Investing in commercial properties can be a lucrative business endeavour, but only with proper planning. First, you must decide whether you will invest in single-tenant or multi-tenant commercial real estate.
While this might seem trivial, several distinctions beyond the number of tenants are vital to understanding which type of property aligns with your investment goals. By examining the differences between single-tenant and multi-tenant properties, you’ll be well positioned to develop suitable investment and leasing strategies to maximize profitability for your business.
Interested in a specific aspect of single and multi-tenant commercial real estate? Click on the topic below to skip ahead.
- What is the difference between single-tenant and multi-tenant leases?
- What is a co-tenancy clause?
- What are the benefits of single-tenant commercial real estate?
- What are the challenges of single-tenant commercial real estate?
- What are the benefits of multi-tenant commercial real estate?
- What are the challenges of multi-tenant commercial real estate?
- The key to managing both single-tenant and multi-tenant leases
What is a single-tenant lease?
A single-tenant lease is a rental agreement between a lessor and the sole lessee of a property. Often, single-tenant properties are rented via absolute triple net (NNN) leases by investment-grade corporations, providing consumer staples in ideal locations and are insulated against economic disruptions. Common examples of single-tenant properties include:
- Convenience stores
- Childcare and early learning centres
- Dollar stores
- Gas stations
- Car washes
- Fast-food restaurants and drive-thrus
- E-commerce fulfilment facilities
- Warehouse and distribution centres
- Industrial and manufacturing plants
What is a multi-tenant lease?
A multi-tenant lease is a rental agreement between a lessor and several lessees in a larger, multi-unit property. However, it’s also common for lessors to rent out each unit in a multi-tenant property individually to a single tenant via a gross or net lease. The strongest multi-tenant investment properties consist of a diversified portfolio of reliable tenants offering consumer staples in a prime location. Common examples of multi-tenant properties include:
- Office centres
- Shopping malls
- Industrial warehouses
- Repurposed urban buildings
- Retail strip malls
- Two-tenant centres
- Healthcare centres
- Apartment complexes
A co-tenancy clause in a commercial lease agreement permits lessees to reduce their rent if a core lessee or a certain number of lessees leave the multi-tenant property. A core lessee, sometimes referred to as an “anchor”, often generates a significant amount of traffic and provides incentive for other lessees to locate to that specific property. The reduced rent helps to compensate for a loss of traffic associated with the departure of the core lessee.
Co-tenancy clauses are fiercely negotiated items that can severely impact the profitability of commercial real estate. Often, lessors will insist on certain conditions to protect themselves from further legal action in the event of a co-tenancy violation. For example, lessees may not be able to invoke a co-tenancy clause if they are under default on the lease or they may have to provide evidence of a drop in sales during the co-tenancy violation period.
Further reading: 5 ways to optimize your property lease management strategy
Predictability from longer lease terms
Lease terms for single-tenant properties tend to be longer, fixed periods, ranging from 10–20 years. These long leases allow you to predictably accrue rental income and develop a transaction history with your tenant, generating enough data to be analyzed for insights to support long-term planning.
Triple net (NNN) lease structure
Single-tenant properties often operate with NNN leases, which means that, in addition to rent, the tenant pays for the taxes, insurance, common area maintenance (CAM), capital expenditures, and any other property maintenance costs. An absolute NNN lease enables a hands-off management style, allowing you to passively collect rent and focus your time on other endeavours.
Straightforward lease management
One unit, one tenant, one lease—that’s what a lease consists of for single-tenant properties. While some complicated terms and negotiations can still exist, you won’t have to handle anything nearly as complex as managing the multitude of leases required to operate a multi-tenant property.
A gap in rental income while you search for a new lessee or complete property improvements can severely impact your bottom line. With only one lessee, you risk facing total vacancy if they leave at the end of the lease term. This is especially true if there is debt on the property, as you’ll still be expected to pay the mortgage, taxes, and other expenses.
Cash flow is reliant on quality of tenant
You won’t be the only one aware of the risk of all-or-nothing occupancy. Lessees of single-tenant properties tend to have better leverage than lessees of multi-tenant properties because they can singlehandedly impact your cash flow. Whether they’re overly zealous negotiators or forgetful space cadets, improper tenant screening could lock you into a situation where you must either accept unreliable payments for upwards of ten years or pay hefty penalties to find a new tenant.
Inflated tenant improvement costs during resell
Multi-tenant properties often have reusable exterior and interior finishes, but single-tenant properties are usually heavily customized for the current tenant. When the time comes to sell, you’ll likely have to budget for a bloated tenant improvement allowance and preliminary maintenance charges to improve the property’s marketability. If prospective tenants cannot easily envision themselves in the space, it will be nearly impossible to convince them to sign the lease.
Value decreases over time while rent stays the same
The value of a single-tenant property depends on the length of the lease term. While these properties may initially benefit from a lower capitalization rate than multi-tenant properties, the reverse will become true once the lease has less than seven years remaining. Additionally, longer lease terms prevent lessors from regularly adjusting rent, so while a single-tenant property may offer predictability, its value is not guaranteed.
Low risk of complete vacancy
Unlike single-tenant properties, there is a low risk that all the lessees of a multi-tenant property will leave at the same time. You can even take measures to help further prevent this, like staggering the length and end dates of the leases and leasing to tenants from various industries.
Steady income from diverse portfolio of tenants
It is unlikely that every industry will experience disruption simultaneously or to the same degree. Therefore, multi-tenant properties with a diverse portfolio of lessees are often better equipped to survive recessions and continue to provide a steady income for lessors year-round.
Current tenants benefit from scalability
Multi-tenant properties give lessors the unique opportunity to lease to tenants early in their growth journey. Rather than having to move, reliable tenants can lease out more units as they expand. Lessees can benefit by keeping costs low while scaling, and lessors can benefit from the value added to their property.
Shorter lease terms provide flexibility
Multi-tenant properties offer shorter lease terms than single-tenant properties, often lasting between three to seven years. These lower commitment leases allow lessors to acquire higher value tenants, facilitate building upgrades, regularly adjust rent, and sell the property during a prime window of opportunity.
Increased duties and responsibilities
While the variety of tenants can help insulate you against market disruptions, it can also add to the managerial responsibilities. Accommodating different payment options, managing multiple leases, and responding to various emergencies are part of these properties’ more hands-on approach.
Tenants expect to sign a gross lease
It’s common for tenants of multi-tenant commercial properties to pay a gross lease rather than a net lease. In these scenarios, lessees do not pay for secondary expenses like maintenance, insurance, or taxes. While you can still negotiate a net lease, you might lose prospective tenants who’ve only budgeted for a gross lease. Lessors frequently perform a balancing act to ensure that the rent covers costs without accidentally pricing out potential lessees.
Frequent tenant turnover
Short-term leases are often a double-edged sword because, while they can provide flexibility, they commonly lead to more frequent tenant turnover. At times it may feel like there is a revolving door of lessees, and the uncertainty in vacancies can hinder your ability to project long-term income.
Higher maintenance costs
This is one of the biggest drawbacks to investing in multi-tenant properties. Unless you can negotiate a net lease, it’s far more likely that the lessor will be responsible for common area maintenance and building expenses. These responsibilities include numerous, time-consuming, and expensive tasks, such as repairing the plumbing or installing security systems.
Complicated lease terms and negotiations, proving regulatory compliance, allocating liability insurance, and paying taxes and management fees are some of the confusing minutiae that come with complex lease management. Without the proper tools, keeping track of the details of multiple leases can quickly spiral out of control.
Fortunately, solutions like Property Lease Management can help you accurately manage your leases without becoming overwhelmed. By automating processes like rent collection, compliance with accounting standards, and reporting, you’ll free up precious time to tend to the more challenging aspects of property management.