Retail tenants have closed 7,564 stores in 2019 according to Coresight Research, with Walgreens (Walgreens Boot Alliance: WBA) being the most recent in the string of bad news.
I contend that net lease property owners shouldn’t be nervous despite these closures, so long as they are well-positioned to deal with the changing marketplace.
In this article, I outline factors that affect profit and vacancy in the lease renewal process. As always, I recommend that net lease investors sit down with a professional asset manager, such as Confidant Asset Management (CAM), to discuss options and strategy.
Single v. Multi-tenant Concerns
Single tenant net lease property owners experience the pressure of retail closures more than multi-tenant owners. This is in part because tenants have a significant amount of leverage over single-tenant owners as their sole income stream at that location. Tenants often also have a much larger support team to analyze and negotiate leases.
To level the playing field, there are a number of precautions and “warning signs” an owner should monitor to optimize lease renewal revenue and profit with minimal vacancy.
Tenant Performance at the Property
Including clauses in the lease which require the tenant to disclose financials for the specific location and the guarantor is extremely valuable. Landlords should request store financials on an annual basis – at a minimum – when tenants are obligated to do so.
In lieu of required disclosures, conversations with local store managers on a regular basis may also result in beneficial disclosures regarding the tenant’s performance at the property.
For example, conversations between a Confidant Asset Management representative and a store manager resulted in CAM obtaining information that the store was producing sales above $3.0 M (3.5% rent to sales ratio). CAM tactically used the information to negotiate an expansion of the premises for the tenant into adjacent space, and an extension of the lease by seven years.
This lease extension and expansion increased the value of the property by 48%.
Given that tenants are not afraid to close underperforming stores in the current retail environment, landlords should monitor performance far in advance of lease renewal to prevent an unplanned vacancy and loss of rental income.
Supply of Comparable Properties
A significant supply of comparable vacant land and buildings may result in a tenant moving to a superior site, or a location with better lease economics.
The seemingly simple economics of supply and demand are challenging for net lease property owners to firmly ascertain due to privacy and the lack of readily available data.
Properties may not be publicly available, and rents, rent comps, and sales prices may be undisclosed. Owners should build and maintain strong connections throughout the local brokerage community to gain a firm understanding of land price per acre, rent per square foot for comparable properties, typical lease downtime between tenants, construction costs, and the financial incentives landlords are providing to entice tenants to their properties.
Markets with a limited supply of available properties will experience more drastic rent growth, higher rent numbers per square foot, and less “property hopping” by tenants.
Buildings with poor and dilapidated conditions will likely require the landlord to put up funds to entice the tenant to renew the lease if the deficiencies are not addressed prior to lease renewal negotiations.
CAM works with landlords to determine short-term replacement requirements far in advance of lease renewals. We also manage the inspection and negotiation process in an effort push the tenant to adhere to the terms of the lease and maintain the property to required standards. The bill for property improvements is typically left in the hands of the landlord when disregarded until the end of the lease.
Get ahead of deferred maintenance!
Municipalities which offer development incentives such as reduced impact fees often experience a significant influx of supply driving the price and rents for existing properties downward as tenant demand shifts to newer supply.
Strong job growth and population growth will lead to strong tenant interest in the market. Owners should monitor the demographic conditions surrounding their property and in the property market in general to get ahead of population fluctuations and tenant exoduses.
Confidant Asset Management
There are many factors that affect landlords in the lease renewal process. Confidant Asset Management provides landlords with the necessary tenant and property monitoring outlined above to maximize value and minimize the likelihood of vacancy.