How to Navigate Today's Net Lease Market

Source: GlobeSt.com - By Natalie Dolce | National
August 11, 2015 

ATLANTA, GA—If you are closing multiple lease transactions, knowing which regulations, taxes, forms and procedures to follow under each jurisdiction can be a daunting undertaking says Zack Markwell, co-founder of locally based Stonemont Financial in the below Q&A. 

GlobeSt.com: What challenges are common when closing a new lease transaction? 

Zack Markwell: Transactions can often be bogged down in lease negotiations. Sometimes this is a result of over-zealous representation on behalf of tenant or landlord and in other instances it is because of perfectly reasonable issues. Understanding the difference is critical, but not always obvious. If this is not managed well, the tenant-developer-landlord relationship can start off on poor footing, which can affect the life of the project. 

One of the most devastating issues is not having capital secured for closing. If a capital partner does not have debt and equity capital readily available, a transaction can become derailed.  Unfortunately, this often happens as the closing deadline nears. This can leave the developer and the tenant in a terrible position. However, finding the right capital partner, who can bring certainty of execution, meaning an on time closing and smooth closing process is important to ensure all parties involved, including developer and tenant, are happy with the final deal. 

GlobeSt.com: How can developers navigate through these challenges?  

Markwell: Developers too often assume they can rely on their internal expertise when competing for build-to-suit projects, however, most of the time it is best to bifurcate the development and capital markets aspects. Developers should concentrate on the myriad ways in which their expertise can improve the development of the project and find a capital partner that can tackle the lease-structuring and bring the entire capital stack to the table. This can lead to better-structured deals and more deals won for the developer while preserving the developer’s capital.  Look for a capital partner that has experience with your type of project. For example, if your project is single-tenant, look for someone with single tenant experience that will be well-versed in the nuances of those transactions. This will help ensure things go smoothly on the front end, throughout development, and through the life of the lease. Also, look for a partner that has a strong track record of closing deals. Speak to their references and find out if they deliver on what they promise. 

GlobeSt.com: What are alternative ways for developers to overcome these challenges? 

Markwell: In addition to partnering with a capital provider, developers may also hire real estate advisors to help with closing their lease transactions. Advisors can bring experience and expertise that differ from capital partners in two significant ways. First, is their service fee, which can impact the economics of a deal. Second, is that their role in the transaction is only temporary.  In other words, their goal is to get the deal closed whereas a capital partner is not only focused on closing, but also on the entire life of the investment. 

GlobeSt.com: What are common mistakes made by tenants and landlords? 

Markwell: Tenants and landlords often overlook the accounting implications of single-tenant leases.  Depending on how the leases are structured, these can either be on or off the balance sheet. 

GlobeSt.com: What are the best ways a landlord can add value for the tenant when structuring a lease? 

Markwell: The best way a landlord can add value is by understanding the tenant’s needs and goals.  Is the property strategic?  Is the tenant committed to staying in the property long term?  Is flexibility important and the tenant needs the ability to expand the property?  Are balance sheet implications of the lease important?  Is the tenant focused on net present value of lease payments?  A good landlord will understand their tenant’s operational and financial needs and structure the lease accordingly.  If these needs are met, the tenant may end up with a lease that exceeds their expectations and become a client for life.

GlobeSt.com: Do accounting rules factor into how leases are structured?

Markwell: Yes, depending on how the lease is structured, it can either be off-balance sheet or an on-balance sheet capital lease. GAAP-focused tenants in particular can be significantly impacted by this designation.  It is important for a landlord to understand their tenant’s priorities and structure a lease that meets the tenant’s financial and accounting goals. 

GlobeSt.com: What impact does the lease have on equity and debt capital for a deal? 

Markwell: The lease can impact whether a deal is able to be financed at all. Lease maturity, tenant/guarantor credit and tenant “outs” are just a few of the terms lenders consider when evaluating a debt investment in a property.  These and other factors are also important to equity investors and can have a dramatic impact on how deals are priced.  There is a direct relationship between the lease and the inherent risk in the deal.  A well-structured lease can lower a cap rate significantly and conversely a poorly structured lease will lead to a higher cap rate. 

GlobeSt.com: How can capital partners help developers that are trying to win build-to-suit business? 

Markwell: By structuring leases that are efficient from a capital market perspective, capital partners can lower lease rates for tenants and improve the developer’s chances to win the business.  Also, a strong capital partner will bring certainty of execution that will give the tenant comfort since build-to-transactions are often critical for operational purposes.  The right capital partner can leverage their experience to structure leases that meet the tenant’s financial and operational needs and perhaps bring creative options, such as free rent periods, that the tenant may not have previously considered. 

GlobeSt.com: What are the pros and cons of NNN leases vs gross or NN leases? 

Markwell: NNN leases offer a lower lease rate than gross or NN leases, since the tenant is not paying the landlord’s markup on property management. However, this means that the tenants will need to manage the property themselves or hire a third party, which may or may not be preferable, depending on the tenant.  For a landlord, NNN leases allow them to be a more passive owner which can be attractive to other investors should they decide to eventually sell the property.  As previously stated, these leases typically offer lower rents than gross or NN leases, but do not allow landlords to utilize their property management services as a profit center. Again, this may or may not be important depending on the landlord. 

GlobeSt.com: Does the local real estate market factor into how a lease is structured (e.g. lease term, NNN vs. gross, tenant credit)?

Markwell: Yes, this is particularly true for areas that may be considered secondary or tertiary markets or markets that are currently facing occupancy or absorption challenges.  Longer lease terms, strong tenant credit and well-structured leases can determine whether a project gets built at less than what the ultimate cap rate is.  Lenders and investors need to mitigate market risk.  It is crucial that developers understand the hot button items so that they can present tenants with deals that they can deliver.  Having a partner that understands the relationship between leases and real estate capital markets is paramount, particularly for challenging real estate markets.

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