Investment Grade STNL. Going Dark or extending lease term?

[Zahid Aziz]

When does an investment grade tenant typically renew their original lease term? 

Lets assume there is a medical property like a dialysis center Davita/Fresenius with 1 year left on the lease and 1 - 5 year option to renew. 

When would the landlord be informed if the tenant will renew or not. Would it be on the last 5th or 6th year. If property with similar lease terms are on market. Is it possible that the current owner knows that the tenant is not planning to renew their lease? 

[Joel Owens]

Hi Zahid,

We have talked in the past.

Often what attracts investors to STNL that has 1,3,5 years left on the lease is the HIGHER CAP RATE potential on the purchase. That is until they understand how the financing works in that space.

Lenders assess RISK based on credit of tenant (investment grade usually most coveted), followed by lease term, location, and borrower.

If you flip the credit of the tenant to where it is mom and pop or small franchisee then it becomes reverse typically. In that case the lenders rely more heavily on the borrower and their income. The lenders know odds can be higher the tenant goes dark and the lender wants to know the borrower can keep paying on a vacant property and have enough money to pay all the fees involved to lease it back up.

So in the past (FASB) Financial Accounting Standards Bureau the tenant only had to book a partial primary  term lease value for their debt load. With recent changes it can require many tenants to book the full value of the primary term of the lease. So it has caused primary lease terms in some cases to shrink from 15 to 25 years to 10 to 15 years.

With a newly minted lease the developer usually wants the LOWEST cap rate on sale because they have short term capital gains tax, legal fees, real estate commissions to pay and they have not hardly made any cash flow off of the property. 

There is a sweet spot where some years have gone by on primary but good loan terms can still be found. Developers often will sell at a slightly higher cap rate because they have made some years of cash flow off of the property and are typically looking at long term capital gains tax versus short term if they do not want to 1031 exchange. The minimum loan guideline is 7 years and up remaining in primary term for most STNL lenders. Anything under that is very hard to finance think typically 50% down or more and short amortization to accelerate paydown. Lenders want mortgage balance to be below dark value before primary term ends in case option is not renewed. That way if owner can't lease the property back up in a reasonable period of time the lender can likely take it back and sell at break even and not a loss on the note after legal expenses.

Notice to renew is spelled out in the lease. Most are 3,6,9, or 12 months. I have on a rare occasion seen 18 months or even 24 but not typical. If you can find 9 to 12 months that tends to be good. There are buyers of a few remaining years left on the lease ( I am one of them for value add) but are typically all cash plays.