Tenant interview - is this reasonable to request for S&P

[Raj Singh]

I am looking to close on a NNN property. I find it a bit highly priced psf (370 psf) but reasonable based on tenant profile and ROI. its basically 7.1% ROI of a national dental chain in Southfield MI paying about 25++ psf with escalations and 7.8 years remaining.

Since this deal is clearly predicated on tenant strength, one of the stipulations I requested for prior to executing the s&p agreement is to allow for a tenant interview and to review tenant financials to assess likelihood of tenant renewing. 

I was advised by my realtor and lawyer this is not commonly requested. Almost made to feel this was an odd request and "Ordinarily, in all commercial leases, theres is a provision with respect to a renewal option that the tenant must exercise with in a stipulated period prior to the expiry of the lease. I assume, that is likely the case in this lease as well. We will certainly have the opportunity to review all this during the due diligence period."

We do have a copy of the lease and there is options to renew, but ofcourse these remain tenant options. My confidence of easily renting it out at the end of expiry at the current entry price to maintain the same NOI is not high should tenant not renew.

Are my requests entirely out of the ordinary? At 2M+ price tag, Id have imagined tenant interviews are reasonable, particularly in tenant dependent leases. 

[Joel Owens]

Your broker and your attorney should be helping you with due diligence as that is what they get paid for to earn their fees.

So you have a single tenant national dental chain with 7.8 years remaining on the primary term correct?

You mention NNN lease but is it really? Often the flyers or offering memorandums are input by assistants that make all kinds of errors. You have to verify what it says against the leases and amendments to see if accurate. You could think you have a NNN property when it is a ground lease, or that it's not a NNN but NN. The NN leases could just be roof with a warranty transferable to buyer or it could be roof structure, utility lines, parking lot, etc.

You mentioned a national dental chain. That means nothing. It's WHO is on the lease. They could have 2,000 locations but for this lease set up a subsidiary of just 300 stores, even worse a few local locations, or the worst a single entity remote LLC they can easily bankrupt and walk away from the location.

Look for any early termination clauses in the lease. Notice to renew I have seen 3, 6, 9 months or 1 year for advance notice. The longer the better. For most STNL lenders for high quality loans the cut-off is 7 to 8 years remaining on the primary lease term. We do not typically conduct tenant interviews for STNL national tenants that are investment grade. That is usually more for regional tenants to mom and pop in retail strip centers for a level of clarity in how their business operations are running.

Whether the national chain discloses parent company financials and local store level financials is based on what is in the lease. If they are not required they can tell you to go pound sand. Sometimes if not in the lease but seller has a great relationship with them (they onw or developed a lot of locations for them) they can get something verbally (off the record) or if in writing the business will not guarantee as accurate or audited.

It is important the sight lines of the property and what junior to large anchors are surrounding the property for daily feeder cross-traffic to the site. Check how many dental locations in 1,3,5 mile ring radius for competition and how are this locations online reviews and testimonials.

2m+ for STNL is like 50,000 house in residential. My clients all the time think it is a big range but it is very limiting in what you find in that range for quality of location and the tenants. More realistic is 3 million plus. It can be done in 2m+ but good stuff gets offers the first day or two on the market. Lot's of junk and little quality in that range.

It's like houses. Lot's of home builders have pulled back on development. Houses under 100k have declined by about 15% even though demand is strong for those properties by home buyers as that is all they can afford. Problem is with land and building costs most homes starting price brand new is 200k plus and usually starting from 250k.

In MI it is especially important to not have a NN property in a cold belt state. Those parking lots and roofs can get trashed and need constant work due to the extreme weather patterns compared to many warm belt states where weather is more stable and generally requires less maintenance even if you have a NN lease.  Most STNL lenders will want to see corporate parent books and not just the individual location.

They can feel better about a company that is doing well overall and this particular location might be struggling. In that sense they have time to figure it out showing systemwide they are a success. If store is doing well for location but the whole system has issues that tends to give the lenders much more pause and concern.

Check rent rates for that box size to make sure vintage rent in place is replaceable. Check last time store was reimaged as that can be a good sign even if sales are not disclosed that they are performing well. Typically if they are doing okay the business will hold off on major improvements and wait to move to somewhere else better. Additionally pay attention to assignment rights in the lease and if at some point the guarantee burns off or they can transfer the lease to another tenant and leave and be released off the hook. If they move and sub-lease until primary runs out you want their guarantee to remain. Check property taxes with re-assessment upon sale. Even if absolute NNN the tenant will be paying you the lease rate for rent and then that business will be paying the property taxes, landlord insurance, repairs and replacement to the property, and all their other business costs. So a state, county, city on a recovery can jack up the property taxes to a point where it affects your STNL tenant in a negative way. This can cause them to move to another area or renegotiate the rent when options come up. Most STNL properties around 2 million are about 75% cash purchases with no loan. When you get to 4,5,6 million type properties it reverses. Maybe 25% are cash purchases and rest are financed with some down. Reason is if someone has all of that cash they do not want to place into one property. They would rather buy multiple and spread risk among tenant types and market locations to diversify the portfolio.

Good luck. No legal advice given.