Lease negotiation during due diligence

[Todd C.]

Hey all—I'm a residential investor making the move to commercial after having a good experience with a mixed use property. I'm looking at a 3 unit industrial building with 2 tenants up for renewal within 2 years. As such i have a LOI in at a nice cap rate.

Obviously this deal is only as good if the tenants extend, so I'm curious what I can do during the due diligence period to either a) get them to extend and b) reduce my risk of vacancy as much as possible. Both tenants have 5-yr extensions and one has very favorable rates (nearly 50% below market NNN rates and is on gross terms).

Secondly, is there anything to do to help massage the very cheap psf tenant closer to market and/or to get them to NN or NNN despite them having an extension option (don't have leases yet so unclear what terms are in there)?Lastly, have you found banks willing to lend with such short terms remaining? Any help would be greatly appreciated!

[Nathan Gesner]

Quote from @Todd C.:

Hey all—I'm a residential investor making the move to commercial after having a good experience with a mixed use property. I'm looking at a 3 unit industrial building with 2 tenants up for renewal within 2 years. As such i have a LOI in at a nice cap rate.

Obviously this deal is only as good if the tenants extend, so I'm curious what I can do during the due diligence period to either a) get them to extend and b) reduce my risk of vacancy as much as possible. Both tenants have 5-yr extensions and one has very favorable rates (nearly 50% below market NNN rates and is on gross terms).

Secondly, is there anything to do to help massage the very cheap psf tenant closer to market and/or to get them to NN or NNN despite them having an extension option (don't have leases yet so unclear what terms are in there)?Lastly, have you found banks willing to lend with such short terms remaining? Any help would be greatly appreciated!

The first part doesn't make sense. The deal is only good if the Tenants extend, but one of them is 50% below market? Why in the h-e-double-hockey-sticks would you want a deal like that? If it's a $2,000 rental, you're losing $1,000 a month, $12,000 a year, and $60,000 in five years. If you sat on a vacancy for one year, then rented it for four years at market rate, you would be ahead $48,000 according to my highschool math. What am I missing?

Second, you should only keep this tenant if they are willing/able to get to market rate during the 5-year renewal term. I would start with a 30% increase the first year (still 20% below market) and then a 5% increase each year after that. By the time their five-year period ends, they should be within 10% of market rates.

I would read the lease agreement carefully. Is the option to renew mandatory for the Landlord to accept? If so, that's a terrible contract and I would recommend you walk away from the purchase.