Single-tenant properties can provide a great return on investment, but they are not without their risks. Before making the jump into single-tenant properties, it is important to understand these risks so you can make an informed investment decision.
Types of Single-Tenant Properties and Their Characteristics
Around a quarter of all commercial properties are of the single-tenant type. Many are owned by large investment funds. While small investors should consider investing in single-tenant properties, they should also know the basic types available.
The first type of single-tenant property are those that were initially owned by a corporation. The corporate entity sold the property to an outside party, either because they didn’t want to maintain the property or because they needed to raise funds for another use. Then, the corporation signed a long-term lease with the new owner.
Build-to-suit properties, meanwhile, have been constructed for a specific use by a tenant. These can be industrial, warehouse, or office space, but in each case, the building has been designed to the specifications of the client. These properties are most often owned by the developer, who may later choose to sell the building to a third-party investor.
Finally, some single-tenant properties were once occupied by multiple tenants but have since been reconfigured to be single-tenant properties. Normally, this is a result of one tenant needing increased space and being willing to pay more for it. These properties are often older than other single-tenant properties, as they may well have been multi-tenant properties for years before their conversion.
Risks Associated with Single-Tenant Properties
While single-tenant properties offer many enticing advantages for investors, they do come with some risks. It is important to fully understand these risks before investing in a single-tenant property because what may look like an easy and steady stream of income can quickly become a major financial disaster for the unwary investor.
The biggest risk of a single-tenant property is losing the tenant. If that happens, then the property is not generating income. If it subsequently takes a long time to find another tenant, the property might become a drain on resources, as it still must be maintained during its vacancy. This is why many single-tenant properties have long-term leases with a corporate client. Thoroughly research the type, length, and terms of the existing lease before investing.
If the property was configured for a particular type of business and that tenant leaves, it can be very expensive to repurpose the property. A bank would have a large vault area that would not be enticing to a fast-food restaurant, for example. Unless another tenant of the same type can be found, the building will have to be reconfigured and the costs to do so could be extremely high depending on the changes needed. In some specialized cases, it might even be necessary to tear down the building and rebuild it from the ground up.
Single tenants have considerable advantages when the time comes to extend their lease. The risk of losing your only tenant can force you as the owner to make certain concessions, including rent reduction or building improvements. In areas where the tenant has many options for relocation, the advantage they have in negotiations is even greater. In the case of a shorter-term lease (e.g., five years), this problem can crop up again relatively quickly and the concessions you agreed to can cut heavily into your profit margin. The flip side of this is that you could give up certain things in exchange for a longer lease. This will almost always be worth it, as it puts you in a more secure position.
A great way to lower the risks of a single-tenant property is to require the tenant to have a very high credit rating. This can ensure you will get a reliable tenant who will pay their rent. Another option is to write into the lease agreement a clause that requires the tenant to make all rental payments, except in the case of the destruction or condemnation of the property. A clause such as this protects against many contingencies, including any future restrictions placed on businesses by, for example, a new major pandemic outbreak. Mitigating the major risks associated with single-tenant properties makes investing in these properties much more secure.