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Case Study: Creating value from a vacating commercial tenant

July 2, 2019
Categories: Case Study

The names, dates and locations featured in the following events have been changed or omitted to protect the privacy of the related parties.

For commercial property syndicators who are truly on the line with their investors, bumps and all, three major goals exist:

  • Protect investors’ initial capital at all costs
  • Maximise investor return wherever possible
  • Increase asset valuation with strategic initiatives

So, when a major tenant in a homemaker centre suddenly entered liquidation and closed all their stores last year, we knew these three goals were threatened.

Challenge: A major tenant vacates

Our asset is a robust homemaker centre servicing a strong regional catchment. Furniture, bedding and homewares make up the major tenancies who all have significant lease tenure which provides certainty of rental income. A large focus of ours is protecting this tenancy mix to ensure we provide the best platform for the continuing performance of these retailers.

“We went from sweet to sour news very quickly,” says Allan Weinbauer, Acquisitions Manager at Properties & Pathways. “The day after we secured a new lease agreement with one of the tenants, their next-door neighbour announced it was closing all stores nationally.”

Loss to investor return

A short time after announcing a nation-wide closure, the vacating company was purchased by a competing homemaker. There was a possibility the acquiring company would occupy the premises, but they had unfavourable demands:

  • Would only accept reduced rent
  • Wanted only 1% annual fixed rent increases (existing annual increase was 3.5%)

If we accepted, the shortfall in rental income would be damaging to our investor return. If we didn’t, the vacancy had potential to reduce the overall asset value.

Damage of tenancy mix

The loss of the tenant would not only mean a monetary hit to our investors. It would potentially weaken the business mix and foot traffic generation for our remaining tenants.

The tenancy mix of our asset is homeware retail, which means our tenants have heavy foot traffic from shoppers looking for larger scale home-related products. Replacing our tenant with a non-homewares brand could bitter the flavour of the centre.

So, not only did we need to avoid losing investor return by maintaining the same income from a new tenant. We also needed to safeguard the overall value of the investment by keeping the tenancy mix consistent.

We were facing a deterioration of investor return and of the property’s attraction in this local market.

Solution: Study the fine print. Weigh up the options.

The day they closed the store, we issued a breach notice.

We then studied the lease agreement to confirm the vacating tenant had a guarantee in place with its parent company, who was responsible for the tenant’s leasing commitments.

“We wouldn’t just let them walk away from their obligations,” says Allan.

Seeking legal advice

Years as active commercial property investors gave us foresight to realise this was a unique and serious matter, requiring expert legal advice. We consulted our legal counsel, who advised we were in our right to claim damages. But this would be a very time consuming exercise.

Replacement tenant

We negotiated a new lease agreement with a new retailer acquiring our vacating tenant:

  • We accepted a significantly reduced rent (see “Claiming damages” below)
  • We obtained a six-month bank guarantee to replace the existing bank guarantee.

We now had an appropriate replacement tenant (with a long history providing high quality furniture in over 20 showrooms across the country).

Then came the tricky part.

Claiming damages

The reduced rental income and lower annual rent increases would have hurt our investor return, if not for our negotiations with the tenant’s parent company and guarantor.

We pursued the guarantor to cover all our incurred costs from the vacancy. This meant there was effectively no vacancy period from our tenant’s sudden departure.

We also refused to wear the loss of reduced rent, annual rent increases and collateral. So, we agreed the new tenant could occupy our premises on one condition: the guarantor of the vacating tenant would pay ‘top up rent’.

We negotiated a lump sum settlement with the guarantor to:

  • Top up the new tenant rent for the remainder of the existing term
  • Cover the gap of 2.5% fixed annual rent increases
  • Provide additional collateral to ensure the bank guarantee was covering six months’ rent.

Outcome: “It was the best possible result”

“It was the best possible result under this situation. We are now in a stronger position than we were before,” says Allan.

Preserved investor return

“We did not lose a dollar in income. We did not lose a percent in annual rent increase. We did not lose a dime on the bank guarantee.”

Beyond this, we added value to the asset.

Stronger tenant

Our new tenant is a more robust trader than its predecessor. They have a stronger brand, business and backing.

This means the new tenant provides a strong offering to the catchment and our asset will continue to be the homewares destination for the local catchment. We saved the value of the property by avoiding vacancy. In fact, we potentially increased the value by securing a better tenant.

No fees to investors

Typical leasing and legal fees to facilitate this replacement would have amounted to approx. $30,000. While we’re aware other syndicators would claim these costs and their incurred time by charging investors, we didn’t pass any fees onto our investors.

The reason? We’re in it with investors on the investment journey – bumps and all.

For more information on how you can invest alongside Properties & Pathways, get in touch today.