True value Add Investors have had a tough time the last few years. Rising rents and low cap rates have pushed property values and made acquisitions more challenging. Over the past 2 years Summit Commercial Real Estate has been successful finding value add investors opportunities to capitalize on Lease Spreads. Finding reasonable deals has been a challenge for investors- especially value add investors. A common strategy we are using with clients to successfully purchase and profit from Lease Spreads include:
1. Identify overlooked on Market or Off Market opportunities. This is the real work. A Commercial Broker that is dialed into the market is key. Summit Commercial Real Estate just worked with a buyer to close a deal that was on the market over 9 months. The story can be found here (future link for a deal just completed). The right opportunities can be purchased at a discount to estimated sales price as vacant and offer a below market lease. Ideally the lease will be of a short term nature and the tenant will not be easily relocated or not have other options to relocate to
2. Clear the hurdle associated with the opportunity. These opportunities will ideally have an issue that caused other buyers to back off. Is it a costly repair, short term lease, or just way overpriced and forgotten about? For the purpose of this post we are focusing on the opportunity to increase lease rates. So the ideal scenario will be a building with a below market lease rate. The key is the length and terms associated with the lease. The lease must be long enough to dissuade buyers that want to occupy the building, but also be short enough to allow a buyer near to medium term upside by increasing the rates.
3. Execute the Plan. The goal in this step is to get a new lease at market rent. The success of the investment is likely to be significant. These deals are typically purchased 100-150 basis points higher than average cap rates. Once a market rent long term lease is executed, not only does the cap rate reduce, but NOI is increased which is a magnificent increase in value. I recently completed a deal where if the investor renews the lease he will achieve an estimated 3.8X time return on initial investment (plus cash flow) in under 4 years
4.. Know your risk. Commercial Real Estate deals have risk. The example of the deals in this post do not have much construction risk but there is risk associated with the lease renewal which will be coming in the next 1,2 maybe 3 years. These opportunities require an investor to be confident in their underwriting of the market and the vacant value of the building. If the tenant does not renew a new tenant (or a building buyer) will need to be found. the investor must be confident that the renewal will occur or the building can be leased or sold at an acceptable price to keep the asset performing. In this specific example the building was purchased about 22.95% below vacant building cost. So if a new tenant cannot be found the investor is confident the building can be sold at a premium to the purchase price, which will still yield an attractive investment
If you are interested to know more please reach out to Mark@Summit-CRE.com or 262-370-9852