What Would You Do - Rental Offers?

Hey guys,

hope all is well!

I’m hoping you can provide thoughts/guidance on this situation.

I’ve been approached to rent out a warehouse I purchased. The potential tenant is a national brand with over 100 franchised outlets.

They have offered 10 x 5 x 5.

The caveat is, they are offering around 15% below the market rent for that property in that area. The rest of the terms are good, plus outs, plus GST, annual increases etc.

They want a significant cash contribution towards fitout, equal to half a years rent.

The agent is trying to sell it by telling me that a lease of this covenant, this term, will do wonders for the valuation cap rate.

I understand what he is saying but also I know that area is pretty tight and if I went to market I could get 15% more rent but potentially a 3 or 5 year term with a less well known tenant.

Going off your gut, what would you do? Take the long term security at a lower rent, or go for higher/market rent with the potential pitfalls around that.

If you have experience in this area or can provide input could you chime in with thought?

TIA

 

Things to consider:

• 10 year initial lease is attractive
• Who is providing the guarantees (the franchisor or the franchisee)?
• What form - bank guarantee + corporate/personal? How much (6 months gross?)
• Rent review mechanism (you will want the greater of CPI or 4% - your agent will advise the appropriate escalation)
• Is it a nett or gross lease? Which expenses will they be paying?
• Will they be paying the legals for both parties?
• What claw back do you have over the incentives?
• Who owns the fitout? Check with your accountant as to the best structure & your solicitor as to liability for 'make good'
• How long would you be waiting to find an alternative deal (probably only 3-5 years with lesser tenant & 3 month incentive x 2 or more tenants) - what greater hit will you take waiting for other offers?
• What alternative sites are they considering?
• How strong is your position?
• Will the commencing rent be less than the previous rent?
• You will be receiving rent from day 1 rather than in 6 months - are they getting a fitout period as well?
• What will be the effect on value if the cap rate strengthens from say 5% (standard tenant & rent) to say 4.5% (for good covenant & lower rent)? Pick the numbers appropriate to your market.

 

@Scott No Mates cheers thanks for the input, a few things to consider there.

Lease held by franchisor and then sub-lease to franchisee.

Bank guarantee provided by franchisee.

My position is pretty strong, historically there is a very low vacancy rate on this strip. I would do it for ease and simplicity.

I can carry the building if we went to market and it took a while to find another tenant.

In terms of fitout I have not checked who would own it. Will find out more details about that.

I do need to research more ability the cap rate, I spoke to one valuer I know who said it would achieve a lower cap rate but I need to clarify those details. I might pay for some advice around that.

They do want the building ASAP so there is that to consider as well.

Thanks for your input, I’ll keep you updated as it progresses.

 

I'd want the franchisor to provide the guarantee as the franchisee may change/sell the franchise/fail

Good to have options & a strong location

You don't want the responsibility for maintenance or stripout but if you can depreciate it or claw back if the franchisee sells during the term

The earlier the cash starts to hit your pocket the better.

Push to increase the rent to maintain your asset value.

 

Have you counter offered at all? I would always counter offer on something like that as no one puts their best foot forward.

Run the sums but you could go back with +10% on their offer plus 3mths at 50% rent plus equiv of 3mths fitout

 

@SeanR - how did it pan out?

 

@Scott No Mates thanks for checking in, I have been meaning to update.

As @Westminster mentioned, I have countered twice. They are coming to something that is worth considering, but only if I can source another property for my business. There are two options in that regard at the moment, I am just weighing up whether I want to go for them, and how hard.

I have also spoken to a town planner about adding around 150m2 of GFA, and he thinks there is a good chance to get it through. So I'm just letting that mull over for a bit.

@Scott No Mates if they raised their offer by 10%, I would jump on it, but these guys have been continually just low-balling, almost to the stage where it's been funny. Even the agent was shaking his head at the start of this process, it's been quite frustrating. At the end of the day, I don't need to lease the property to these guys, and unlike other owners, I don't feel pressure to get it rented from day 1. That would be good, but I don't want to lock it up at below market rates for the next 10 - 15 years.

 

OK...so one of those options I mentioned is off the table. Agent just called.

I had put in a bid, reasonable size but not over the top. Put it in yesterday. Agent just called to say they have had another cash unconditional offer at 70% above my offer!!! Even the agent is shocked. This offer is around 50% above what he thought it would go for...

 

Hey guys,

so there have been a few updates:

- I paid an independent property consultancy firm to review their offer and also provide a report on other leases in our area for this kind of business and provide an indicative valuation if we did proceed with them. Honestly, that was awesome as it was great to see what else is happening in the marketplace and get a peek "behind the curtain." It cost me a few grand but a great investment in my opinion.

- Once they knew I was doing this then suddenly they bumped their offer and sweetened the terms.

Now we are back in negotiations and they have increased again and it is getting somewhere serious. I am just concerned about locking it in for so long at a lower rate but there is also the security it would provide. Now they offering a 10 x 10 lease and landlord owns all the fitout. Yearly increase is not that great (3.25% or CPI) but it's better than the original offer.

Question for those out there, have you noticed a slow down in leasing/sales/general activity at the moment?

 

I think this answers your original question.

 

@SeanR - sounds like they're moving in the right direction.

A market analysis is money well spent if it provides support for your position and you have adequate background information.

A 10 year lease would usually have a market review at the mid-term and on option.

The greater of % or CPI covers a multitude of sins, if it's retail you must nominate the type of increase applicable, in current climate possibly CPI or CPI+1% if they have no alternative sites.

 

@Scott No Mates thanks for your assistance and thoughts here, greatly appreciated.

So basically they wouldn't meet my lowest figure so they bumped the lease term to 10 years, that is how we arrived at 10x10. So I said, "ok fine, but there is a ratchet clause during the initial 10 years" and they agreed to that.

Now...they come back today that they won't agree to the greater of 3% or CPI. They want it a flat 3% increase for 10 years. So yeah, I wish they had outlined that when we started the negs as I have been firm on that since the outset (i.e. greater of 3% or CPI.)

Anyway, kinda frustrating as I thought this was pretty much wrapped up. But I am not going to get locked in for that period with a flat increase. So I rang an agent I have dealt with, he suggested if they are firm on this, put a market review after 5 years and a ratchet clause during the 10 year term.

So a review after 5 years and at option.

Do you think that compensates for having a flat 3% increase and no CPI increase?

 

If you're stuck on 3%, market at yr 5 & 10 will address any shortcomings provided that the market review can lapse should you decide not to have a review (why? If market falls, you don't want to chase the market down & it's better to receive a $nil review than to reduce the rent).

 

Ok got you. Wouldn't having a ratchet clause during the initial 10 years help in this regard as well?

 

@Scott No Mates it's pretty frustrating to be honest, but at the end of the day this location/area may just be too high cost for them. I.e. property values are incredibly high and the area is slowly turning more into a high end showroom location. I can always move my business in there which is actually better for me in terms of cashflow as I don't have to give these guys the big incentives. I do have another larger and much more industrial property under contract which I got at a decent price so I'll look to lease that one out instead if this falls through.

 

If it's retail, you can't have a ratchet clause for all other commercial, it's fine. A market review exercised at the lessor's discretion serves the same purpose.

 

It's an industrial area and this would be a commercial lease.

So yeah, it seems like the 3% is a sticking point. They won't agree to a mid-term review, so they want 10 years at a flat 3%.

I rang the consultant who provided the market advice and he said he didn't think 3% is that bad to be honest and wouldn't affect the valuation. I thought not having a "greater of % or CPI" increase would be a pretty big negative.

In your recent experience is a 3% increase on that term ok? Or a complete deal breaker?

TIA and appreciate all your input.

 

2-3% has been the target for CPI by the Reserve Bank over the past several years.

CPI over the next few years will be above the target range.

All of the longer leases that I've dealt with have contained a mid-term market review.

Do some numbers - a 3% pa increase for 10 years = 30.4% above the initial rent.

If it's a nett lease, then the outgoings will increase at market rates regardless.