Are We Seeing a New Underwriting Trend Emerging in Commercial Real Estate?

Includes: FNIO, RTL-OLD
by: Chris Rodriguez

I received a marketing brochure today that, quite frankly, left me a bit shocked. The property is a multi-tenant retail building in a power center in Southern California. The shocking part of the offering was that the seller and broker were NOT attempting to capitalize income from the vacant suites.

Maybe CRE practitioners are starting to figure out that seller rent guarantees and seller leasebacks are total fool’s gold. Buyer’s are finally starting to realize that paying $14.29 for $1 of seller guaranteed income ($1 / 7.00% CAP = $14.29) does not make sense. It is clear why sellers would offer this. They make an additional $13.29 less commissions and any other credits which may be given to the buyer (leasing commissions, TI’s, etc.).

One thing I found very interesting in the offering memorandum was that the vacant suite was quoted as having a market rental rate of $1.50 PSF / month while the adjacent (and identical) suites are leased at $3.00 PSF / month. Even more perplexing is the fact that the package claims that market rent for the leased suites is $2.75 PSF / month. Can you have it both ways? Maybe the vacant suites are haunted and therefore less desirable. Who knows. It seems to me this is inviting prospective purchasers to write the in-place rents down to $1.50 PSF / month. Needless to say, the “upside” in this investment offering will diminish if the existing rents are cut in half.

I hope the buyer for this property has deep pockets.

If this trend continues, we may actually see sellers agreeing that full credit cannot be given to over-market rents. I’m not going to hold my breath.