The rent bump schedule is what made a 7.4 sale-leaseback work

The debt term point is the part I'd underline for anyone reading. I run small multifamily and I've been on the wrong side of that, refinancing a 12-unit with a rate I didn't choose because the loan came due first. With a single tenant it's worse because you have no ability to raise rent to cover a payment change. Rent is the rent for 13 years.

What's the residual look like if the tenant vacates at year 13 and doesn't renew? You said 8,300 sf in a town of 4,500. Who's the second-generation user there? I ask because on my small portfolio the thing that actually breaks is vacancy in places with a thin tenant pool, and a purpose-built discount box isn't easy to cut up.

Naive question maybe, but how do you get comfortable with 1.5% annual bumps when that's below most inflation assumptions? You're still losing real rent every year, just slower than flat.

Escalation was a new term to me, so I read up on it before following this. So the rent goes up a set amount on a schedule written in the lease, and flat means it never moves until the tenant renews? That seems like a big difference to be a secondary point in a listing.

@kestrel is asking the right thing and the answer depends on what you think you're buying. A 1.5% annual escalator does not preserve purchasing power against a 3% inflation assumption. It compounds the rent roughly 21% over 13 years, so you end the initial term with real rent below where you started if inflation runs above the bump. What the escalator buys you is terminal value. @meridian is exiting on a rent number 21% higher than the entry rent, and at a constant exit cap that is 21% more sale proceeds than the flat-rent version of the same building. That is where the IRR difference he described comes from, and it is why flat-rent net lease trades at a wider cap than escalating net lease for the same credit.

On @thicket's question, the residual is the real exposure and it is not solved by lease structure. Single-tenant purpose-built retail in a thin market has a small pool of second-generation users, and re-tenanting can mean significant capital to reconfigure, a long vacancy, or both. The way institutional net-lease buyers underwrite it is by asking what rent a different user would pay for the space, then comparing that to the contract rent. If contract rent is well above market rent for the box, you are partly buying credit rather than real estate, and the day the credit stops paying is the day you find out what the real estate was worth.

Also worth being direct about the concentration point @meridian already made. One tenant is one point of failure. Nothing in the structure changes that.

Towns of 4,500 are what I look at, and the discount chains are usually the only national credit anyone will get in a market that size. The flip side is that when they do close a store they're closing it because the market is thin, so the vacancy and the reason for the vacancy arrive together. I don't think that's a reason not to buy. It's a reason the cap rate is a 7.4 and not a 5.8.

@meridian did you look at the ground under the box separately? I keep coming back to land value because that's the piece that doesn't depend on the tenant. Even in a small town a paved corner pad with utilities has some floor to it. Curious whether you assigned a number to that or just treated the whole thing as one asset.

@rena-expert that framing about contract rent vs market rent for the box is the thing I've been missing. I've been underwriting these as a yield and a credit rating. Going to go back through the three I passed on last year and work out what a non-national user would have paid per foot. Suspect two of them were well above.