Question of the Month: Is it best to sell, re-tenant the property upon lease expirations, or try to negotiate extensions? by Michael Ferrara

November 15, 2016 - Spotlights
Michael Ferrara, <a class=Highcap Group" width="150" height="150" /> Michael Ferrara, Highcap Group

There are many times a landlord is faced with this situation and will have to ask themselves the following question: Do I sell, re-tenant the property upon lease expiration or try and renegotiate a renewal with my current tenants? To be able to help your client make the best decision, you need to fully understand the current market from every angle. Additionally, it is important to note that there will never be one right answer to this question as market conditions change and you will need to look at this as a case-by-case situation. To help answer this question, I will provide a real life example in which my client was faced with, making this very important decision and provide you with an inside look of how we came to a decision in just 750 words.

The background: My client owned a retail condominium at 312-314 Bleecker St. that was 100% occupied by two tenants. Both tenants were paying below market rents and both of their leases were coming due within the year. The owner had existing debt on the property at an interest rate that was higher than the current market and he had owned the property since 2005.

Do I sell?

If you don’t have to sell, my advice is to hold onto the property. I’m a believer that if you own property in New York City, you will see continued appreciation over the long term. There are reasons however why owners have to sell and the most common ones that I see are: death, divorce, partnership breakups and the value-added investor who looks to purchase a property, create value and then put that property back on the market to take advantage of the value that was created. In this situation, the owner didn’t fall into any of the above mentioned categories and did not have to sell; he preferred to hold on to the property for the long term.

Do you re-tenant the property upon lease expiration?

After doing some due diligence and looking into the retail comps we were able to understand that the current tenants were paying below market rates. At the time, the retail market was seeing downward pressure in leasing activity and there was a high risk that the property could be on the market for months sitting vacant; providing no income to the landlord while having to carry the costs of the property, a situation you would not want to be in. Between the decline in the retail leasing market, costs to carry the property vacant during marketing and the tenant improvements that would be needed to accommodate a new use, vacating his tenants to test the market was a risky road we did not want to go down.

Do you try to negotiate lease extensions with the current tenants?

Assuming that we could negotiate lease extensions at market value, this option provided the landlord with zero downtime and no loss of rent. Both tenants had been there for some time, knew they were paying below market and were very successful in this high trafficked location. From the tenant’s point of view, finding a new location would cost them both time and money when they could simply renew their lease without any interruption to their business–a true win-win for both sides. We decided that this was the best course of action and after successfully negotiating the lease extensions with both tenants the landlord now had increased his rent roll and provided himself with stable cash flow for an extended period of time.

Lastly, he still had existing debt on the property with a high interest rate. With historically low interest rates at this time and now having brand new lease extensions, I advised him to refinance–pay off his old debt and lock in at a lower rate. I sat down with Michael Becker, the director of finance at Highcap and we went to work in securing the best deal for the landlord. We arranged a $6.9 million refinance for a term of 10 years, interest-only with a rate of 3.65%.

At the end of the day, the owner was able to continue to hold onto the asset and realize further appreciation, lock in his tenants on long term leases, increase his cash flow and lower his overall interest rate. His tenants were happy to keep their businesses there for years to come without interruption and the landlord was extremely pleased with how we strategically tackled his situation.

As you can see, it is important to understand every angle when faced with this decision and by analyzing each scenario you can advise your client when he reaches that fork in the road.

Michael Ferrara is a senior director at Highcap Group, Manhattan, N.Y.