Ground floor bay sitting empty at month five: hold for a credit tenant or fill it with the local operator at a better rent?

Question

Two owners I have been talking to this month landed on opposite answers to the same question, and I cannot decide which one I would follow.

Both have small mixed-use buildings, apartments above, one vacant ground floor bay of somewhere between 1,200 and 1,800 square feet. Both have had the space empty since spring.

The first is holding for a regional or national tenant. His argument is that a corporate lease with a real balance sheet behind it is the thing an appraiser and a buyer will pay for, that it keeps the ground floor from becoming his second job, and that he will happily take $16 a foot from a credit tenant over $22 from someone who might be gone in fourteen months. He is willing to carry the vacancy another year to get it.

The second is signing a local operator, a coffee roaster, at a rent about 30 percent above what any chain offered. His argument is that the chain rent is permanently below market, that the local tenant draws the residential tenants upstairs and helps his apartment rents, and that vacancy costs him real money every month while the credit tenant is theoretical. He is taking a two year term with a personal guarantee and expects to re-tenant if it fails.

Both have a point. The first is underwriting the exit. The second is underwriting the operating years. I have not worked out which risk I would rather own, and I suspect it changes with how much cash you have behind you.

carlos_nunez · Answer

I have the second version running right now and it is going fine, which does not mean it was the right call.

What nobody prices properly is the buildout. My local tenant needed $40 a foot of work in a raw bay and had maybe $12 of it. I funded the rest as landlord TI against a two year term, which means I do not get my money back until month 26 even if he pays every month. A regional tenant would have brought their own construction money and their own contractor. So the 30 percent rent premium was not really 30 percent, it was closer to break even over the first term.

The honest split is whether you are buying rent or buying a signature. I bought rent and I am still carrying the construction cost on my line of credit.

dmitri_v6 · Answer

@quarry 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.

Ground floor bay sitting empty at month five: hold for a credit tenant or fill it with the local operator at a better rent?

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