Are they asking for a reasonable rent reduction?
I own a NNN lease that I purchased 15 years ago. I have some residential real estate experience but nothing in commercials. The property is in a different state and I'm not familiar with the market in that area.
For the first 10 years, the rent was $17.35 a sqr ft
For the last 5 years, the rent was $19.28.
The tenant is coming to the end of their lease and they are requesting a substantial reduction: $17.20 for another 10 years.
They sent me a “Lease Comps Summary” report to support the notion that the rent should be lower.
I’ve called some local brokers to try and find out what the market rate should be and brokers tell me, “high teen”. That’s just too vague.
How can I determine what the market rate should be for this property?
Is there a service out there that can help me?
Any advice would be appreciated. Thanks
Rents are not necessarily a science and no broker can guarantee you what rent is. There's a lot of factors that go into the base rent. There could have been a huge TI contribution prior to yo purchasing the property that bought the rent up 15 year ago... I would tell you in this case to look at your personal situation. What's your goal? Are you looking to sell the property or hold on to it for another 10 years? Is the Tenant a good Tenant that you want to retain? If you were to achieve $19 or $20 with another tenant, how much would that deal cost you in TI and commission and what would your effective rent be after all costs associated? Generally, though, I would like to see a 7.5% or 10% bump in rents every 5 years. Where is the property? Is it a desirable asset or will it sit vacant for 9 months or a year while you try to relet it?
There are so many variables here, most of which relate to you as the owner and the market itself. What else can you tell us about the market where the property is located?
By the way, what I think you definitely should NOT do is agree to flat rent for the next decade no matter where you land with them for next years rent.
Mr. Sullivan, Thank you very much for your reply but I'm afraid it still leaves me without a clear direction.
This is an excellent tenant. They are a national retailer and I would like to keep them. If I could keep them I would continue to hold the property for at least for another 5 years.
You asked, "If you were to achieve $19 or $20 with another tenant, how much would that deal cost you in TI and commission and what would your effective rent be after all costs associated?"
The problem is, this is a 1031 exchange property that I purchased many years ago. I don't live near it and I don't know the market area well enough to answer these questions.
Without knowing the market well, I feel like I'm flying blind. I always felt I could acquire a report from some real estate data company and I would have a better feel for prices and vacancies, but I can't seem to find a service that readily provides this information. Now I feel I need to get someone else involved who knows the market well, but I don't want to pay a full commission for a negotiation that seems relatively simple - and I'm not eager to introduce another party into this situation.
Many people have purchased these types of investment properties. I'm sure I'm not the first guy to find myself in this situation. What do landlords like me do in a situation like this?
Any further advise would be much appreciated.
First, I will say, you should not be hesitant to involve a broker and pay a fee. It will be much more expensive for you if you try to negotiate with a national tenant on your own without understanding the local market. They will walk over you...
Retail rents are a lot tougher to track then, say, residential rents. Generally with residential rents, what you see is what you get. There's too many variables in a retail rent to look at a data print out of base rents ONLY and be able to tell what "market" is.
Where is the building located and who is the tenant? How big is the building? If you can get more granular with the information, maybe we can help a little more.
As a SUPER basic example, lets say the building is 5,000 ft.
Current rents: $19.28, NNN ($96,400/yr)
Requested rent: $17.20, NNN ($86,000/yr)
Income Difference: $10,400/yr or $104,000 lease life value.(Assuming flat rent for the ten years as you described)
Value difference @ 6%CAP : $173,333.33
Scenario 1: You give the Tenant the reduction and lose 10k per year in potential rents which equates to $173,333.33 in sale value if you were to sell. This deal costs you zero dollars out of pocket and you continue with the great Tenant.
Scenario 2: You decline to give them the rent reduction and they sign a long term lease at your asking rent. This is the best case scenario.
Scenario 3: You decline to give the reduction and they leave. You relet the space using a broker (which you need for this) at $20/foot, NNN. Here are some costs you may incur:
1. Vacancy $7,166.67/month
Commission : $44,000 ( Assumes a 10 year deal, no rental increases, commission is 6% years 1-5 and 3% years 6-10)
Tenant Improvement Allowance: $15 - $20 PSF or $75,000 to $100,000.
"Total Cost" of deal excluding vacancy: up to $144,000.
Net Value on sale from doing the new deal(Value added - cost): $29,333.33
Total additional rent from doing the new deal(Total Potential Rents - Total requested Rents X 5,000ft X 10 years): $140,000 over the life of lease.
Net revenue of Lease life if you do not sell(Total revenue - Cost): -$4,000.
This example is extremely basic and assumes a TON as I don't have sufficient information. You can start to see though that there is no right answer. Your situation/desire for the future is going to weigh heavily into what you need to do.
Alex you purchased a NNN property 15 years ago and do not have any further experience since then?
You haven't mentioned the TIME factor? Exactly have many years or months left on the primary term? Based on their lease is it 12 months,9 months, 6 months, 3 months notice?
Tenants try to do stuff all the time regardless of what the options say. If they are requesting something then guess what you can also change the landscape of the lease as well with changes. How often they report sales, guarantees, length of lease term, change to base rent but add a sales kicker for upside where you get more rent if they do well, etc.
Commercial brokers make THOUSANDS or more per hour for their time. They are not going to sit there and give you all this free time and knowledge without compensation. What kind of leverage you have if any in negotiations will generally depend on the quality of your site for their business type and what alternative choices do they have in the marketplace? A leasing commercial broker might say (teens on the phone) in your area. Comps though have variations. If this has a drive thru as an example and no more drive thru's are allowed in the area. Is this a going to work or going to home side business? Are traffic counts high on your side of the street? What do the sightlines look like from the main road (easy to see, down in a hole, high up on a hill?) Is access easy where you do not have to turn around in a median to get there? Are you on a corner or have a cross road with the corner tenant for daily feeder traffic? Are you mid block away from most of the commercial action? What kind of junior anchors and large anchors are around the site (junior might be Starbucks freestanding, Mcdonalds, Chick Fil a, national brand gas station) or larger anchors ( Super Walmart, Home Depot, Publix, Lowe's, Costco, Target, etc.)
You need to know how valuable your site is. Sometimes these tenants employ a leasing broker or commercial attorney to negotiate the rent with the landlord on renewals and then keep part of the expected savings with payment from the tenant, etc.
I would have to see the location and what type of tenant we are talking about here and then have to know your goals with keeping the property or trying to sell it. With under 1 year left it is a cash buyer and cap rate has to be high. If you get tenant to sign new 10 to 15 year primary lease term then it could possibly improve the cap rate value. Example you might have bought at a 7 cap 10 years ago with flat rent but now that property price and tenant type is going in that area for a 5 cap so you might have increased value you do not even know about.
I look at about 1,000 a week for clients nationwide. I stay on the transaction side and then I am an investor and syndicator of retail properties also. Consulting work, property management, tenant leasing is a low return for my time per hour and not something of interest to me.
Good luck. No legal advice given.
I think the feedback above is right on the money particularly the math on scenarios & commissions etc by Mr Sullivan. But if you are already talking to a broker why not see if you can work out some sort of flat fee to help you really dig in and assess the situation instead. $10k might be a great deal for you and the broker.
Mr. Sullivan, Mr. Owens, Mr. Williams, thank you all so much for your fine advise.
Mr. Sullivan, you said : "First, I will say, you should not be hesitant to involve a broker and pay a fee. It will be much more expensive for you if you try to negotiate with a national tenant on your own without understanding the local market. They will walk over you..."
I agree, and I feel that's exactly what's happening. I know I'm dealing with pros and I'm out of my league with them. I've also worked out the scenarios you've described but without having a good grasp of the market, I'm really just guessing.
I want to get a local professional broker involved and I'm willing to pay them for their efforts but I don't know how deals like this are done. I just need some basic help through this negotiation and I'm willing to pay well for that, but the broker didn't find the tenant so I don't want to pay full commission for something like this. Also, if some broker does agree to take my deal for a smaller commission or a flat fee, what's to stop them from luring my tenant away to another landlord who'll pay full commission? Sorry if this sounds a little paranoid, but like I said, I'm not experienced in this market and I come out of an industry where vendors went after my clients all the time.
How do you approach a local commercial broker for help in negotiating a deal like this? Is this what landlords in my position typically do? What would a commercial broker expect to get paid in an arrangement like this? How can you protect yourself and make sure they won't try to move your tenant to another landlord who will pay them a full commission?
Again gentlemen, any advise is greatly appreciated.
Why not get a commercial retail attorney to help you? They typically charge by the hour.
Any brokers worth anything are not typically going to want to work for reduced fees.
Look at it this way. Unless they are a commercial principal broker and keep all the money they make they will have a split with a brokerage. Most commercial that is 50% on a team or maybe slightly better split if just them.
In commercial real estate it works usually like this:
Broker:
Property management: Retail center with 300,000 gross rent at 4% management fee is 12,000
Consulting fee maybe 10,000 so doesn't even pay what property management does which is usually the lowest return.
Then leasing broker commissions. On a 5 year deal worth 600,000 in rent maybe 24,000 fee of 4% of primary term lease value.
Then say a transaction of 4 million for a broker commissions might be 100,000 for one deal.
Then highest is a retail syndicator taking a fee going in, ongoing cash flow, and upside on the deal.
It just seems a commercial retail attorney that charges by the hour and is familiar with STNL properties and negotiating renewals might work best for you. The good ones are typically 300 plus an hour for billable time or greater.
No legal advice given.
Thanks Joel,
I have a commercial real estate attorney that I work with. He gives me good advice but he's not very knowledgeable on specific rental rates in particular areas. Frankly, I don't think I could find an attorney with this kind of in-depth, up-to-date market knowledge. My current attorney advises me not to engage a broker just yet - for the same reason I described above: if we don't pay the broker a full commission, they may consider stealing our tenant. I really think I need a broker - but only to evaluate the market. I don't need a broker to help me find a tenant.
And what if I hire a broker, agree to pay a full commission, and the broker comes back to me and says, "Your tenant is right. The market is down and you have to reduce your rental rate." Now I'll have to reduce my rental rate AND Ill have to pay out a huge commission!
I think my tenant has done something clever. They see that I'm a landlord that doesn't live in the same state as my property. They've assumed correctly that I don't know the market well and their taking advantage of that. They do 1031 exchanges and they must have thousands of landlords just like me, so they know how to play this.
They're requesting a rent reduction that is substantial, but not so much that I'm eager to hire a local broker and pay a large commission for their involvement. When I work out the different scenarios, I see that they are asking for a rent reduction that will cost me roughly the same as it would cost me to replace them with another tenant. They're figuring that I'll give in because the cost of replacing them doesn't put me in a much better place.
I see from your signature that you're involved with NNN investments. You must know landlords who have faced situations similar to mine. What do they do in instances like this?
I think you think your tenant is looking a lot deeper into their landlord then they really are. If they truly are a national tenant, they aren't researching you and finding out where you live an asking for a $2 reduction because they think you're weak.
It seems you've gotten a lot of similar feedback here but just don't want to move in that direction. That's totally fine if it's the decision you want to make, but the fact of the matter is that you bought a retail asset and there are costs associated with that which include commissions to brokers and TIA. If you really don't want to pay a broker or you think you will break even by hiring one, then just sign them at $17.20 and go back to enjoying yourself!
@Alex Rand - I dont have zero experience in commercial, only residential, so maybe you should not listen to me at all...
That said, with the ever expanding to e-commerce, the traditional retail has been and will continue to shrink, meaning the demand for retail space has been reducing and will continue to reduce....
I would not get too greedy here....
@Diane G. We don't have any information on the tenant so it's impossible to comment on the effect e-commerce is going to have on the business. Retail footprints for anchors are decreasing and the uses are changing, however, retail demand is super strong it's just in different sectors than we have seen in the past.
correct, that is why I put a disclaimer there... Lol
That said, there were over 9000 store closures in 2019, and over 1500+ so far in 2020...
The retail world has been changed by e-commerce... Either you are Nordstrom or Walmart, or you are a nail salon... but all the "office depot", all the "foot locker" are dying.....
That is why I would not be too greedy here, if it was me... Lol
Hi Diane G,
I'm aware of the pressure on retail stores but the sales of this particular location is trending up. It's a good location. This isn't a matter of greed. I'm not looking to take advantage of my tenant but I don't want to be taken advantage of either.
The value of commercial real estate is entirely tied to what you can earn from the property. Lock in a lease rate that is too low for too long and you substantial devalue the entire asset. It's important to go through the negotiation process and establish the correct market rate as best as you can.
Hi Mr. Sullivan,
You said: "It seems you've gotten a lot of similar feedback here but just don't want to move in that direction."
If that's what you think than I'm simply not communicating well.
People have suggested that I get a professional broker involved, but no one has told me how people typically arrange this and what they pay for this kind of help.
Joel first suggested that I offer a broker a flat fee of $10,000, but when I pointed out that working below a full commission might encourage the broker to lure my tenant to another location, he then seemed to change and suggested that I might seek a commercial real estate attorney. The problem there is that most commercial real estate attorneys don't have the market information needed to carry out this negotiation. On top of that, I have the added problem that I could engage someone, they could come back to me and say, "your tenant is right; you need to cut your rate." Then I'm hit with the lower rental rate AND a commission.
Even though I've gotten similar feedback, I really haven't found the answer to this question: "How do landlord in this situation typically handle this? Again, I'm not the first person in a situation like this. Lot's of people have invested in a 1031 exchange property outside of their local area. I'm not looking to re-invent the wheel. What do landlords like me typically do in a situation like this?
The rent value is generally tied to not who is currently in the space and on the vintage lease but WHAT the current local market is doing and WHO the new tenant might possibly be national, regional, mom and pop, etc.
I mentioned it is not even about the rent value only but other factors. For example if you have a mom and pop tenant based on 17 bucks a foot rent because that is all their business model can support but a national tenant wants the site and can pay 22 because of location not only can rent potentially increase but also that new tenant value can be a massive difference.
Mom and pop at 17 a foot and an 8 cap for instance.
Say 4,000 sq ft box X 17 = 68,000 (8 cap) = 850,000
National tenant at 22 a foot. 4,000 X 22 = 88,000 (6 cap) = about 1,470,000
There are expenses involved getting the new tenant but value difference can be massive.
Leasing brokers can perform a (void analysis) which not only looks at rent comps for box size but also what existing tenants are in the market,saturation levels, and what possible tenants optimally could go in that space.
Renewal options are a dance between landlord and the tenant. I have seen tenants cry that they are losing money and want a big rent reduction. Updated financials were requested. They did not want to show. Landlord sued the tenant. Once tenant saw landlord was serious the tenant caved on rent reduction request and has been paying their normal rent for years now without a peep from them.
Another tenant a nail salon complained of paying highest rent in the center which they were not. They just wanted to test the new landlord. New landlord said they have list of tenants ready to go into that space and let them know when they want to vacate. Nail salon still there years later paying the rent like clockwork.
You have to see as a landlord if tenant is bluffing and has real financial problems and if so are they long term or short term in nature?
You might be overthinking all this and the tenant is just throwing out a reduction and seeing what happens. You could also try to change the structure of the lease with a base rent plus bonus rent to landlord with annual sales over a certain gross number.
Remember there is the location quality itself, the building design and quality of construction fit and finish, the parcel layout and parking ratios, any junior or large back anchors close by, the sightlines, the access, the traffic counts, and on , and on for valuation. Valuation is part science and part art. You could get a commercial retail appraisal completed by a specialist appraiser who focuses on retail. Those costs generally about 3k to 5k depending on type of building and the size. There can be a big difference between a building on main road frontage and one that is tucked behind another building or turned to the side. There are also leasing consultants in some areas but at the end of that process the possible answer might not be as black and white as you hope for.
So you have many reasons a business can fail or not do well. The location, the business type, the company brand within a business type, the local operator running a business. The magic is when all components are hitting on all cylinders (great location, operator, business type, parent company corporate support, etc.)
I am not telling you what to do or try. This is your property you bought and your money. The ultimate decision of what to do with a tenant rests solely at your feet for the final call.
No legal advice given.
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Originally posted by @Alex Rand:Hi Mr. Sullivan,
You said: "It seems you've gotten a lot of similar feedback here but just don't want to move in that direction."
If that's what you think than I'm simply not communicating well.
People have suggested that I get a professional broker involved, but no one has told me how people typically arrange this and what they pay for this kind of help.
Joel first suggested that I offer a broker a flat fee of $10,000, but when I pointed out that working below a full commission might encourage the broker to lure my tenant to another location, he then seemed to change and suggested that I might seek a commercial real estate attorney. The problem there is that most commercial real estate attorneys don't have the market information needed to carry out this negotiation. On top of that, I have the added problem that I could engage someone, they could come back to me and say, "your tenant is right; you need to cut your rate." Then I'm hit with the lower rental rate AND a commission.
Even though I've gotten similar feedback, I really haven't found the answer to this question: "How do landlord in this situation typically handle this? Again, I'm not the first person in a situation like this. Lot's of people have invested in a 1031 exchange property outside of their local area. I'm not looking to re-invent the wheel. What do landlords like me typically do in a situation like this?
Your attorney is only for negotiating the numbers you provide. No attorney is going to be a market expert like a broker. That said, I think you're evaluating it incorrectly. The $10k is for knowledge, you pay that because you lack something. Its not a bad deal if you pay and find out market rent is $17.20. Thats the price to play.
My 0.02$ take the 17.20 with 3% increases and see if they bite.
Originally posted by @Jameson Sullivan:By the way, what I think you definitely should NOT do is agree to flat rent for the next decade no matter where you land with them for next years rent.
As an attorney, I have little else to say on this matter, but I would stress this. Flat rents are lost money, and are huge concessions to your tenant. For all we know, inflation could be 3% next year with the growth in the stock market, and you need to manage the risk of the $17.20/ft2 being worth less than $17.20 in 2020. You need to manage the risk of the property or the neighborhood appreciating. I would not give a 10 year lease for a flat amount unless they are already paying a big premium for year 1. A flat rent lock-in with rent reduction is foolish.