At times, landlords feel like they're running a concession stand at the local carnival.
They say timing is everything, but if you’re a landlord who has been investing in the commercial real estate market for the long term, you can expect to see all the market has to offer.
MacRo Inc. is in the business of helping property owners make smart investment decisions, including setting rental terms that maximize the value of their property.
I often meet with investors who have been managing and renting their own properties for many years, and as a matter of policy, the owners are offering below market rent in order to fill vacancies quickly.
Because a property's rental record has a significant impact on the property's value, many investors often feel locked into rental agreements.
For owners of commercial real estate investment properties (retail, office, flex space, industrial space, etc.), it is important to implement some basic leasing strategies when marketing your vacant space.
Now consider this:
A free rental is often better than a low rental.
At first glance, this may not seem like it makes sense, but all too often property owners negotiate a low base rent with tenants just to fill vacant units. That base rent may (or may not) have an annual rent increase clause built into the lease terms. In Frederick County's commercial real estate market, the typical increase is about 3 percent.
The long-term impact of below-market rents can have a negative impact on the future value of a property. In the right circumstances, offering a few months or more of free rent and using base market rents can give tenants the incentive they need to sign long-term leases without sacrificing future cash flow growth.
The left half of Figure 1 shows a simple example of how this logic works. Consider a situation where the market rate is $15 per square foot and a tenant is offering a 10-year lease at $12. In the long run, a $15/sq. ft. rate with the tenant making a concession equivalent to a one-year rent abatement is better for the landlord than a rate of $12 without the abatement.
From a valuation perspective, if one were to value such property solely based on an income approach (e.g., using an 8% capitalization rate), after year 1, a rate of $15.00 would indicate that the property would be worth 25% more than the lease rate of $12.00.
The right half of Figure 1 shows an example of the value differential for a 5,000 square foot freestanding office building using the lease terms above, illustrating the 25% factor that carries over from the lease rate to the value.
Of course, other factors such as similar sales, the condition of the property and replacement costs will also be taken into account in a full valuation.
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Rocky Mackintosh, president of MacRo, Ltd., a land and commercial real estate company based in Frederick, Maryland, has been active in the Frederick community for more than 40 years. He has served as chairman of the board of directors for Frederick Memorial Hospital and served on the Frederick County Charter Board from 2010 to 2012. He currently serves as chairman of the board of directors for Frederick Mutual Insurance Company. Founded in 1843, the company is one of the longest-standing businesses in Frederick County.