Why Multi-tenant Properties Offer Better Risk-Reward Ratios Than Single Tenant Properties
A multi-tenant property, by definition, has more than one tenant. Lease terms are generally shorter than those found in a single tenant leased property and can typically range from 3–10 years. A multi-tenant property also has a number of benefits from an ownership/investor perspective, in addition to some disadvantages. First, we’ll start with the advantages.
Multi-tenant properties generally provide a diversified rent roll. This means that they are leased to unrelated tenants in different businesses and across various industries. If one tenant’s business should fail unexpectedly, the overall cash flow for the property may be reduced but it does not become zero as it would in a single tenant property. Additionally, if the overall economy suddenly affects one industry — such as government spending reductions for defense — tenants in other industries will likely not be impacted and will be able to sustain the property’s cash flow.
A multi-tenant property is more likely to have reusable interior and exterior finishes than a single tenant property. This sustainability of current finishes can significantly reduce tenant improvement costs for future tenants and can enhance a specific space's marketability because prospective tenants will (i) need less imagination to envision how the space will look, and (ii) can more easily visualize themselves in that space. In addition, the savings accrued to an owner by reusing existing walls can be significant. In today’s market, completely eliminating all existing walls in an office space and replacing them in a different configuration could cost $40–$60psf. By reusing most of the walls and replacing paint and carpet, the cost would be reduced to $12–$15psf. For a 5,000 sf office suite, that would translate to savings of more than $200,000.
The cash flow to the owner/investor of a multi-tenant property is more sustainable and regular. This is because the property has multiple leases with varying lease expiration dates. For example, although a multi-tenant property may only periodically achieve 100% occupancy — and typically be stabilized at 90–95% occupancy — it would take a catastrophe to experience 0% occupancy as could be the case when a single tenant property experiences vacancy.
Tenants in a multi-tenant property often have less negotiating strength. A tenant that occupies an entire building has significant negotiation strength because the owner would face 100% vacancy and no cash flow if that tenant vacates. A tenant in a multi-tenant property may have far less negotiating strength due to its smaller size and far less impact on the property’s overall cash flow. For example, if a tenant occupies 7–10% of the property’s total space in a multi-tenant property and then vacates, the owner will still likely have sufficient cash flow from the other tenants to pay operating expenses and debt service.
Multi-tenant properties offer owners/investors a more stabilized value throughout an entire economic cycle. A single tenant property’s value diminishes as the length of the lease term decreases. Based on our experience, a multi-tenant property’s value tends to be more stabilized because of its varying lease expirations and diverse rent roll. Although a multi-tenant property’s capitalization rate may be higher (meaning less valuable) than a single tenant property when the tenant’s lease has more than 7–10 years remaining, the opposite is generally true when the single tenant property has less than 7 years lease term remaining. Because value is so dependent on lease term for a single tenant property, a multi-tenant property can offer a more stabilized value and offer less risk to the owner/investor.
Multi-tenant property rents adjust to the market more quickly. Due to the generally shorter lease terms of single tenant properties, rents are not regularly adjusted. Multi-tenant property rents typically adjust to market annually, which is a big reason why investors prefer this type of asset.
There can also be disadvantages to owning or investing in a multi-tenant property:
- There are increased property management needs. In a multi-tenant property, the owner is typically responsible for maintaining and repairing the common areas, such as landscaping, the parking lot, and the roof. This results in the owner needing to be “hands-on” and to develop relationships with service providers and contractors.
- Since there are more leases, the owner will receive multiple rent checks, which can be more time-consuming. There is also the potential that some rents may be late, which will require collection efforts.
- With more tenants, the owner will also be negotiating leases — both new and renewal — more frequently.
However, all of the aforementioned risks can be mitigated by a high-quality and experienced property management company. And Kenwood Management Company possesses the systems and processes to effectively address and manage these factors. We understand the local real estate markets and offer our clients an extensive wealth of knowledge on how to create the most value possible. If you're looking to find out whether a multi-tenant property is right for you and your business goals, contact us today to learn more.