6,000 feet of ground floor: one bay for a grocer at $14, or four bays at $26 each

Question

Toured a building going up in a mid-size market, 28 apartments over 6,000 square feet of raw ground floor shell. The developer is selling it before stabilization and he's open about the fact that he can't decide how to demise the ground floor, so whoever buys it inherits the decision.

Option A is one tenant. There's a small-format grocer that's expressed interest in the whole 6,000 at roughly $14 triple net, fifteen years with options, and they'd want a build-out contribution somewhere north of $40 a foot. One rent check, essential retail, the kind of tenant that keeps the sidewalk busy and makes the apartments above lease faster.

Option B is four bays at 1,500 each. Local operators, coffee, a nail salon, a small clinic, whatever the market brings, at $24 to $28 modified gross. Higher gross rent per foot, more tenants, lower lease-up costs per bay, but four sets of renewals, four sets of collections, and small local businesses fail at a rate that a grocer doesn't.

Run crudely: A is $84k of NNN rent with almost no leakage. B is maybe $156k gross, minus recoverable expenses I probably can't fully recover on modified gross leases, minus real vacancy across four small tenants, call it $105k to $115k effective if it goes well. B wins on paper by a fair margin. A wins on the residual, because a fifteen year essential-retail lease is worth a different cap rate than four local leases with two years average remaining, and it's the thing my lender will look at hardest.

There's also a demising cost problem. If I build for four bays and then want one tenant later, I'm tearing out walls and moving plumbing. If I build for one and lose them in year six, I'm demising 6,000 feet of dark space in one go.

I'm not a developer and this is my first serious look at anything this size, so I'd like to hear people who've actually held ground floor space argue this out.

karen_whitfield · Answer

You've buried the answer in your last paragraph and then walked past it. The demising decision is the irreversible one. Rents renegotiate, walls and plumbing don't, at least not cheaply.

What I'd want to know before either option is whether the shell was poured with the drains and grease capacity for four food-capable bays or one grocer's layout. If it's already committed structurally, your choice is narrower than the developer is implying.

samantha_ruiz · Answer

$40 a foot on 6,000 feet is $240k of tenant improvement money before you collect a dollar. On $84k of annual rent that's nearly three years of gross rent going out the door up front. Where's that coming from? If it's a TI reserve funded at closing, it's in your basis and your lender's sizing. If it's out of pocket, option A just got a lot less comfortable for a first deal at this size.

Option B's build-out is usually cheaper per bay and staged, which matters when you're funding it yourself.

marcus_hale41 · Answer

I look at this from the exit. A buyer three or five years out underwrites your ground floor by weighted average lease term and tenant credit. Four local operators with rolling two year leases means the next buyer assumes turnover and prices it accordingly, and every dollar of that assumption comes out of your sale price. The fifteen year lease does the opposite.

So the real comparison isn't $115k versus $84k of income. It's $115k at one cap rate versus $84k at a lower one, plus the $240k of TI as a basis adjustment. Run it both ways with an exit and the gap narrows a lot, sometimes reverses. Depends heavily on what cap spread your market actually shows between anchored and unanchored ground floor, and if you can't find that spread in local sales, you're guessing. In a fair number of states sale prices aren't public at all, so you may need a broker to pull comps for you.

paulgrant17 · Answer

The thing I'd want to check is what the grocer does to the apartments above. Twenty-eight units leasing into a building with a small grocery on the ground floor is a different marketing story than a building with a nail salon and a vacant bay. If it pushes residential rents even $30 a unit that's $10k a year on the residential side, which changes the comparison and doesn't show up anywhere in the ground floor math.

Goes the other direction too if the grocer's loading dock and 6am deliveries sit under someone's bedroom.

priya_n21 · Answer

Option A, for the reason I keep coming back to on everything: one rent check versus four. I'm trying not to buy a job. keystone's TI number is the real objection though, and I don't have an answer to it.

dmitri_v6 · Answer

Before either option, read what the grocer's letter of intent actually asks for. Fifteen year essential retail deals of that size routinely come with an exclusive use clause, a co-tenancy provision, and restrictions on what you can do with the rest of the ground floor and sometimes the parking. If they get an exclusive on food sales you may have permanently killed the coffee tenant in option B as a future fallback.

Also look at the assignment and go-dark language. A tenant that can go dark and keep paying rent for eight years leaves you with income and a dead sidewalk, which is the worst version for the apartments upstairs. Have a real estate attorney in that state read it, the enforceability of some of these provisions varies.

kevin_lombard · Answer

warrant, I had to read your reply twice. So a tenant can stop operating and keep paying, and that's worse than them leaving? Because the space stays occupied on paper so you can't re-lease it, but nobody's walking in the door for the other bays?

ember, the part that surprised me in your post is that the developer is happy to sell before deciding. That feels like he's selling you a decision he doesn't want to be wrong about.

6,000 feet of ground floor: one bay for a grocer at $14, or four bays at $26 each

7 replies