When looking to sell a commercial property, landlords will often find themselves in a very fortunate position. All they need to think about is what motivated them to purchase that particular piece of commercial real estate, in the first place.
Why is this? Because there is a very strong possibility that any new commercial property investors looking at the property will share a similar mind-set, and armed with this knowledge, investors can shape their marketing to attract just the right sort of buyer.
Naturally, over time, the value of the commercial property investment is likely to have risen, simply due to market appreciation. Only now the proposition can become even more attractive with the property now having good tenants in situ, with no desire to break their lease and no indication that they are going to forfeit.
In this article, we’ll look at the benefits of selling a commercial property with tenants, as well as the more common issues that arise.
There are some commercial agents who will advise that the landlords allow a lease agreement to come to an end before selling, if that date is within the next 3-6 months. However, this really only makes life easier for them, as they can show the property to prospective purchasers without having to schedule appointments with the existing tenants.
But a commercial property with strong tenants in situ is presented as so much more than just a building – it is a working business model. The commercial property investor is in a position to sell a going concern, and as such that the investment is presented in such a fashion.
Documentation is Key
There are various pieces of key information that the commercial property seller should have on hand in order to maximise interest on the part of their buyers. The first are details of the occupancy rate.
This is particularly useful if selling office space with multiple tenants. At the point of sale, it is possible that the commercial space will not be at maximum occupancy, and this can be seen as a negative from the buyers’ perspective. After all, if, at the point of viewing, the potential buyer sees a building only generating between 60 and 70% of its rental income potential, then the buyer is likely to either consider elsewhere or come in with an offer substantially below market value, believing the seller to be coming from a weak negotiating position.
However, it may well be that a number of tenants’ leases came to an end at the point at which the commercial property owner chose to put the property on the market, hence they mutually agreed to part company – the tenants may not have been comfortable with the uncertainty of a new landlord, for example.
This is why documentation of the occupancy rate over the entire life of the property’s ownership needs to be shown. If buyers can see that occupancy generally fluctuates at between 85 and 100% capacity, then they will immediately recognise that they are investing in a sound and profitable business model.
Whilst being safe in the knowledge that their monthly expenses will be met by their existing tenants’ rental income, any commercial property investor is fundamentally interested in maximising the return on their investment, hence the forecasted monthly income is going to be a very important metric for them, so make sure it’s not only available, but that it can be verified either by the buyer’s accountants or solicitors.
Average Lease Length
Intrinsically tied to how many tenants are housed in the commercial property is how long they are likely to stay there. Serviced office spaces are notorious for offering shorthold tenancy agreements, with some companies only taking up occupancy for six months.
This doesn’t necessarily represent a problem if there is a high number of tenants regularly coming in, which the figures above will illustrate. However, to show true stability, a commercial property housing tenants with lease agreements of at least five years represents a much more attractive proposition to a commercial property investor.
Longer leases come with break clauses, so how many tenants left at the point of that break clause, how many chose to remain until the end of their lease and, best of all, how many chose to extend the terms of their lease?
These figures, added together and divided accordingly, will represent the average lease length of tenants in the commercial property in question. For many investors, a lower number of tenants on long leases can prove to be a much more attractive proposition than numerous tenants and a high rate of attrition.
This is especially true for the commercial property investor who is not looking for a ‘hands on’ approach as a landlord. They don’t want to be frequently marketing and showing new tenants around their property, and whilst there is always the option to appoint a commercial agent to take care of that for them, such continuous management is going to eat into their profits, thus making the entire commercial property and business model, a less attractive proposition.
Whilst forecasted figures are important, they are never as concrete as current figures. It’s important that the commercial property seller is able to show the rental income that is actually being gathered at the point of sale.
Whenever a commercial property is sold with tenants in situ, those tenants’ current lease agreement is binding, even with new landlords. As a consequence, buyers cannot simply acquire the property and immediately raise the rent. Should they want to increase rent once the current leases expire, then they are well within their rights to do so, but that can come with some risk.
Tenants could simply choose to find alternative accommodation for their businesses, and this is a compounding problem. First, and most obviously, the rental income from that tenant is lost, meaning that the new commercial property owner starts either running at a smaller profit margin or worse, at a loss.
Second, marketing activities will need to begin to attract and acquire new tenants. This means appointing agents, advertising, plus time spent negotiating, dealing with solicitors and so on.
What’s worse, there is a strong possibility that word will spread locally that the rent rates in the building are considered unreasonable for the area, and this will make things considerably harder to find a new tenant.
We fully appreciate that this is a worst-case scenario, but in our efforts to provide a guide to selling a commercial property with tenants in place, it’s important that we present a balanced outlook.
But approaching this topic from a more positive perspective, the current rent figures form the solid foundation of a marketing campaign for the property. What sounds better – “3000 square feet of office space available” or “Office space currently generating £25,000 per month with 80% of lease agreements signed for five years”?
Once again, it’s important that the marketing focusses on sharing a mind-set with fellow commercial property investors. Granted, real estate investment is a long-term game with the majority of investors looking to see a return after at least ten years of ownership, thanks to simple market appreciation. But selling a commercial property with tenants in place is not simply a matter of selling real estate, it is the sale of a successful business, therefore any marketing material that is prepared needs to reflect that.
Seek Cooperation from Tenants
The most effective advocates for any commercial property are its existing tenants. Whilst new potential buyers are viewing the property, they’ll want to know what they can expect from both the building and its tenants, should they take it over.
This makes it a good idea for the commercial landlord to get the cooperation of their tenants. Now if there have been no issues and a model tenant has been renting from a model landlord, then each party should be more than happy to help each other.
However, this is not always the case, and so it can sometimes be in the commercial landlord’s best interests to incentivise their tenants by offering a reduced rate of rent whilst the property is on the market. Anyone wanting to walk through their offices is a disruption to their business – at one end of the scale it simply means people have to stop what they’re doing for a few minutes but on the other, it may well be that the property is being viewed by a rival firm and tenants would not want those people viewing the property to come into contact with any sensitive information. As a result, they may well have to shut down operations for a period of time, which of course would be at a cost to the business. Should this be the case, they would therefore deserve to be compensated for the inconvenience.
Of course, such as an example is extreme, but it does occur, and so it’s important that anyone looking to sell commercial property with tenants in situ consider the needs of those tenants from the very moment that the prospect of selling comes into consideration. Those tenants have the right to be given as much notice as possible of proposed changes to their businesses, and a change in building ownership represents a significant change.
Marketing the Complete Package
As we mentioned at the outset, the process of selling a commercial property starts with marketing. It’s important that the commercial property investor chooses to market the property to like-minded investors. Whatever attracted the current owner is going to attract the next one.
If the commercial property was initially purchased empty, then it will be important to think about those headaches that will no longer be there for the new buyers, simply because there are now tenants in place.
If, on the other hand, the commercial property was purchased with tenants in situ originally, then the current owners will be aware of both the benefits and pitfalls of taking on a commercial property in this manner. Whilst it is important to be transparent with any potential buyer, it’s equally important that the marketing package put together highlights the benefits of buying a commercial property with tenants already in place.
The most obvious benefits have already been highlighted throughout this article, but there are some other, less obvious benefits that merit being mentioned here.
Health and Safety
Any commercial property with an operating business within its walls must comply with health and safety legislation. The nature of the business in question will determine just what health and safety standards need to be in place, and more importantly, just who is responsible for their upkeep – landlord or tenant.
For any new buyer, regardless of who is responsible, this is good news. Taking over a building which has been vacant for some time will mean that additional surveys will need to be conducted and any and all repairs made prior to occupation to ensure that the property meets current health and safety legislation. This can be costly and time consuming.
Purchasing a commercial property with tenants in situ means that these standards are likely to already being met. That being said, there are varying degrees of health and safety standards, and we would recommend seeking independent advice on such matters.
That being said, it can form part of the commercial property owner’s marketing strategy to point out this often-overlooked advantage.
Decoration and Maintenance
Issues surrounding health and safety lead on neatly to decoration and maintenance. When taking on board an empty property, it’s important for the new landlords to present as blank a canvass as possible in order to attract new tenants. If the previous tenants have truly made their mark upon a property, then redecoration can prove expensive.
Once again, with tenants already in place, such steps are simply not necessary, and business can continue as normal. Once again, it’s important that this is pointed out to potential buyers at the earliest available opportunity, as the opportunity to save money automatically boosts the profits of their new proposed business venture.
A Seamless Transition
When selling a commercial property with tenants in place, what the commercial property owner is doing is offering a seamless transition. Tenants will continue paying the same amount of rent and will ideally, notice no major changes in the day to day running of their business – so much so that they’ll want to renegotiate a new lease once their current one expires.
Whilst we would love to suggest that the process is entirely without complication, we simply cannot guarantee that’s always going to be the case. That’s why at Prideview Group, we have an entire team of experts on hand to answer any questions and accompany you through every step of the process of either buying or selling commercial property, so let us know how we can help.