How to negotiate long undesirable lease on apartment purchase

Question

I am currently looking at putting in a offer on a apartment building.  The dilemma I have is that the property management company is renting one of the lower units to conduct business.  This company is also the company listing the pocket listing.  He is currently paying about half of what the market rent is. Maybe even a little more.  He has been the property manager for the building for about 10 years.  He sais he has 3 more years on the lease with a 10 year option to extend.  My thoughts where that the discount was in exchange for managing the building but he said that is not the case. This will be my first bigger apartment building with retail space.  I want to put a offer on the property but not with him having the rent at half market price and having the option to extend.  Does anyone know what can be done to get him out if I purchase or what I can do to make the adjustment in the rent even thought he supposedly has a valid lease with 3 more years.  I think property owner and manager are working together to get him a lower rent after purchase or there is some kind of compensation for the management side that is not being disclosed.  Thanks in advance for any feedback.

Henri Meli · Answer

@Terrence Williams In addition to the comments made by others, let me add another angle.

The company doing the listing seems to be providing a service to the owner. The owner seems to be paying for the service by giving them a discount on the rents. This would indicate 2 contracts between these two parties. First, you need to ask to see the contracts. Seller must show you the contracts if you have shown serious intent to purchase the asset. I'm actually surprise, you are ready to make an offer without having seen these contracts.

If there is NO contracts and it is only a verbal agreement, ask for it to be written as an official contract.

Generally, when you purchase an asset, you need to keep the contracts in place until their expiration. Some contracts allow for agreements to be renegotiated in case of a sale. That's why you want to see the contracts.

If you decide to move forward with the offer, make sure to spell our clearly (Exhibit B ) under what conditions, you want to purchase the asset. Let the seller deal with his current tenant to meet your requirements/conditions. Since you don't own the asset yet, you shouldn't be discussing with tenants.

One step that is sometimes forgotten is, once you have made a serious offer (your due diligence period), you should explicitly ask the seller ( as part of the offer) NOT to enter into another leasing agreement at prices/conditions not approved by you.

Good Luck !!!

Thomas S. · Answer

As Scott suggests lower your offer accordingly, make it clear as to why you are lowering the price and move on.

Scott Skinger · Answer

@Terrence Williams As part of your DD you need to have your lawyer review the actual lease and see what your options are. For now, take the PM's word on it and assume that what they are telling you is accurate. The amount they are paying should be included in your underwriting for the current year and the next 13 years (including the new 10 year option to renew). The gross income should be adjusted down to include what is actually to be collected (not the market rate). Less income lowers the NOI and thus the value of the property.

You should only buy the property based off of the actual gross income, not what it could be generating. Ultimately, if they are trying to lock in a long term "good deal" for themselves they are really just screwing themselves because they are lowering the value of their property exponentially.

You don't make clear whether or not you plan to continue using the PM. This could be a strained relationship. Feel free to share numbers if you want some specific feedback.

Good Luck!

Hadar Orkibi · Answer

it’s tricky having him locked in there for 3 years.

It depends on how good is the deal for you to consider if it’s worth pursuing.

What’s the upside? And cash on cash returns?

Considering he is also the manager it’s somewhat tricky,

You should first vet him as a PM and make sure you can change pm if required.

Work the numbers on actual rent, including his lower one.

Are all other rents at Market?

Talk to the tenants for some feedback about him!

How to negotiate long undesirable lease on apartment purchase

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