Are they asking for a reasonable rent reduction?

Question

I own a NNN lease that I purchased 15 years ago. I have some residential real estate experience but nothing in commercials. The property is in a different state and I’m not familiar with the market in that area.

For the first 10 years, the rent was $17.35 a sqr ft

For the last 5 years, the rent was $19.28.

The tenant is coming to the end of their lease and they are requesting a substantial reduction: $17.20 for another 10 years.

They sent me a “Lease Comps Summary” report to support the notion that the rent should be lower.

I’ve called some local brokers to try and find out what the market rate should be and brokers tell me, “high teen”. That’s just too vague.

How can I determine what the market rate should be for this property?

Is there a service out there that can help me?

Any advice would be appreciated. Thanks

Justin Abdilla · Answer

As an attorney, I have little else to say on this matter, but I would stress this.  Flat rents are lost money, and are huge concessions to your tenant.  For all we know, inflation could be 3% next year with the growth in the stock market, and you need to manage the risk of the $17.20/ft2 being worth less than $17.20 in 2020.  You need to manage the risk of the property or the neighborhood appreciating.  I would not give a 10 year lease for a flat amount unless they are already paying a big premium for year 1.  A flat rent lock-in with rent reduction is foolish.

Joel Owens · Answer

Why not get a commercial retail attorney to help you? They typically charge by the hour.

Any brokers worth anything are not typically going to want to work for reduced fees.

Look at it this way. Unless they are a commercial principal broker and keep all the money they make they will have a split with a brokerage. Most commercial that is 50% on a team or maybe slightly better split if just them.

In commercial real estate it works usually like this:

Broker:

Property management: Retail center with 300,000 gross rent at 4% management fee is 12,000

Consulting fee maybe 10,000 so doesn't even pay what property management does which is usually the lowest return.

Then leasing broker commissions. On a 5 year deal worth 600,000 in rent maybe 24,000 fee of 4% of primary term lease value.

Then say a transaction of 4 million for a broker commissions might be 100,000 for one deal.

Then highest is a retail syndicator taking a fee going in, ongoing cash flow, and upside on the deal.

It just seems a commercial retail attorney that charges by the hour and is familiar with STNL properties and negotiating renewals might work best for you. The good ones are typically 300 plus an hour for billable time or greater.

No legal advice given.

Jameson Sullivan · Answer

First, I will say, you should not be hesitant to involve a broker and pay a fee. It will be much more expensive for you if you try to negotiate with a national tenant on your own without understanding the local market. They will walk over you...

Retail rents are a lot tougher to track then, say, residential rents. Generally with residential rents, what you see is what you get. There's too many variables in a retail rent to look at a data print out of base rents ONLY and be able to tell what "market" is.

Where is the building located and who is the tenant? How big is the building? If you can get more granular with the information, maybe we can help a little more.

As a SUPER basic example, lets say the building is 5,000 ft.

Current rents: $19.28, NNN ($96,400/yr)

Requested rent: $17.20, NNN ($86,000/yr)

Income Difference: $10,400/yr or $104,000 lease life value.(Assuming flat rent for the ten years as you described)

Value difference @ 6%CAP : $173,333.33

Scenario 1: You give the Tenant the reduction and lose 10k per year in potential rents which equates to $173,333.33 in sale value if you were to sell. This deal costs you zero dollars out of pocket and you continue with the great Tenant.

Scenario 2: You decline to give them the rent reduction and they sign a long term lease at your asking rent. This is the best case scenario.

Scenario 3: You decline to give the reduction and they leave. You relet the space using a broker (which you need for this) at $20/foot, NNN. Here are some costs you may incur:

1. Vacancy $7,166.67/month

Commission : $44,000 ( Assumes a 10 year deal, no rental increases, commission is 6% years 1-5 and 3% years 6-10)

Tenant Improvement Allowance: $15 - $20 PSF or $75,000 to $100,000.

"Total Cost" of deal excluding vacancy: up to  $144,000.

Net Value on sale from doing the new deal(Value added - cost): $29,333.33

Total additional rent from doing the new deal(Total Potential Rents - Total requested Rents X 5,000ft X 10 years): $140,000 over the life of lease.

Net revenue of Lease life if you do not sell(Total revenue - Cost): -$4,000.

This example is extremely basic and assumes a TON as I don't have sufficient information. You can start to see though that there is no right answer. Your situation/desire for the future is going to weigh heavily into what you need to do.

Jameson Sullivan · Answer

I think you think your tenant is looking a lot deeper into their landlord then they really are. If they truly are a national tenant, they aren't researching you and finding out where you live an asking for a $2 reduction because they think you're weak.

It seems you've gotten a lot of similar feedback here but just don't want to move in that direction. That's totally fine if it's the decision you want to make, but the fact of the matter is that you bought a retail asset and there are costs associated with that which include commissions to brokers and TIA. If you really don't want to pay a broker or you think you will break even by hiring one, then just sign them at $17.20 and go back to enjoying yourself!

Jameson Sullivan · Answer

By the way, what I think you definitely should NOT do is agree to flat rent for the next decade no matter where you land with them for next years rent.

Ronald Rohde · Answer

Your attorney is only for negotiating the numbers you provide. No attorney is going to be a market expert like a broker. That said, I think you're evaluating it incorrectly. The $10k is for knowledge, you pay that because you lack something. Its not a bad deal if you pay and find out market rent is $17.20. Thats the price to play.

My 0.02$ take the 17.20 with 3% increases and see if they bite.

Joel Owens · Answer

The rent value is generally tied to not who is currently in the space and on the vintage lease but WHAT the current local market is doing and WHO the new tenant might possibly be national, regional, mom and pop, etc.

I mentioned it is not even about the rent value only but other factors. For example if you have a mom and pop tenant based on 17 bucks a foot rent because that is all their business model can support but a national tenant wants the site and can pay 22 because of location not only can rent potentially increase but also that new tenant value can be a massive difference.

Mom and pop at 17 a foot and an 8 cap for instance.

Say 4,000 sq ft box X 17 = 68,000   (8 cap) = 850,000

National tenant at 22 a foot. 4,000 X 22  = 88,000  (6 cap) = about 1,470,000

There are expenses involved getting the new tenant but value difference can be massive.

Leasing brokers can perform a (void analysis) which not only looks at rent comps for box size but also what existing tenants are in the market,saturation levels, and what possible tenants optimally could go in that space.

Renewal options are a dance between landlord and the tenant. I have seen tenants cry that they are losing money and want a big rent reduction. Updated financials were requested. They did not want to show. Landlord sued the tenant. Once tenant saw landlord was serious the tenant caved on rent reduction request and has been paying their normal rent for years now without a peep from them.

Another tenant a nail salon complained of paying highest rent in the center which they were not. They just wanted to test the new landlord. New landlord said they have list of tenants ready to go into that space and let them know when they want to vacate. Nail salon still there years later paying the rent like clockwork.

You have to see as a landlord if tenant is bluffing and has real financial problems and if so are they long term or short term in nature?

You might be overthinking all this and the tenant is just throwing out a reduction and seeing what happens. You could also try to change the structure of the lease with a base rent plus bonus rent to landlord with annual sales over a certain gross number.

Remember there is the location quality itself, the building design and quality of construction fit and finish, the parcel layout and parking ratios, any junior or large back anchors close by, the sightlines, the access, the traffic counts, and on , and on for valuation. Valuation is part science and part art. You could get a commercial retail appraisal completed by a specialist appraiser who focuses on retail. Those costs generally about 3k to 5k depending on type of building and the size. There can be a big difference between a building on main road frontage and one that is tucked behind another building or turned to the side. There are also leasing consultants in some areas but at the end of that process the possible answer might not be as black and white as you hope for.

So you have many reasons a business can fail or not do well. The location, the business type, the company brand within a business type, the local operator running a business. The magic is when all components are hitting on all cylinders (great location, operator, business type, parent company corporate support, etc.)

I am not telling you what to do or try. This is your property you bought and your money. The ultimate decision of what to do with a tenant rests solely at your feet for the final call.

No legal advice given.

Alex Rand · Answer

Hi Mr. Sullivan,

You said: "It seems you've gotten a lot of similar feedback here but just don't want to move in that direction."

If that's what you think than I'm simply not communicating well.

People have suggested that I get a professional broker involved, but no one has told me how people typically arrange this and what they pay for this kind of help.

Joel first suggested that I offer a broker a flat fee of $10,000, but when I pointed out that working below a full commission might encourage the broker to lure my tenant to another location, he then seemed to change and suggested that I might seek a commercial real estate attorney. The problem there is that most commercial real estate attorneys don't have the market information needed to carry out this negotiation. On top of that, I have the added problem that I could engage someone, they could come back to me and say, "your tenant is right; you need to cut your rate." Then I'm hit with the lower rental rate AND a commission.

Even though I've gotten similar feedback, I really haven't found the answer to this question: "How do landlord in this situation typically handle this? Again, I'm not the first person in a situation like this. Lot's of people have invested in a 1031 exchange property outside of their local area. I'm not looking to re-invent the wheel. What do landlords like me typically do in a situation like this?

Alex Rand · Answer

Hi Diane G,

I'm aware of the pressure on retail stores but the sales of this particular location is trending up. It's a good location. This isn't a matter of greed. I'm not looking to take advantage of my tenant but I don't want to be taken advantage of either.The value of commercial real estate is entirely tied to what you can earn from the property. Lock in a lease rate that is too low for too long and you substantial devalue the entire asset. It's important to go through the negotiation process and establish the correct market rate as best as you can.

Diane G. · Answer

@Jameson Sullivan

correct, that is why I put a disclaimer there... Lol

That said, there were over 9000 store closures in 2019, and over 1500+ so far in 2020...

The retail world has been changed by e-commerce... Either you are Nordstrom or Walmart, or you are a nail salon... but all the "office depot", all the "foot locker" are dying.....

That is why I would not be too greedy here, if it was me... Lol

Are they asking for a reasonable rent reduction?

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