Our new CompVault feature has triggered a variety of reactions, ranging from “Why hadn’t I thought of this” to “This feature is useless.”
The cynics’ usual reaction is to say “Every deal is different”, so what a landlord proposes to one tenant isn’t applicable to the next. Each deal is heavily dependent on the tenant’s credit and the length of the lease term.”
While I agree that this is true, I have never seen anyone actually attempt to quantify just how much these two variables impact the terms a landlord is willing to offer.
At the highest level, every landlord is concerned about the tenant’s credit and lease’s term simply because these two variables have an immediate impact on the value of their property.
While a tenant’s credit and the length of a lease do impact the value of the property, it is not a 1:1 ratio. For instance, if the tenant agrees to a 10 year lease, instead of a 5 year lease, the landlord isn’t going to agree to cut the rent in half, from, say, $20.00 psf to $10.00 psf.
The reason for this is that doubling the lease term isn’t going to double the value of the building.
What a longer lease term will do is compress the capitalization rate a buyer would be willing to buy the building for by 25 or 50 basis points. Let’s looks at an example.
Assume a 10,000 square foot building and offering to lease space to a single occupant on a 5 or 10 year term:
|Base Scenario||Option #1||Option #2||Option #3|
|Lease Term||5 years||10 years||10 years||10 years|
|NNN Rent PSF||$20.00||$20.00||$19.00||$19.50|
|Market Cap Rate||10.00%||9.50%||9.50%||9.50%|
Assuming the cap rate falls by 50 basis points from 9.0% to 8.5%, the landlord can do one of four things:
- Hold the rental rate constant at $20.00 and realize an increase in asset value of $105,263
- Reduce the rent by $1.00 from $20.00 psf to $19.00 psf and maintain the building’s value of $2 million
- Something in the middle, so that the tenant realizes some savings, but the asset still has an increase in value, too
- Provide with an incentive package of $105,263 (in the form of more TI, etc) if they do select the 10-year option
Let’s say the Landlord opts to hold the value of the asset constant at $2 million and reduces the rental rate by $1.00 psf to $19.00. This means that the tenant would realize a savings of 5.0% for agreeing to sign a 10-year lease, instead of a 5-year lease.
Using LeaseMatrix’s CompVault to record and refer back to prior landlord proposals, brokers will begin to see a patterns which help them better identify landlord preferences.
For instance, some landlords would prefer to avoid upfront capital expenditures and opt to reduce the rental rate to entice the tenant to sign a longer lease. Alternatively, some well capitalized landlords prefer to make an upfront investment in order to maintain their property’s rental rate.
While every deal is different, understanding each landlord’s preference enables you to become a better negotiator.