
I’m sure you’ve seen more and more references to Gluten-Free-this and Gluten-Free-that lately, but what does it mean? Even after looking into it, admittedly half-heartedly, I’m not sure I… ‘get it’. What I have been able to surmise is that, in the aggregate, most of us seem to agree that ‘Gluten-Free’ is heavily hyped, potentially beneficial, and only partially understood. By and large, most folks I have asked about it don’t have a good understanding of what it is or does or doesn’t do, and whether it’s any good for ‘me’. The ads say it is, but is it? Perhaps, maybe, not necessarily, it depends.
Commercial real estate (CRE) transactions can have many elements which are also heavily hyped, potentially beneficial, and only partially understood. Much of what is contemplated or negotiated in a lease or sale transaction can have varying benefit, unwarranted emphasis, and unintended consequences. You know, like Gluten. In both applications, information is power!
Leases - Poorly structured rent concessions, expense caps and floors, TI allowances, escalations, and option terms, to name just a few could have unintended consequences for either the Landlord or Tenant. For both parties, every aspect and business point of the agreement needs to be fully understood, calculated, and considered not on it’s own merit, but for it’s contribution to the total objective of each party.
Investment – The Gluten in these transactions is most likely the economics of the asset and the cash flow it produces. Understanding the economics behind a high or low return, proper analysis of future expenses, revenue, and income (the deadly Pro Forma), and the cost of capital can all make or break any deal.
Here’s an example: Owen owns a building in which Tom’s Truck Tuners is the Tenant occupying 100% of the building. Bill wants to buy the building as an investment based on the in-place cap rate of 9%. Bill thinks this is a pretty good return and hopes to benefit from a 3% rent increase due to take effect next year. Tom has been in the space for 5 years and has 2 years left on his lease and then a 7 year option with 3% annual escalations. In this example, Gluten = vacancy and this deal seems Gluten-Free.
Bill buys the building and in 2 years is surprised that Tom will not be renewing his lease. Only then does Bill realize that the rent he has been receiving from Tom is well above market, and Tom couldn’t wait for his lease to expire. In fact, Tom just bought a vacant (gluten) building just down the street for ½ of what Bill paid for his building… it had been vacant for over a year. For Bill, Gluten-free was good and it turns out that Tom really DID benefit from the Gluten (vacancy). The morale of the story is “Know what your tolerance for Gluten is before you hop on the Gluten-Free fad-wagon”.