WinIndustrial / Warehouse (Passive Hold)

Renewed a 48,000 sf tenant 22 months early, gave up rate, took the roof off my own balance sheet

I've owned a 48,000 square foot single tenant distribution building since 2016. Third generation family distributor, 28 foot clear, seven docks, decent yard. Lease was running to late 2027 at $5.95/sf flat, which was well under the $8.50 to $9.00 the submarket was quoting for comparable space.

Last spring the tenant's CFO called about racking. That call told me two things: they were spending money in my building, and they were thinking about time horizons. So I opened a blend and extend instead of waiting for 2027.

Where we landed. New 10 year term starting immediately, rent at $7.80/sf with 3.25 percent annual bumps, one month free at commencement, and the tenant took over roof maintenance below a $15,000 per occurrence threshold with me carrying replacement. In exchange, I replaced the roof up front, a full tear-off and 60 mil TPO with new insulation, $412,000, which is $8.58 a foot.

So I gave up rate against market (I could have chased $8.75 in 2027 with the building possibly dark for six months first) and I spent $412,000 in year one. What I got: rent went from $285,600 to $374,400 immediately, the bumps compound to about $10.60 by year 10, and my rollover risk moved from 2027 to 2035. Both my lender and an appraiser treat 10 years of term on a credit-ish local tenant very differently from 22 months of term.

The part that nearly broke it: my first roof number was an overlay at $214,000, and the tenant's insurer wanted documentation on the existing deck and saturated insulation that the overlay wouldn't address. Going to a tear-off nearly killed the economics until we split the difference by extending the free rent instead of cutting the rate further.

What I'd keep: negotiating term when the tenant is spending their own capital in the space, not when the lease is expiring.

Open question for the room, and it's the one I'm still unsure about. On the roof spend, should I have amortized it into the rent as a separate line rather than absorbing it and taking the higher base? I took the base rent route because it survives a sale better. Curious where people land on that.

Answer

1mikeoconnell7SP2APRO6

On the roof question, base rent was the right call and the reason is how each version reads to a buyer and an appraiser.

If you amortize $412,000 over 10 years at, say, 8 percent as a separate additional rent line, you're collecting roughly $60,000 a year that a careful buyer will strip out of NOI because it stops at year 10 and it's tied to a capital item that's already spent. Your base rent stays at whatever you agreed, and the extra shows up as a receivable, not as income. Buyers pay a capitalized multiple on durable base rent. They pay something closer to face value on a defined recovery stream. At an 8 cap, $88,800 of extra base rent is worth $1.1M of value. The same money coming through an amortization line is worth $412,000 plus interest and nothing more. That's the whole argument.

On the roof scope itself, since that's the part I see daily. Overlay at $214,000 versus tear-off at $412,000 is a normal spread, and the insurer was right to ask about the insulation. Wet insulation under a new membrane keeps losing R value and the fasteners keep working loose, so you get a 10 year roof out of a 20 year system and you can't warranty the assembly properly. Get the manufacturer's NDL warranty registered in your name and keep the moisture survey in your closing file, because a buyer's inspector will ask for both and a roof with paper behind it is worth more than a roof with a receipt.

One thing I'd tighten next time: the $15,000 per occurrence maintenance threshold should have an annual aggregate cap too, or a tenant with a leaky year hands you five separate $14,000 repairs.

2 replies

1paulgrant17PassivePRO5

I don't have anything useful on the roof accounting, but the racking phone call as a signal is going in my notes. It never occurred to me that a tenant asking about their own equipment is telling you about their planning horizon.