In a NNN investment, the tenant IS the investment. The property is just the collateral. The contracted rent stream depends entirely on the tenant's ability and willingness to pay over the long lease term. If the tenant fails, the lease has no value beyond what the property could be re-leased or sold for.

This is why NNN investors obsess over tenant credit. A 6% cap NNN lease with an investment-grade tenant is fundamentally different from a 7% cap NNN with an unrated regional tenant. The cap rate spread is the credit risk premium.

This lesson covers how to analyze tenant credit, what investment grade actually means, and how to evaluate non-rated tenants.

Why credit drives NNN value

Compare two NNN deals:

Deal A: Walgreens NNN

$200K NOI
18 years remaining primary term
5.5% cap rate
Value: $3,636,000

Deal B: Local pharmacy NNN (non-rated)

$200K NOI
18 years remaining primary term
7.5% cap rate
Value: $2,667,000

Same income, same lease term, same property type. The Walgreens deal is worth $970K more because of the credit difference. The market is saying that the certainty of getting paid by Walgreens for 18 years is worth nearly $1M more than the certainty of getting paid by a local pharmacy.

That's the credit risk premium, expressed as a cap rate spread. In NNN investing, you're buying credit-backed cash flows. The credit IS the value.

Investment grade ratings explained

The major credit rating agencies — S&P (Standard & Poor's), Moody's, and Fitch — assign letter ratings to corporate debt. The ratings express the likelihood that the company will pay its obligations.

S&P and Fitch scale

| Rating | Meaning | Default risk | |---|---|---| | AAA | Highest quality | Extremely low | | AA+, AA, AA- | Very high quality | Very low | | A+, A, A- | High quality | Low | | BBB+, BBB, BBB- | Adequate quality (investment grade floor) | Moderate | | BB+, BB, BB- | Speculative | Elevated | | B+, B, B- | Highly speculative | High | | CCC, CC, C | Substantial risk | Very high | | D | In default | — |

Investment grade = BBB- and above (S&P/Fitch) or Baa3 and above (Moody's). Below that is "speculative grade" or "junk."

Moody's scale

Equivalent ratings: Aaa, Aa, A, Baa (investment grade) → Ba, B, Caa, Ca, C (speculative).

What investment grade means for NNN

An investment-grade tenant has:

Audited financial statements
Sufficient liquidity to weather downturns
Diversified business operations
Strong management
Low leverage relative to cash flow
Long history of paying obligations

Investment grade tenants almost never default on individual NNN leases. When they do close stores, they typically continue paying rent through lease expiration (the cost is small relative to total operations).

For NNN investors, investment grade = sleep at night. You can essentially treat the rent as a contractual obligation that will be paid.

Common investment grade NNN tenants

| Tenant | S&P Rating (approx) | Common NNN format | |---|---|---| | Walgreens / Walgreens Boots Alliance | BBB | Drug stores, freestanding | | CVS Health | BBB | Drug stores, freestanding | | McDonald's Corp | BBB+ | QSR, ground lease or build | | Starbucks | BBB+ | QSR, freestanding | | Walmart | AA | Retail boxes, ground leases | | Costco | A+ | Big box ground leases | | Home Depot | A | Big box ground leases | | Lowe's | BBB+ | Big box ground leases | | FedEx | BBB | Industrial / distribution | | Amazon | AA | Industrial / distribution | | Bank of America | A- | Bank branches | | Chase / JPMorgan | A | Bank branches | | 7-Eleven | A | Convenience stores (parent: Seven & i Holdings) | | AutoZone | BBB | Auto parts retail | | O'Reilly Auto Parts | BBB | Auto parts retail | | Tractor Supply | BBB | Rural retail |

These ratings change over time. Always verify current ratings before investing.

Below investment grade tenants

Non-investment grade tenants (BB or below) trade at higher cap rates. They include:

Smaller chains (Sherwin-Williams subsidiaries, regional brands)
Highly leveraged tenants (some quick service restaurants post-LBO)
Cyclical businesses
Special-use tenants (car washes, daycare centers, medical specialties)

A BB-rated tenant might trade at a 75-150 bps cap premium vs investment grade. A B-rated tenant trades at a wider premium.

Non-rated tenants — the reality

Most NNN tenants are NOT publicly rated. The major rating agencies only rate companies that pay for ratings (typically because they issue public debt). Many private companies, franchisees, and smaller chains have no rating at all.

Non-rated does NOT mean bad credit. It just means there's no third-party rating. You have to do the credit analysis yourself.

How to assess non-rated tenants

1. Public information

For private companies, look for:

News coverage (financial trouble? Growth? Recent layoffs or store closures?)
Press releases
Industry analysis
Bankruptcy or litigation history
Owner/founder background

2. Tenant-provided financials

Request from the tenant (or seller):

Audited financial statements (last 3 years)
Tax returns (where available)
Sales reports (for retail tenants)
Bank statements showing operating cash flow
Borrowing history and current debt

If the tenant won't provide financials, that's a red flag. Strong tenants are willing to share information that supports their value.

3. Dun & Bradstreet (D&B) report

D&B provides commercial credit reports for private companies:

Payment history
Credit scores
Public records (judgments, liens, bankruptcies)
Industry comparisons

Cost: $50-$200 per report. Worth it for any non-rated tenant.

4. Sales-to-rent ratio

For retail tenants, the sales-to-rent ratio (also called the occupancy cost ratio) measures whether the rent is sustainable:

Occupancy cost = (Rent + tenant-paid expenses) / Annual sales

Industry benchmarks:

QSR / fast food: 7-9% (sustainable below 9%)
Casual dining: 6-8%
Specialty retail: 8-12%
Convenience: 4-6%
Auto parts: 6-9%
Drug stores: 3-5%

If a tenant's occupancy cost is significantly above benchmark, the rent is unsustainable. Either the tenant will struggle or rent reductions will be demanded at renewal.

For a NNN drug store paying $300K annual rent, you'd want sales of at least $7-9M to fit the 3-4% occupancy cost. If sales are only $5M, the rent is unaffordable.

5. Site-level performance

Beyond corporate financials, evaluate the specific site:

Location quality (visibility, traffic, demographics)
Years in operation at the location
Sales trends if available
Competition nearby
Whether the site is on the tenant's "preferred" list

A strong tenant at a weak site is risky. A weak tenant at a strong site might still pay because the location matters to them.

Franchise vs corporate guarantor

A critical distinction in NNN investing: who is on the lease?

Corporate-guaranteed lease

The corporate parent is the tenant on the lease. If the lease says "McDonald's Corporation," the entire $50B+ corporate balance sheet stands behind the rent.

This is the strongest form of credit. Even if a single store closes, the corporation continues paying rent.

Franchise-guaranteed lease

A franchisee is the tenant. If the lease says "Smith Holdings LLC dba McDonald's," only Smith Holdings stands behind the rent. McDonald's Corporation has no obligation.

Franchisee credit varies widely:

Large franchisee: A franchisee with 50+ stores has more credit strength than a single-unit operator
Small franchisee: A single-unit franchisee has minimal credit strength

For NNN investors, franchise-tenant leases trade at significantly higher cap rates than corporate-tenant leases — often 100-200 bps wider.

How to know which you have

Read the first page of the lease. The "Tenant" defined term tells you exactly who is bound:

"Tenant: McDonald's USA, LLC" — corporate
"Tenant: ABC Restaurant Holdings, LLC" — likely franchisee
"Tenant: Smith Family Investments, LLC" — definitely small franchisee

Some leases have a "guarantor" provision separate from the tenant. Make sure you understand both:

Tenant: who occupies and operates
Guarantor: who is liable if the tenant fails

Sometimes a small franchisee tenant has a corporate guarantor. Sometimes neither has corporate backing. Read carefully.

The "credit cliff" effect

NNN cap rates have a "cliff" between investment grade and non-rated:

Investment grade tenant, prime location: 5.5% cap
Strong non-rated tenant, prime location: 6.5% cap
Average non-rated tenant: 7.0-7.5% cap

The 100 bps spread between investment grade and non-rated is significant — it represents a 15-20% price difference for the same income.

Why so wide? Because NNN buyers (especially 1031 exchangers) are highly risk-averse. They're buying for income certainty, not yield maximization. A small credit doubt drives them away — and demand for non-rated tenants is much thinner than for investment grade.

Tenant credit decay over time

Tenant credit isn't static. A AAA tenant today could be BB tomorrow. Examples:

Sears — once an A-rated retailer, declined over decades to bankruptcy
JCPenney — once investment grade, defaulted in 2020
Kmart — once a major NNN tenant, now barely exists
Toys R Us — once a strong tenant, bankrupt 2017

When you buy a 20-year NNN lease, you're buying the tenant's credit not just now but for the entire 20 years. Companies can decline. Industries can change. Make sure your tenant is durable.

Better tenants for long holds:

Essential services (drug stores, dollar stores, grocery)
Logistics and distribution (Amazon, FedEx)
Branded QSR with strong unit economics (McDonald's, Chick-fil-A)
Specialty services with limited online disruption (auto parts, banks)

Riskier for long holds:

Apparel retail (Amazon disruption)
Big box electronics (Best Buy, etc.)
Casual dining (high failure rate)
Specialty retail with online substitutes

Diversification in NNN portfolios

For investors building a NNN portfolio (not just a single deal), diversification matters:

Tenant diversification: don't put 100% of your portfolio in one tenant
Industry diversification: don't be 100% drug stores or 100% QSR
Geographic diversification: spread across multiple markets
Lease term diversification: mix of long and shorter remaining terms

A diversified NNN portfolio reduces single-tenant concentration risk while preserving the income predictability that makes NNN attractive.

What to take away

The tenant IS the investment in NNN — credit drives value
Investment grade = BBB- or better; trade at lowest cap rates
Non-rated tenants are not automatically bad — do your own credit analysis
Use D&B reports, financial statements, sales-to-rent ratios, and site-level analysis
Understand whether the lease is corporate-guaranteed or franchisee-only
Franchise leases trade 100-200 bps wider than corporate-guaranteed leases
Tenant credit can decay over a long lease — pick durable industries
Diversify if building a portfolio: tenant, industry, geography, lease term
The credit risk premium (cap rate spread) is the price for taking on tenant risk

Next lesson: cap rates and pricing NNN deals — how to value a NNN property and whether the cap rate fits the risk.

Tenant Credit Analysis — Investment Grade and Beyond