Should you choose a single-tenant or a multi-tenant CRE property? Your choice can have a profound effect on your returns and risk profile. Each option presents advantages and challenges, and the key is to understand their differences to find the best fit for your investment goals. In the following sections, we’ll explore the pros and cons of both options so you can choose the right type of CRE property and build a profitable — and a much more sustainable — portfolio.
Understanding the differences: Single-tenant vs. Multi-tenant properties
Firstly, it’s important to differentiate the two options to understand the potential risks and rewards associated with each.
Single-tenant commercial real estate
A single-tenant CRE is leased only to a sole lessee and is often rented under absolute triple net (NNN) leases from investment-grade corporations. They provide consumer staples in strategic locations and are typically leased under a triple-net (NNN) agreement, where the tenant is responsible for property taxes, insurance, and maintenance costs. This structure often involves leases with investment-grade corporations, providing a degree of stability and protection against economic downturns. And because single-tenant properties often cater to essential services like food, fuel, and healthcare, they tend to be resilient to economic fluctuations.
Single-tenant CRE properties are usually rented by:
- Retail: Convenience stores, pharmacies, gas stations
- Industrial: Warehouses, distribution centers, manufacturing plants
- Service: Car washes, early learning centers, fast-food restaurants
Multi-tenant commercial real estate
Multi-tenant commercial real estate involves a single property owner (lessor) leasing space to multiple tenants. These properties are typically larger multi-unit structures, such as:
- Office buildings
- Shopping malls
- Industrial warehouses
- Two-Tenant centers
- Repurposed urban buildings
- Healthcare centers
- Retail strip malls
- Apartment complexes
Unlike single-tenant properties, multi-tenant CRE offers a diversified tenant base, which can help mitigate risks associated with individual tenant performance. You can enhance the property’s overall profitability if you know how to strategically lease space to reliable tenants who cater to a specific market.
Note that lease structures for multi-tenant properties can vary. While net and gross leases are common, the specific terms will depend on the property type, location, and tenant profile.
What about co-tenancy?
A co-tenancy clause in a multi-tenant lease agreement is a provision that can affect a tenant’s rental obligations if an anchor tenant vacates the property. This clause is designed to protect tenants from reduced foot traffic or revenue resulting from the departure of the anchor tenant.
For example, a co-tenancy clause might stipulate that if the anchor tenant leaves, the remaining tenants’ rent will be reduced. This can be particularly beneficial for smaller tenants who rely on the anchor tenant to attract customers.
Because co-tenancy clauses can be complex, they often require careful negotiation. Lessors typically include specific conditions to protect themselves from potential liabilities. Understanding the implications of co-tenancy clauses allows both landlords and tenants to mitigate potential risks.
Ways a single-tenant commercial real estate can benefit you
Single-tenant CRE offers the following benefits:
- Simplified lease management – You only have one unit with one lease and a single tenant, so managing a lease for a single-tenant CRE building is fairly straightforward. While negotiations and lease terms can be complex, the process is less complicated than managing multiple tenants and leases in a multi-tenant property.
- NNN lease structure – Single-tenant properties typically use triple net (NNN) leases. This means that the tenant helps pay for common area maintenance (CAM), taxes, capital expenditures, insurance, and other property maintenance expenses in addition to their rent. With an absolute NNN lease, you can passively collect rent and entertain other business endeavors, much like a hands-off management practice.
- Predictability – Longer single-tenant lease terms of 10 to 20 years offer predictable rental income. And because you have a solid track record of the tenant’s performance and can analyze historical data to make informed long-term projections, you can plan your finances and investments more effectively.
Cons of investing in single-tenant commercial real estate
Investing in a single-tenant property presents a few challenges:
- All-or-nothing occupancy – If your sole tenant vacates the property, you’ll have a period without income until you find a new tenant — a period that could stretch out to several months, depending on the market. This can lead to significant income loss especially if the property is financed with debt, as you’ll still be responsible for expenses like property taxes and mortgage payments.
- Cash flow depends on your tenant – The quality and reliability of your tenant can significantly impact your financial returns. If you find a reliable tenant who pays rent on time and maintains the property, then you can build a steady income stream. But having a problematic tenant can create a host of problems, from missed rent payments to property damage and even legal fees.
- Higher tenant improvement costs when reselling – Multi-tenant commercial real estate properties typically have reusable interior and exterior finishes. Meanwhile, single-tenant properties are often designed and tailored for the existing tenant. When it’s time to sell, you must account for the increased tenant improvement allowance and initial maintenance charges to make the property marketable again. If prospective tenants cannot picture themselves in your property, it’s almost impossible to negotiate and push them to sign a lease.
- Fixed rent, decreasing value – The value of your CRE property is affected by the length of its lease term. Longer leases often result in lower initial capitalization rates, but they can reduce the property’s flexibility. You cannot immediately adjust the rent as market conditions change, and this can decrease your property’s value over time. Also, even though single-tenant properties offer more predictable cash flows, their value can still fluctuate due to broader market trends and other unforeseen factors.
How multi-tenant commercial real estate can benefit you
There are four key advantages to investing in multi-tenant CRE:
- Low total vacancy risk – Lessees of a multi-tenant commercial real estate are unlikely to leave all at the same time. And as the owner, you can take steps to prevent them from leaving, such as catering to tenants from different industries and staggering the end dates and lengths of leases.
- Steady income– Having a diverse tenant portfolio can provide a more stable income stream. A property with a good mix of tenants from various industries is less likely to be significantly affected by economic downturns — after all, it’s unlikely that all of your tenants will face industry-specific challenges at the same time. This makes multi-tenant properties more resilient during recessions and provides a more consistent income for property owners throughout the year.
- Scalability to benefit existing tenants – A multi-tenant CRE offers a unique opportunity to partner with growing businesses. By leasing multiple units to reliable tenants as they expand, you can help them reduce costs and scale their operations. In return, you can increase the value of your property through long-term leases and higher rental income.
- Flexibility with shorter lease terms – Multi-tenant commercial real estate has shorter lease terms — often between 3 to 7 years. This means that you have opportunities to acquire high-value tenants, adjust rent regularly, and fulfill building upgrades. You can also sell your property when market conditions are optimal.
Multi-tenant properties and related challenges
Just like single-tenant CRE, multi-tenant commercial properties also present a few challenges:
- More responsibilities and duties – Having various tenants can cushion you against market volatility, but this can also mean more management responsibilities. As the lessor, you have to be open to different payment options, ready to respond to more emergencies, and able to manage complex multiple leases. Plus, managing a multi-tenant CRE requires a hands-on approach.
- Frequent turnover of tenants – A short-term lease may offer flexibility, but it’s a double-edged sword that may result in frequent tenant turnover. This constant churn can make it difficult to predict long-term income and profitability.
- High maintenance costs – One of the biggest disadvantages of investing in a multi-tenant CRE is the higher maintenance cost. You will be responsible for all building expenses, including common area maintenance. These responsibilities — from installing security systems to fixing the plumbing — can be time-consuming and costly.
- Tenants expect a gross lease – Most lessees of multi-tenant properties expect to pay a gross lease instead of a net lease. This means they won’t pay for secondary expenses such as taxes, insurance, and maintenance. Although you can negotiate for a net lease, this may turn off potential tenants who prefer a gross lease structure. Experienced CRE investors circumvent this problem by setting a rental rate that covers operating expenses without significantly increasing leasing costs.
Which commercial real estate property should you choose?
The right choice between multi-tenant and single-tenant CRE ultimately depends on your needs, risk tolerance, long-term plans, financial objectives, and capabilities.
If you prefer a steady cash flow with minimal operational hassles, then a single-tenant property may be for you. The longer lease provides a consistent income, and you only need to work with a single renter. However, this arrangement leaves you vulnerable to vacancy risk when the tenant leaves and you can’t find a replacement right away.
Multi-tenant CRE may be more suitable if diversification is your priority. You could spread the risk among various renters instead of depending on a single source of income.
Have you made the choice?
Our team of private commercial real estate lenders here at Private Capital Investors can offer custom financing solutions for your next CRE project. Call 972-865-6206 or email info@privatecapitalinvestors.com to get started.
