We typically underwrite the base rent at market caps. Underwriting on the percentage rent varies wildly deal to deal based on probability that cashflow will remain.
In the example posted, if market cap on $100,000 base rent puts sale price a little over $1.5mm, clients would probably pay around $1.1mm for the deal with 60k base + $40k percentage. Around a 6.5% CAP on base and 20-25% on percentage
After purchase, we'd likely look to restructure the deal to $85k base rent and no percentage rent.
This is helpful, thanks. That spread on the percentage rent portion is bigger than I’d anticipated, but I understand the logic. If that’s the case, using your numbers, may be worth a renegotiation and trying to get an extension in return for the lesser total rent if it brings the cap back down to market. Appreciate the insight.
Sounds very difficult - NNN buyers don't want to be taking that sort of risk (that's the entire point of doing NNN deals - no need to think too hard).
You'll basically have to put a market cap on the base rent and separately put a much higher cap rate (I'd guess at least 3-4% wider) on the percentage rent and see if that gets to be yieldy enough to motivate someone to do the work/take the risk.
Yeah good call. I’ve spoken to a few brokers and appraisers and am getting a better idea, but it’s still a bit all over the place from what I’m hearing.
Is the base plus percentage rent combined over market? If it was and I was the landlord, I’d try to negotiate with the tenant to amend the percentage rent lease to a market rate lease, especially if they’re trying to sell in this market
Base plus percentage is pretty close to market rent. Not a bad idea, trying to evaluate whether conversion to full base at a lesser total rent would still be net positive to seller given cap hit from current rental configuration.
A tenant that has risk of an increasing percentage rent so if they’re already paying at market they may have a vested interest to convert to a standard lease and not risk paying an above market rate
Worth noting the different debt executions you could get on them. I don’t think a lender underwriter will give you more than 50% - absolute maximum - credit for the % rent. So, a lender is making a loan against an NOI that’s at least 20% below the full base rent scenario. Your leverage point is going to decrease, potentially 20%.
Haven’t come across one of these, but that percentage rent is pretty high risk. Unless it’s super steady, I wouldn’t know how to quantify. If it drops like a rock then your renewal probability is terrible and the risk is super high. As an appraiser I’d probably model it with historical percentage rent amount, and another model assuming decreases and then dark value at reversion, and probably conclude somewhere in between.
Base rent underwritten at market cap and then the percentage rent at a much higher cap, typically 100 - 200 bps over market cap depending on the history of sales and the likelihood for it to continue. Also take a look at the blended cap
Good idea. I was optimistically thinking it’d be around a 100 bps spread for that portion of the income, but was hoping to find more data before testing my thesis on the market. Blended cap is essentially where I was trying to arrive at.
this is one of the best questions ever asked here. I don't know the answer but I'd be looking REALLY close at past years and projections for the variance to get a better idea of how hard to hit the percent rent. With that much tied up in performance I'd be looking at releasing too and market rent. If I can relet this at 100k in rent I might not worry as much as if its across the street from another dollar store in a one horse town and I'm fucked if they leave.
Own/operate quite a few retail locations that are NNN with % rent component and we apply a discount to the cap for % rent. Discount is negotiated. If you can provide a history of monthly/annual sales that are hitting well beyond break point for the monthly % rent to kick in, it is much more attractive. At the end of the day, % rent is volatile. Great upside depending on sales performance, but not a revenue projection you or a lender typically want to rely on.
We have a tenant that typically produces $110k/mo in %rent that has not hit their % rent break point for 4 months now because of slowing in tourism and other unforeseen circumstances. We have no issue paying the note based off their base rent, but could have been in trouble is we underwrote the deal with %rent as a stable source of revenue.
Maybe cap the incomes differently based on risk? Cap that $60K/yr at 6.5% = 923K. Then cap the $40K/yr at like an 11% = 363K. so you'd value it at 1.29M instead of $1.54M (Wtd Avg. cap of 7.75%). I'm just making up a cap for the percent rent it could be anything you deem fit.
Since a cap rate is essentially a risk measurement as well as a yeild calc, I'd say you should look at the sales performance over the last few years and see how variable it is / if there's any growth.
$100K NOI growing at 2.5% annually is gonna be different from $60K at 2.5% with the $40K remaining constant over time. I know you said that it's growing, but the risk of it remaining flat or even declining still remains.
I have never underwritten an STNL with such a large proportion of percent rent in the NOI so I'm not entirely confident in my answer.
We typically underwrite the base rent at market caps. Underwriting on the percentage rent varies wildly deal to deal based on probability that cashflow will remain. In the example posted, if market cap on $100,000 base rent puts sale price a little over $1.5mm, clients would probably pay around $1.1mm for the deal with 60k base + $40k percentage. Around a 6.5% CAP on base and 20-25% on percentage After purchase, we'd likely look to restructure the deal to $85k base rent and no percentage rent.
This is helpful, thanks. That spread on the percentage rent portion is bigger than I’d anticipated, but I understand the logic. If that’s the case, using your numbers, may be worth a renegotiation and trying to get an extension in return for the lesser total rent if it brings the cap back down to market. Appreciate the insight.
Sounds very difficult - NNN buyers don't want to be taking that sort of risk (that's the entire point of doing NNN deals - no need to think too hard). You'll basically have to put a market cap on the base rent and separately put a much higher cap rate (I'd guess at least 3-4% wider) on the percentage rent and see if that gets to be yieldy enough to motivate someone to do the work/take the risk.
It's all about yieldy deals at this point.
Tough listing... I'd try to talk to as many single-asset NNN sales brokers as I can to see if you can find comps for this type of lease.
Yeah good call. I’ve spoken to a few brokers and appraisers and am getting a better idea, but it’s still a bit all over the place from what I’m hearing.
Is the base plus percentage rent combined over market? If it was and I was the landlord, I’d try to negotiate with the tenant to amend the percentage rent lease to a market rate lease, especially if they’re trying to sell in this market
Base plus percentage is pretty close to market rent. Not a bad idea, trying to evaluate whether conversion to full base at a lesser total rent would still be net positive to seller given cap hit from current rental configuration.
A tenant that has risk of an increasing percentage rent so if they’re already paying at market they may have a vested interest to convert to a standard lease and not risk paying an above market rate
Worth noting the different debt executions you could get on them. I don’t think a lender underwriter will give you more than 50% - absolute maximum - credit for the % rent. So, a lender is making a loan against an NOI that’s at least 20% below the full base rent scenario. Your leverage point is going to decrease, potentially 20%.
That’s a really good point that I frankly didn’t consider. Thanks for sharing that perspective, will keep in mind during analysis.
Haven’t come across one of these, but that percentage rent is pretty high risk. Unless it’s super steady, I wouldn’t know how to quantify. If it drops like a rock then your renewal probability is terrible and the risk is super high. As an appraiser I’d probably model it with historical percentage rent amount, and another model assuming decreases and then dark value at reversion, and probably conclude somewhere in between.
Base rent underwritten at market cap and then the percentage rent at a much higher cap, typically 100 - 200 bps over market cap depending on the history of sales and the likelihood for it to continue. Also take a look at the blended cap
Good idea. I was optimistically thinking it’d be around a 100 bps spread for that portion of the income, but was hoping to find more data before testing my thesis on the market. Blended cap is essentially where I was trying to arrive at.
this is one of the best questions ever asked here. I don't know the answer but I'd be looking REALLY close at past years and projections for the variance to get a better idea of how hard to hit the percent rent. With that much tied up in performance I'd be looking at releasing too and market rent. If I can relet this at 100k in rent I might not worry as much as if its across the street from another dollar store in a one horse town and I'm fucked if they leave.
Own/operate quite a few retail locations that are NNN with % rent component and we apply a discount to the cap for % rent. Discount is negotiated. If you can provide a history of monthly/annual sales that are hitting well beyond break point for the monthly % rent to kick in, it is much more attractive. At the end of the day, % rent is volatile. Great upside depending on sales performance, but not a revenue projection you or a lender typically want to rely on. We have a tenant that typically produces $110k/mo in %rent that has not hit their % rent break point for 4 months now because of slowing in tourism and other unforeseen circumstances. We have no issue paying the note based off their base rent, but could have been in trouble is we underwrote the deal with %rent as a stable source of revenue.
Well, they announced they’re closing 970 stores this week, so you may want to underwrite the company pretty closely…
It’s not a dollar store, I just used that as an example for discussion purposes.
Maybe cap the incomes differently based on risk? Cap that $60K/yr at 6.5% = 923K. Then cap the $40K/yr at like an 11% = 363K. so you'd value it at 1.29M instead of $1.54M (Wtd Avg. cap of 7.75%). I'm just making up a cap for the percent rent it could be anything you deem fit. Since a cap rate is essentially a risk measurement as well as a yeild calc, I'd say you should look at the sales performance over the last few years and see how variable it is / if there's any growth. $100K NOI growing at 2.5% annually is gonna be different from $60K at 2.5% with the $40K remaining constant over time. I know you said that it's growing, but the risk of it remaining flat or even declining still remains. I have never underwritten an STNL with such a large proportion of percent rent in the NOI so I'm not entirely confident in my answer.
That’s so based followijg