Hi all,
Probably a dumb question, but I'm curious why it's not great to have a tenant locked in to above market rates long term.
If you have an industrial building, for example, with a long term tenant, locked into above market rental rates, is that so bad? Understandably, there is little to no rental upside but what if market rates mirror the rental rates for the tenant over the lease term? That seems to make out fine, no?
I get that if the market is running hot and rental rates move up quickly, the market rate would outpace what the tenant is paying. But if rates are moving up at per say just a 2% annually, this would be more than fine I assume?
Thanks.
There are a list of reasons. Lack of upside is one piece of it, but what happens if your tenant bankrupts/leaves during term/gets acquired and larger company pays termination/etc. and you have your project levered up at those higher rents? Can't re-tenant it at that higher rate then you're underwater.
Just because you have a 10yr lease doesn't meant that tenant will always be there for that term. I've had countless long term leases blow up during their term.
It’s just a risk that your NOI will decline. It’s great while you have that elevated rate, but you wouldn’t pay that much more for it over an identical building with market rate rents. You would pay a little more, but you wouldn’t take the same cap rate on both buildings, you would want to get the above market rate building at a higher cap rate. That way if/when rents decline (when you re-lease it) you didn’t vastly overpay for something.
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