Landlord keeps roof and structure, and the roof is 18 years old

Under contract review on a freestanding 8,200 sf retail box in a midwest town of about 22,000, auto parts type user, national chain on the sign and the corporate entity on the lease. Price $1.42M, NOI $106,500, so 7.5% going in.

The lease is where I'm stuck. It gets marketed as NNN but the landlord holds roof and structure, so it's really a double net. Tenant pays taxes, insurance, interior, and their own HVAC service contract. Six years and four months left on base term, two five-year options at 8% bumps.

I climbed it. TPO membrane, mechanically fastened, 18 years in, seams are still tight but the flashing at the curbs is patched in four places and there's ponding on the north third where the drain is undersized. My own number for a tear-off and new membrane is $9.25 to $10 a foot installed in that market, call it $80k. Lot is worse than it looks in photos, alligatoring across the whole east half, and a mill and overlay bid I pulled on a similar footprint came in around $52k.

So I'm looking at roughly $130k of landlord capital inside a six-year hold, against $106.5k of annual NOI. That's a year and a quarter of income going into the shell.

Options I see: ask for $90k off and eat the timing, ask the seller to replace the roof before close, or reserve $2.60/sf/yr and treat the price as fine. What I can't get comfortable with is what the building is worth in year six if they don't renew. Nothing else in that town needs 8,200 feet.

3 replies

2ehernandez74PO2BPRO5

Do you have unit-level sales, or any reporting clause at all? A box that chain is doing well in gets renewed and the roof is a rounding error over 16 years. A box they're carrying gets handed back at expiry and your $130k bought you nothing.

Also, 8% bumps on the options are attractive enough that a tenant who's marginal will just leave. Cheap options renew. Expensive options tell you the tenant has to want to be there.

1Rena Expert

The whole answer turns on one assumption: whether you're buying an income stream or a building. At 7.5% with six years of term and $130k of near-term landlord capital, you're being paid a coupon and taking residual risk, and nothing in your post prices the residual.

On the capital, spread it correctly. Roof at $80k over a 20-year membrane life is $4k a year of true expense, not a six-year hit, but the cash comes out in year one or two and your basis has to carry it. Lot overlay is a 12 to 15 year asset with the same problem. If you fund both at close, your effective basis is $1.55M and your yield on total cost is about 6.9%, before the reserve you'd still want for curbs and drains.

Roof and structure retained by the landlord is common in older single-tenant retail and it's the reason those deals trade wider than absolute net. Price it as a double net, not as NNN. Have counsel confirm exactly where the structure obligation ends in your document, because the boundary between structure and building systems is drafted differently deal to deal.

Quill is right that lender sizing to lease term is the constraint that can kill the return regardless of price. Get the amortization and term quoted in writing before you counter.

Residual test: find the second-generation asking rent for comparable vacant box space in that market and rerun your exit assuming the tenant leaves at expiry and you re-tenant at that rent with 12 months down and TI. If the deal still works, negotiate the roof. If it doesn't, you're buying a bet on renewal at a 7.5% cap.

Landlord keeps roof and structure, and the roof is 18 years old

3 replies