Trying to secure long-term government lease
Hello, community!
I am about to close escrow on a large commercial building here in Northern California. The non-profit owner/occupant was facing foreclosure and so they listed the building at a very aggressive price point to sell quickly. I tied it up immediately when I saw it for $525k and will be closing this week with a private loan I arranged. The 20,000 SF building sits in a busy retail district in a central location and is on nearly 3 acres, which is great because it has over 200 paved parking spaces. The building was constructed in the 1960's and does have some deferred maintenance, although it isn't that bad and the current tenants use the building on a daily basis. I've had roof and HVAC inspections which came out in fair condition.
My main question here is regarding a potential tenant. I called the county liaison who handles most of the county leases and who coordinates different departments with the real estate needs they may have. She expressed interest in the building and said she had a couple agencies that were indeed looking to move locations. Well, I got a call yesterday from her again and she had just finished pitching my building to a large department needing to move locations within the next 6-12 months. We met at the building yesterday and there were about 6 decision-makers there who all walked the building and grounds with me. They were very interested and spent over an hour at the site. They asked me what kind of rate and terms I'd be looking at. I told them I'd be very motivated to get them in the building and would be competitive with my rates. They said they want a minimum of 8-10 years.
I know that the rate and terms for commercial lease with a government agency will vary widely depending on location, geography, age of building, etc. but I am hoping to get some guidance here. It seems in our area there are a couple large spaces available for around $.85 /SF to lease, but those lack adequate parking. The parking seems to be the clincher with these guys as they have a pretty large fleet of vehicles. I've researched my market intensely and there really is nothing available quite like my building. If I could get close to $.85 /SF with this particular government department I would be elated. The tricky thing is they asked if I'd be willing to do TI's. I said that I would be willing to spend some money on specific improvements they would need (I'm guessing about $200k in build-out) but their only caveat is they can't technically sign a lease with me until the improvements are done, and they also cannot put up a non-refundable deposit. From what I understood, the reason why they can't do those things is because when the unions see that there are improvements being done, they will immediately require that the workers are being paid prevailing wages, which would basically double the costs of construction. I understand the benefit for myself and this lessee to avoid having the increased costs of prevailing wage, but I would not be excited to spend that kind of money on the space without any assurance that they would be compelled to move forward once the renovation is complete. It would basically be a non-binding LOI they would sign. They've told me that it is a low probability that they would change their mind once we entered into non-binding agreements, but it still seems risky to me if the TI's being done are specific to their needs and not just general improvements.
I think a better idea is to offer them a reduced rate which could allow them to do any improvements they need. I believe they would have the budget to do this or could probably make it work, although then obviously they have to pay 2x as much for their build-out costs with prevailing wages. How motivated should I be to capture this tenant? Should I offer them an artificially low rate for the first few years of the lease to compensate for the money they would be spending on my building? If I secure a 10 year lease with this department I've got to imagine that the building would become much more valuable than my acquisition price. Ultimately, I'd rather acquire this particular tenant and gain long-term value with the building even if it means I have to accept lower returns in the beginning of the lease period. Also, does anyone have experience with valuing a property with a government lease like this in place? Is there more demand from buyers once a government lease is in place, and if so, what type of CAP rates are those investors willing to buy a building for on average? Basically, is there more intrinsic value when an owner secures a long term government lease and do buyers of these deals generally accept lower CAP rates than normal for that type of 'guaranteed' income? I'm curious and interested to hear thoughts from some of the commercial investors. Thanks for your interest.