Negotiating lease terms for NNN commercial build-to-suit

[Scott Morris]

As an investor I am currently negotiating a buil-to-suit NNN lease that I am building from the ground up and will have a lesser known national fast food franchise as the tenant. I will be getting a 20 year lease but I would like some opinions on determining what the base rent, possible percent rent, rent escalators, etc could be? I will be negotiating with the franchisee and not the franchise itself.

Regarding the base rent, if the project (land and construction) is valued $1.5M should I use the CAP=NOI/value to determine the rent? Let's say we agree on a 10 cap rate and the NOI is basically what the rent would be since there would be very little to no expenses (except for attorney/accounting fees) then that would make the annual rent $150,000. Or do I just calculate the rent according to the square footage for this type service in the area? Any other options?

As for a percent lease,  what different formulas have been used regarding what percent over a certain breakpoint on gross vs. net income of the business?

Rent escalators? For commercial properties, what are some are the norms for rent increases, 1% a year, 3% every two years, 5% increase after 5 years?

Please feel free to add any comments regarding your experience with negotiating lease terms. 

[Joel Owens]

Scott you need a broker who knows NNN.

I eat,live, and breathe this stuff.

You should already have a forward commitment from the tenant to get the construction loan from the  bank.

If you already own the land then you would not be doing a leasehold type arrangement for the lease.

Your other options then is a ground lease where they construct the building and if they do not renew the option period you tend to get the building by default.

You could also get the NNN (no landlord responsibility) or NN ( landlord responsible for roof,structure,parking lot ) depending on what you negotiate. You own the land and building on those.

Is your goal to hold for the long term or sell off? Usually when you develop NNN most are all in for land and building for a 9 cap or so and sell at a 6 cap for a newly minted lease. A lot of the value depends on the size of the lot, inter-connectivity to other anchors without going back out on the road. If there is just a median turn in, a stop sign, a stop light. sight lines, daily traffic counts, what the concept is etc.

Sometimes even if the franchisee you can get the corporate to back the lease. Franchisees are generally worth less than corporate guarantee. 

When you sell a franchisee better have a higher starting cap rate and more increases. I do not like rental increases every five years UNLESS it is a corporate guarantee. If I have a franchisee that goes up 10% every 5 years and they go out in year 4 I had ZERO increases in rent to offset inflation and diminished returns the last 4 years.

Writing a bad lease can make you lose money on this deal. You need a marketable lease so that an end buyer finds it attractive and the lease can get good loan terms for purchase of the property.  

One developer called me that built out a bank. What they agreed to in the lease with an attorney representing them was horrible and severely impacted the value of the property going forward. I read it and couldn't believe it.

If you want to talk on the phone I am happy to talk for nothing in return. Just do not go blindly into this and make a bunch of mistakes.