If you own an investment property and are negotiating or re-negotiating a lease with a tenant, the lease rate and structure you agree upon could considerably affect your property's ultimate sale price.
Investor buyers "underwrite" each investment property opportunity they look at. Different investors have different styles, assumptions, and risk tolerances, but generally speaking, a property's Net Operating Income (NOI) is the driving figure for a target purchase or sale price.
In simple terms, NOI is the net income derived from taking either the gross possible income (GPI) or the gross contract rent income, and subtracting all relevant landlord expenses such as taxes, insurance, and maintenance.
In a "capitalization rate" valuation analysis, that NOI figure is then divided by an investor's desired "going in cap rate" to arrive at a target value. A particular investor's desired cap rate depends largely on the market, as well as the risk associated with the tenant, lease length, and the property condition.
For example, if a property is leased for $4,000 per month, the annual GPI or gross rent would be $48,000. Suppose taxes are $8,000, insurance is $4,000, and regular maintenance expenses are $4,000 per year. In this example, the resulting NOI would be $32,000. If an investor buyer is seeking a 10% cap rate on this particular opportunity, then they would place a $320,000 value on such an investment ($32,000 / 0.10). If the tenant is a strong brand/company and the lease has 5+ years remaining or is otherwise less risky, the investor may be accepting of a much lower cap rate. If, say, an 8% cap rate was acceptable on the proposed transaction, then that $32,000 NOI has a value of $400,000 instead of $320,000.
So when you are negotiating or renegotiating a lease, every rent dollar, every landlord expense, the length of the lease, and the strength of the tenant can all have significant impact on the ultimate price. Investor buyers also like to see increasing rents on longer term leases, so agreeing to a static rent figure for a long term lease can also have a negative impact on your property's value, especially in an inflationary environment where gross income may stay stagnant in the face of rising taxes, insurance, and maintenance costs.
The above cap rate/NOI analysis is just one simple way investor buyers might underwrite possible acquisitions. There are much more in-depth analyses which consider multiple years of cash flows and make many more assumptions, such as the investor's holding period, particular tax bracket, cash vs. financing, and so forth.
Curious about how the structure of your lease may affect your property's value, or want to know how much your investment property might be worth? We'd love to help.