Developer · Fayetteville · Member since 2016 · 91 posts · 57 votes
Hello everyone,
I am currently looking at a value-add office building. The value is converting the current tenants who are all on a month-to-month lease into annual leases and filling current vacancies. Most tenants have signed these leases 2-3 years ago and still occupy the building which shows their commitment to their space and would make a case of asking them to sign an annual lease. Obviously the risk is that in attempting to convert these leases you lose some occupancy (the building is currently at 63%) or worse case all of the current tenants. I deal mostly with annual leases in value-add deals so converting month-to-month leases are a new avenue for me. Can anyone share insight into converting these leases and the best course of action?
Rental Property Investor · Cranford, NJ · Member since 2019 · 245 posts · 148 votes
6y
@Brian Wheeler I would wait till the vacancies are occupied with tenants that signed a lease. Then I would approach each M to M individually and discuss their commitment to stay and sign a lease. Also, if you can try and stagger the termination dates. Don't have them both expire the same time. Try and spread them 6-12 months apart.
Rental Property Investor · Cranford, NJ · Member since 2019 · 245 posts · 148 votes
6y
@Brian Wheeler I would wait till the vacancies are occupied with tenants that signed a lease. Then I would approach each M to M individually and discuss their commitment to stay and sign a lease. Also, if you can try and stagger the termination dates. Don't have them both expire the same time. Try and spread them 6-12 months apart.
Real Estate Agent · Renton, WA · Member since 2019 · 27 posts · 29 votes
6y
@Brian Wheeler Since you would be asking for something of value from the tenants I would be prepared to offer something in return (i.e. a slightly lower rental amount, a month of free rent, etc.). I would start the conversation by asking them questions about their future plans for their business and taking the approach of how you can help them while also improving your situation as their landlord. You are after all, giving them more stability as well in that you can't terminate their lease and make them move their entire business on short notice.
Also, it costs tenants to move and it is a hassle. Therefore, as long as the deal you offer them in a new lease is competitive I would think that you could greatly mitigate the number of tenants that vacate, if any. Additionally, I can't think it would be very easy for them to find another landlord that would offer them a month-to-month lease.
Finally, you mentioned "annual" leases, just to be clear I would enter into multi-year leases to the extent that they make sense with your business plan for your building. Lenders like to see long term leases at or above market lease rates. So, if you ever decide to refinance or sell, long-term leases would be a plus for you.
@Brian Wheeler I would wait till the vacancies are occupied with tenants that signed a lease. Then I would approach each M to M individually and discuss their commitment to stay and sign a lease. Also, if you can try and stagger the termination dates. Don't have them both expire the same time. Try and spread them 6-12 months apart.
I totally agree. I wouldn't lose sleep over the idea of tenants leaving because they have to sign a lease. Moving an office is a big deal, and they probably expect to move to an annual lease now that there's new ownership in place. In addition to Gaspare's advice, I would deal with each tenant one at a time. That way, if one tenant does get upset and moves out, you still have the others bringing in cash flow while you fill the vacancy.
Attorney · Skokie, IL · Member since 2016 · 270 posts · 109 votes
6y
Lease payments can be among the most significant expenses for business owners. But the fact of the matter is that there are many non-rent fees and use restrictions that can have a significant economic impact on a commercial tenant. For example, if the commercial lease stipulates the tenant is responsible for utilities, consider taking on that expense. Likewise, if the company is responsible for paying maintenance fees, as the building owner, maybe waive common maintenance costs instead of reducing rent.
Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
6y
The month to month leases the rent value may be above market as the tenants are given ultimate flexibility with no commitment to the spaces.
So what they are valuing the building at for 60% plus current occupancy might not be accurate for your model of putting in long terms leases and filling up the property.
So when you offer a price you need to figure in your numbers to get it stabilized and not necessarily current NOI the seller is saying to justify their asking price.
Think of an apartment building renter. If month to month the owner usually charges more maybe 25 to 50 bucks or more a month in rent but if they sign a 1 year lease then a lower monthly amount typically. A lot of office building leases can be gross or modified gross so it's key to know what repairs or updates are needed because that can really eat into a property owner investors returns. Brand new builds still need to inspect for construction and design issues and as you get into older age buildings then lots more things to watch out for. Even if you can convert the office building tenants to an unusual NN or NNN scenario for that product and 1 year leases they might not can sustain the rents.
You have to take inventory of each tenant currently in the building for office. Are they a single location operator or multi? Are they mom and pop in nature, regional, or national (even global)? What is the saturation level for office in the area where the property is located at (rural, weak suburban, strong suburban, urban core)? Talk to an SIOR broker about rent rates, competition and amenities offered from other landlords, etc. and expected best case and worst case for cost and time to get stabilized.
Once you evaluate current business owners in the building analyze them to see if they really need a location there or can they easily move to cheaper warehouse space or move into a home office if they had to. If the do need the location is the current space they occupy reasonable for the business model or do they occupy it because space is cheap or if economic downturn they no longer are expanding but want to stay there but give some space back to you?
I saw this in last downturn where office hit vacancy of 25 to 30% across the board as even with no new building the contraction of existing space put a strain on the market when little to no businesses were expanding. I am not a big fan of regular office. When economy is good those types tend to expand but when economy stalls or goes down those small business owners are looking to save costs anyway they can.
That is why I like retail, medical office, industrial as these spaces serve a specific need and are more hard to vacate and move from due to build outs. If you have a regular office with office and chairs I have seen those places moved overnight before like the wind. I don't like the thought of tenants that can easily move anywhere and set up shop again with little effort. That doesn't give (stickiness) and more safety to a properties cashflow but instead can insert more risk for the investor. Now if the current rent is just a little bit above rent rates for surrounding warehouses then the tenants might see value in office because for a little more they tend to get better construction quality, amenities, and more road front business exposure than being tucked away in a warehouse park. If however the rent gap and difference is very wide then the business owner has to really see the value in the office space as a necessary cost to their business model versus alternatives at cheaper costs.
Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
6y
Additionally the longer the primary term of the lease can be negotiated with terms favorable to the landlord the more typically the cap rate drops on resale because the stability of the cash flow model,tenant base, along with area location is what is being sold.
