Triple nets: the last great tax hedge.

The single-tenant net-leased property has emerged as the best investment for sheltering gains from taxes. Even during the credit crunch of recent years, Acredit triple nets have always been financeable and able to be leveraged at higher loan-to-value ratios than most other real estate investments. The new federal tax regulations, which went into effect in the fall of 1992, have facilitated [sections] 1031 "like-kind exchanges". This combination of favorable tax rules and high-leveraged financing at the best available interest rates together make the investment in triple nets virtually a "can't lose", with tremendous opportunity for upside.

This concept is best illustrated with a hypothetical. Assume a property purchased for $2 million is sold for $10 million. The taxes on the gain would be $4 million, and the seller would net $6 million. If the seller instead were to flip the $10 million proceeds into the acquisition of $10 million worth of triple nets, the tax on his gain would be deferred under [sections] 1031. The seller could then borrow $8 million on the $10 million worth of triplenets. As a borrowing is not a taxable event, this $8 million would be free-and-clear of any tax liability. As the loan would be self-liquidating and non-recourse, the seller is free to dispose of this $8 million. No matter what else happened to the triple net investment, on the tax play alone, he has made a profit of $2 million. It is virtually a "no risk" investment because even if the tenant goes out, the savings on the taxes alone makes this a good deal.

But the initial gain shelter is only one of several unique advantages to the triple net investment. Most triple nets are structured over a long term, typically a 25-year firm term with additional renewal options. The passive nature of the investment, combined with the long term, make it an ideal estate planning tool. The owner of the triple-nets receives the passive income from the property during his life-time, and on his death the "residuals" i.e. the real estate, will pass to his heirs. The financing is usually amortized over the firm term, so the property will likely pass free-and-clear to the heirs. As the basis of the property is increased to fair market value at the time of descent, the taxes on the original gain, and on the amortization, and on any appreciation are all deferred. To again illustrate with a hypothetical, assume the owner of a $2 million property sells it for $10 million, reinvests the $10 million in 25-year triple nets, borrows $8 million on the triple nets with 25 year self-liquidating amortization, and 25 years later dies and leaves an estate to his heirs. His original $2 million investment has leveraged a fiee-and-clear $10 million acquisition. He has borrowed out and kept $8 million, and has not paid any gains taxes.

While the $10 million value of the triple nets will be part of the value of his estate for estate tax purposes, the passage by descent is not a disposition subject to gains tax. Further, the basis of the property for measuring taxable gain will increase to the market value at the time of descent (up from the $2 million basis) and will not be imposed unless and until his heirs sell the property. In this manner the gains tax can be deferred indefinitely.

Even without reference to the tax play, triple-nets are inherently a good investment because they offer high cash-on-cash yields when analyzed over a long-term hold. We currently have a unique window of opportunity to maximize cash-yield. Our country is undergoing a spurt of national euphoria which has caused a huge jump in the value of the long bill, thus significantly reducing interest rates, this occurring at a time when the leases which are at market had been signed during a period of much higher interest rates. This disparity between the cost of financing which is usually pegged to 30-year treasuries, and the lease rent being paid by the tenant, offers an opportunity to negotiate a high return. Specifically, some developers are currently able to offer Arated triple nets at cap rates in the mid-to-high 9's. Financing is obtainable at 8.5 percent interest with self-liquidating amortization. On a 25-year term we'd have a 9.6 constant. Assuming 80/20 loan-to-value, then cash-on-cash yields after debt service and amortization would be 8 to 8.5 percent. This is an excellent yield when one considers that it is consistent over a 25-year hold; that it is passive and low--risk; that equity is being created to the extent of the leverage; that the property is depreciable and thus the income is shelterable; all at a time when most pensions are yielding as little as 3 percent on their funds. Add to this the gains shelter benefits previously discussed, and in sum, net-leased properties are a commendable investment.

As with all real estate investments, timing is significant. Particularly now the confluence of elements maximizing the yield on investments in triple nets is temporal and of indefinite duration. In sum, it would be wise to move swiftly to invest in net-leased properties.