Inflation
Since with NNN lease the main impact of inflation falls not on you, but on the tenants, your first task is to carefully select them. If you rent out commercial real estate, then give preference to stable companies that will work for a long time. In addition, a proven tenant is always better than a new one. Also, do not forget to regularly assess the level of inflation and raise the rent accordingly. It is essential to do this otherwise you will suffer losses.
Since these increases occur against the backdrop of general price increases, they usually do not cause profound discontent. However, it is crucial to maintain a balance and not make significant increases in pursuit of short-term profits. This can have a negative impact in the long term.
FAQ’s
1. How does inflation specifically affect the profitability of triple net lease (NNN) investments?
Inflation can impact NNN investments in several ways:
- Rent Value Erosion: If the lease doesn’t have built-in rent escalations tied to inflation, the real value of rental income decreases over time.
- Higher Operating Costs for Tenants: Tenants in NNN leases are responsible for property expenses (taxes, insurance, maintenance). If these costs rise significantly, tenants may struggle to afford them, leading to higher vacancy risks.
- Property Appreciation: On the positive side, inflation can increase property values, benefiting investors who plan to sell later.
- Interest Rate Impact: Rising inflation often leads to higher interest rates, which can make refinancing or new property acquisitions more expensive.
2. What strategies can investors employ to mitigate the negative effects of inflation on their NNN lease properties?
Investors can take several proactive steps, including:
- Include Rent Escalation Clauses: Leases should have annual rent increases (e.g., 2-3% fixed or CPI-based escalations) to keep up with inflation.
- Choose Creditworthy Tenants: Strong, stable tenants are more likely to withstand rising costs and economic shifts.
- Invest in Essential Businesses: Properties leased to essential services (grocery stores, healthcare, logistics, etc.) tend to be more resilient during inflationary periods.
- Diversify Locations: Some regions experience inflationary pressures differently; investing in multiple markets can help balance risks.
- Long-Term Fixed-Rate Financing: Locking in low interest rates before inflation drives them up can protect cash flow.
3. Are there specific types of properties or industries that are more resilient to inflation within the context of NNN leases?
Certain property types and industries perform better in inflationary environments, such as:
- Essential Retail: Grocery stores, pharmacies, and gas stations have consistent demand regardless of inflation.
- Healthcare Facilities: Medical offices and urgent care centers provide necessary services that aren’t as affected by economic downturns.
- Industrial & Logistics Properties: Warehouses and distribution centers benefit from the growth of e-commerce and supply chain demand.
- Fast Food & Quick-Service Restaurants: These businesses often pass rising costs onto consumers and continue to perform well during inflationary periods.
- Government-Leased Properties: Tenants with government-backed leases provide stability and predictable cash flow.
Conclusion
NNN lease is an excellent investment tool and can be very profitable in the long term. This is especially true during periods of high inflation. In this case, the owner of the building suffers the least from inflation. However, if you are only planning to purchase a building for such a lease, it is better to do it without loans. High interest rates will reduce your profit and make the whole project unprofitable. In all other cases, this is an excellent investment of money in conditions of depreciation of money.
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