How to Increase a Net Lease Property's Value Through Negotiation

There are any number of ways to add value to a net-leased property, most of which fall under the capital expenditure umbrella. However, there is one no-cost method to strengthen an owner’s position, especially before a disposition: lease negotiation.

Net lease property values are defined by their future revenue potential. That’s why locking a creditworthy tenant into a long-term lease can have much more of an impact on an asset’s price than a fresh coat of paint ever could.

Those investors with the will and ability to hold onto a net-leased property for the long term can reap dividends for years. This position also allows one to wait for optimal conditions before selling an asset. Of course, one can create those ideal conditions through well-timed lease negotiations.

For example, my firm, Alliance Consolidated Group of Companies, recently sold a 7,126-square-foot net-leased medical building in Roswell, Ga., for $4.2 million. Not only was that deal a direct result of negotiations with our subtenant, but the property increased in value as a result of those discussions.

The primary tenant, a regional gastroenterology provider, was subletting a portion of its space to a large hospital group. After the sublessor failed to renew, the hospital group, which was satisfied with the location and planning to make extensive capital improvements, moved to control its own destiny by making a purchase offer.

It’s a rare but wonderful scenario when a tenant reaches out offering to acquire their building. We had one major reservation, however. As one of the Atlanta metro’s largest hospital systems, the prospective buyer was answerable to a board of directors who have the final say on significant real estate transactions. There was a very real possibility the board would scuttle the deal at the last minute, leaving us with an untenanted building.

We decided to make the acquisition contingent on the buyer signing a 10-year lease with 2% annual increases. If the sale were to fall through, we would still have a very well-capitalized tenant locked into a long-term lease. But, if all went as planned, the hospital group would be free to tear up its rental agreement, as it would effectively become its own landlord. In the end, the board approved the deal, but we were protected by either outcome.

We faced a slightly different scenario earlier this year in Hallandale Beach, Fla., with a national dialysis provider, the sole tenant in our 10,000-square-foot net-leased property. As the company was nearing the end of its lease term, its in-house broker reached out seeking a one-year extension that was positioned as buying them time to explore alternate locations.

It was immediately clear to us that this was a bluff. First of all, there were zoning and state regulatory issues that would restrict their property search. In addition, Miami is a high-barrier-to-entry market with high competition for the single-story, single-occupier facilities that this type of tenant prefers. 

A final factor – one that’s unique to net lease properties – was that the tenant had recently completed a costly upgrade to the building’s HVAC system. This investment severely diminished the chances of a move, as it would essentially mean the company invested all that capital for the benefit of another user.

In the end, we agreed to renew at a reduced rent with lower annual escalations in exchange for a 10-year term. That was a victory for the tenant, but also for Alliance since we increased the valuation of the asset by locking a creditworthy tenant into a long-term lease. We were able to realize that increased value just a few months later, when we sold the property to a 1031 exchange buyer.

Real estate doesn’t have to be a zero-sum game, as evidenced by these two win-win deals. Our understanding of the healthcare sector, the intricacies of net leases and the high barriers to entry in these markets allowed us to stand firm during negotiations and, in the end, add value to our assets. It’s a strategy other owners can employ, too, with the realization that some of the best leases are the ones that are about to expire.

Ben Reinberg is Chief Executive Officer of Alliance Consolidated Group of Companies.