Occasionally, I’m asked how I get column inspiration. For me, it’s a combination of reporting on macro trends in our industrial real estate market, advice I give my clients, issues that have arisen in transactions and happenings with the business owners I counsel.
Sometimes, a column idea falls from the sky — which happened today.
Allow me to set the stage. I received an email from a client who recently relocated his business to a smaller, leased location. The previous business address is owned. When my client vacated his premises, he leased it to a neighbor. His plans, in the near term, are to move to a bordering state.
Continuing to manufacture from real estate in California would create an undue tax burden on the income received vs. selling the California asset and redeploying the proceeds into a leased building in a tax-friendlier state. Thus, his motivation to sell.
My client asked what considerations should be given for the framework of the lease agreement, allowing for marketability and security.
Below is the advice I offered.
The lease should reflect a market lease rate or as close as he can get. Value is a return on this rent. Consider swapping a couple of months free to get a higher rent figure.
Build in sufficient annual rent increases. Most leases are written with 4% annual bumps these days.
All “purchase rights” options such as rights of first refusal and rights of first offer should be eliminated.
Make sure the tenant is responsible for all property tax increases when the property is reassessed after a sale.
The AIR Single Tenant Net Lease is widely used to document the deal. It’s common and most investors are familiar.
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Most investors want relatively new roofs and HVAC units. Under a NNN lease, your tenant is responsible for maintenance and repair of these items but replacement is the owner’s responsibility, which can then be billed to the tenant monthly over 12 years. So, consider replacing these before any sale.
These days a five-year lease is a minimum. Seven to 10 years is much better, especially if you have the 4% rent increase kickers.
Finally, credit of the tenant is huge. You’ll want to have two years of profit and losses, balance sheets and corporate tax returns on hand. I’d also see if the principals would personally guarantee the lease to add a layer of security.
Allen Buchanan is a principal and commercial real estate broker at Lee & Associates, Orange. He can be reached at 714.564.7104 or firstname.lastname@example.org.