An empty ground floor bay at month five: hold for a credit tenant or fill it with a strong local operator

Question

Take two small mixed-use buildings, apartments above, one vacant ground floor bay of somewhere between 1,200 and 1,800 square feet, both empty since spring, and two owners who land on opposite answers to the same question. One holds for a regional or national tenant. The reasoning: a corporate lease with a real balance sheet is what an appraiser and a future buyer will pay for, it keeps the ground floor from becoming a second job, and $16 a foot from a credit tenant beats $22 from someone who might be gone in fourteen months. That owner is willing to carry the vacancy another year to land it. The other signs a local operator, say a coffee roaster, at a rent roughly 30 percent above what any chain offered. The reasoning: the chain rent is permanently below market, the local tenant draws the residential tenants upstairs and helps apartment rents, and vacancy costs real money every month while the credit tenant is still theoretical. That owner takes a two year term with a personal guarantee and plans to re-tenant if it fails. Both are underwriting something real. The first is underwriting the exit. The second is underwriting the operating years. Which risk is worth owning tends to track how much cash cushion sits behind the decision, more than which argument sounds better on paper.

carlos_nunez · Answer

The second version tends to work out fine in practice, which does not mean it is automatically the right call. What nobody prices properly is the buildout. Say a local tenant needs $40 a foot of work in a raw bay and brings maybe $12 of it. The landlord funds the rest as TI against a two year term, so the money does not come back until month 26 even if the tenant pays every month. A regional tenant would typically bring their own construction money and their own contractor. So a 30 percent rent premium is not really 30 percent, it is closer to break even over the first term. The honest split is whether the owner is buying rent or buying a signature. Take the rent side and the owner is usually still carrying the construction cost on a line of credit until that TI clears.

dmitri_248 · Answer

@carlos_nunez that is the clearest framing in the thread and it points at the documents rather than the rent number. The local operator deal is only comparable to the credit deal if the guarantee is worth something. A personal guarantee from an operator whose only asset is the business you just built out is a piece of paper that costs you legal fees to enforce. A guarantee with a real net worth behind it, or a letter of credit, or six months of prepaid rent held in escrow, changes the comparison entirely. What that guarantee is actually worth and how you would enforce it varies by state, so that is a question for an attorney where the building sits. I would want to see the credit tenant's lease too. Chains often want co-tenancy clauses, exclusives that limit what you can lease the other bays to, and long options at fixed rents. Getting $16 a foot with a twenty year option ladder at $16.50 is a different asset than getting $16 clean.

mitchell_ray4 · Answer

The buildout point decides it for me. Whoever brings their own contractor and their own money is the cheaper tenant, whatever the rent per foot says.

An empty ground floor bay at month five: hold for a credit tenant or fill it with a strong local operator

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