The following Q&A was completed as part of our conversational Commercial Real Estate FAQ Interview Series, we hope you find it helpful:
Net lease real estate cash flows are predetermined, so it’s not the same as adding value creation to the property as you may with other types of real estate. However, being a creative real estate professional can use transition points in the lease, or lease unique pieces of real estate to bring in periods where one may make a profit. Larger properties with a great deal of land, for instance, may be parceled out to additional tenants for a cash infusion and a bit of added value.
Richard Wilson: What would be a way to add value and boost the valuation on a net lease or triple net property? You mentioned earlier maybe extending the lease term so it’s not impaired. So if there’s less than 10 years I would guess that would be one way; is there another way or two to add value and kind of boost NOI or boost the return for an investor?
Peter Von Der Ahe: Yeah, so the cash flows are set. That’s a lease, it’s determined, it’s predetermined, and so all the value creation here is not really going to be something that you’re going to do like another piece of real estate. Where you can offer something else to the tenant or something like that and they’ll pay more, although maybe that would occur. A lot of it has to do with the transition points in the lease and the ownership period, and it has to do with financing. So, many leases for example they have increases that occur, the rent jumps after 5 years, or every 5 years. When that occurs, there is a, obviously the rents jumping the value is going to jump. So depending on what your entry point was on that piece of real estate, what your financing is, you may have a little bit of cap rate compression, and your rent went up so there are certain periods where if they’re timed correctly, that may be transition periods where you can actually make a profit.
Sometimes we’ll see with some of the bigger properties that have a lot of land, there may be a collaboration between you and the tenant to parcel off some of the land and you can use that with another tenant and therefore the company gets a cash infusion and you can add some value. Those are not run of the mill, but there are kind of unique situations that I would put out there that you could look at. So I would categorize that in just being creative with real estate, you know, just a creative real estate professional.
As we discussed, you get toward the end of the lease term, if the tenant is doing very well, they’re not going to want to leave, they’re going to want to extend. Probably the biggest misnomer in the industry is outsiders really discount the value of having the lease with a credit tenant, and having that already done, and cash flowing, and operating, and how valuable that is. So, for example, if you had 2 years left on a lease, and they were going to extend the lease, and the rent was going to go up by 5% or 10%, add that to your point – yes, your rent may go up by 5 or 10% in a couple years, but there may be additional value for you at that moment to extend the lease by 10 or 15 years and not raise the rent as much if you had good credit. Because now a new investor can come in and buy that asset knowing they have a new 10 or 15 years left on the lease instead of 2, and there would be value creation there. So, you kind of play that by ear.