Investor Resources
Single Tenant Properties may look like an attractive investment, but is that really the case?
A single tenant investment property, by definition, is leased to one tenant for some time period. The lease term could be relatively short (5 years or less) or long (10 or more years). The perception among investors/owners is that a single tenant leased property is a risk–free, passive, predictable investment. There are, however, many hidden risks that owners/investors do not completely understand or account for when considering and valuing these investments. To help you determine whether a single tenant property is the right choice, we outlined some advantages and disadvantages below. First, we’ll start with the advantages.
A single tenant leased building typically provides a low property management demand
This is because the tenant generally assumes all repair and maintenance responsibilities. If the tenant experiences a leaky toilet, needs snow removal services, or has a pothole in the parking lot, the tenant is responsible for handling all of the coordination, contracting, and payment. Owners/investors do not need to be concerned with receiving tenant calls in the middle of the night. And leases usually require the tenant to pay directly or to reimburse the owner for property insurance and real estate taxes.
The owner only receives one rent payment each month
This advantage minimizes the time and effort dedicated to the collection of delinquent payments. If a single tenant payment is late, that’s far less time consuming to sort out as opposed to several late payments possible with a multi-tenant property.
The owner only needs to periodically focus on renewing the current tenant or identifying a new tenant
This takes place perhaps only every 5 or 10 years, which allows more pressing items to be prioritized.
Single tenant leased properties have a more predictable cash flow
This correlates directly to the tenant’s creditworthiness and is often characterized as one of the strongest benefits in owning a single tenant leased property.
How creditworthy is that tenant really?
Many consider this investment vehicle as something similar to owning a “bond” in the tenant’s company, since paying rent should be a higher priority payment than returning money to the company’s shareholders (equity). However, we have seen numerous examples of companies who were creditworthy at one point but later failed as a result of competition, poor long-term business strategies, assuming too much debt, or other factors. Notable examples are Enron, MCI, Lehman Brothers, and Compaq Computer.
Who really is the tenant?
In addition, it is also very important to understand who the actual tenant is. Many tenants operating under the names of well-known, publicly-traded companies such as McDonald’s, Burger King, and Subway are actually owned by franchisees and not the corporation. As a result, in the absence of the franchisor corporation’s guaranty, the tenant’s creditworthiness may be significantly less valuable than an investor/owner initially underwrote.
Similarly, many large corporations utilize separate legal entities to lease their properties and these entities often have few, if any, assets.
This brings us to the many noteworthy disadvantages to be considered with single tenant properties.
1. Specific finishes that may not be reusable
The interior and exterior finishes or space layout may be particular to a specific tenant, and not reusable for another tenant in the future. Examples of this include pad sites that are leased to a bank, drug store, or fast food restaurant. Bank spaces may include a massive vault, which can be expensive to remove if the next tenant is a drug store. The interior layout of a fast food restaurant, like McDonald’s, is very different from a casual dining restaurant like Applebee’s or Bob Evans. In some cases, the entire pad site building is demolished and rebuilt when restaurant concepts are changed.
Another example would be a property that has very specific interior finishes, such as a lab space for a biotech company or a Sensitive Compartmented Information Facility space for a defense contractor. These types of spaces are rarely reusable by a successor tenant and are very expensive to redevelop.
2. What can happen when the single tenant vacates
If the tenant does not renew and vacates, then the property’s income can become zero while the owner is still required to pay for real estate taxes, insurance, utilities, and upkeep. While the appeal of steady cash flow from single tenant properties is very appealing, the risk of experiencing a period of zero income is worth consideration.
3. Significant Tenant Improvements costs – are your reserves sufficient?
When a new tenant is identified and the space is re-leased, the expenses for tenant improvements and leasing commissions are incurred. In most cases, an owner must voluntarily or involuntarily (if required by a lender) reserve substantial funds prior to the existing tenant’s lease expiring. These funds are needed to cover the aforesaid operational expenses, debt-service (if the property has a mortgage), tenant improvements, and leasing commissions.
4. A tenant’s real negotiating strength
The existing tenant of a single tenant property has greater negotiating power at lease renewal. In most markets, larger tenants (especially single tenants who lease an entire building) have significant negotiating power because they could vacate and relocate to another property or to a new building that another developer offers to build for them. An owner may have to offer the tenant significant concessions to remain after the lease expiration. These concessions may include a rent reduction, free rent, or other benefits to avoid a vacant property.
A seasoned property management company that possesses systems and processes to effectively address and manage these factors can help mitigate all of the foregoing risks. And at Kenwood Management Company, we understand how to create value in the local real estate markets and pride ourselves on maximizing returns while reducing risk. Whether you’re a business owner looking to lease or an experienced investor looking to expand your portfolio, we can help you figure out if a single tenant property is right for you. Contact us today to learn more.
