Under Contract, Terminated In Due Diligence

46,000 SF. 90% occupied. A basis below replacement cost. We put it under contract and terminated in diligence.

By Jeremiah Boucher | Patriot Holdings

We were genuinely interested in this one. 46,000 SF of small-bay flex in a central Connecticut metro. A diverse tenant base with no concentration risk. 90% occupied. And a strong basis at $117/SF, below what we estimate it costs to build today.

We liked it enough to put it under contract.

Then we got into diligence, started reading the actual documents, and found a stack of red flags that weren’t visible from the outside. We terminated.

Three lessons came out of it. All three are things you can only find by doing the work.

Deal Snapshot

What I Liked

A dense infill location in a metro with very limited competing product. Unit sizes right in our wheelhouse. 90% occupancy with a tenant base that mostly renews, and no single tenant big enough to hurt us on the way out. And a basis below replacement cost, which is the one thing you cannot manufacture later.

Every instinct I have says buy that building. That is exactly why the rest of this matters.

Lesson One: The Best Comps Are the Recent Leasing Activity

Pull CoStar, pull LoopNet, and you’ll get a comp set for small-bay flex in this submarket somewhere between $15 and $18/SF gross. Those are signed deals, real leases at real numbers, not asking rents. On its face that’s a healthy range, and plenty of buyers would take the middle of it and build a model on $16.50.

The problem is that a submarket range tells you what’s achievable somewhere nearby, in somebody else’s building. It doesn’t tell you what this building can get. For that, you want the most recent leasing activity at the property itself: the last 6 to 12 months, in today’s market, with these bays and this landlord.

This one had five of them, all executed on site this year. $14.00, $15.00, $15.00, $15.50 and $18.00. Weighted by size, that’s $15.09/SF.

One deal at the top of the range. Three at the bottom. And the largest suite of the five, at 2,600 SF, signed below the range entirely. Against in-place rents averaging $16.03/SF, that says this building sits at the bottom of its own submarket. There is no spread to capture. The whole reason we were interested just evaporated.

But the rate is the smaller half of the story. Look at what it took to get those signatures. Several of those tenants got a month of free rent. And not one of them carries an annual escalator. Flat for the full term.

That’s the tell. A landlord with pricing power signs a lease at a number and puts a 3% bump in it. This landlord was handing over the first month and promising not to raise the rent for three years, and still only got $15.09/SF. He wasn’t negotiating. He was begging for a signature.

You will never see that in a comp grid. A comp grid gives you a rate. It doesn’t tell you the rate came with free rent and a frozen term, which means the effective number is lower than it looks and the building has no leverage over its own tenants. The only way to find it is to open the leases.

Lesson Two: Check Every Lease for Duration and Bumpers

Quick note on terminology, because “bumpers” is shorthand and not everybody uses it. A bumper is a rent escalator, a clause written into the lease that raises the rent by a set amount every year, usually around 3%. Rent escalator, rent increase, annual bump: same thing. If a lease doesn’t have one, the rent you sign is the rent you get for the entire term.

When you buy an occupied building, you inherit somebody else’s paper. The rent is only ever worth what those contracts allow it to become, and whatever they say, you’re bound by it. You can’t un-sign them.

So go lease by lease. Not the rent roll summary the broker sends. The actual documents. Two questions on each one: how long am I locked in, and does the rent step up while I’m locked in?

Here, 21 of 23 leases had no escalator at all. The other two had bumps. Everybody else sits flat until they roll.

Then look at weighted average lease term. This one is 26 months. That’s the number I want every operator to internalize, because it tells you precisely how long you’re stuck. For roughly two years, across the whole rent roll, the rent does not move. Not with inflation. Not because insurance renewed higher. Not because you put capital into the building. It sits.

Get locked into 3, 4, 5 year leases with no bumpers and you have capped your own upside on the day you close. There’s no lever left to pull. You can be the best operator in the business and the contracts still say no.

Usually a short WALT is the escape hatch. The leases roll, you reprice, the flat terms stop mattering. That’s what made this one so ugly. The leases do roll, and fast. But Lesson One already told us what they roll to: ~$15.09/SF, no bumps, a month free. You’re not locked up for two years and then rescued. You’re locked up for two years and then likely handed the same deal again. Which is why our model could only grow base rent about 1% a year across a five-year hold. That wasn’t us being conservative. That’s what the contracts and the leasing history mathematically permit.

Lesson Three: Gross Leases Put the Landlord at Risk

A gross lease means the tenant pays rent and you pay everything else. You absorb every single expense increase, for the entire hold, with no mechanism to pass any of it on. On a triple net lease, the tenant carries those costs. That’s the whole difference, and over five years it is enormous.

Every lease in this building was gross except one. And diligence handed us a live example of exactly what that costs. We pulled the utility bills and found trash service had gone up 7.4% in a single year. Not a projection. An invoice. So we carried it forward at that rate, because that’s what actually happened. One line item, $18,441 today, becomes $25,898 by Year 5. A 40% increase on the trash bill, absorbed 100% by the owner, recovered from nobody.

Now do that honestly across the whole stack, insurance, water and sewer, snow, repairs, and total operating expenses go from $7.47/SF to ~$8.54/SF over the hold. Growing about 3.4% a year, against rent growing about 1%.

Seller Motivation Check

The leasing file was the motivation. A landlord who gives away the first month and freezes the rent for three years is not testing the market. He is clearing space off a rent roll, and he did it five times this year.

There is a second clock running underneath that. The building currently pays about $95,000 a year in real estate taxes on a stale assessment. Reassessed at what we’d be paying, the assessor’s own methodology comes out around $265,000, and the revaluation date falls inside our hold. Our model carries a tax consultant’s estimate well below that on the expectation of a successful appeal, which means there’s real money sitting on one line hedged by nothing but an argument. Under gross leases, whichever way it lands, we absorb every dollar.

None of that makes the seller wrong to sell. It makes the timing legible. The expense reset is visible on a public calendar, and the person holding the asset can see it as clearly as we can.

Read the P&L Like an Operator

Here is the math, stated plainly, on our contract basis.

Basis. $117/SF across 46,000 SF = $5,382,000.

1. ‍Going-in cap on Year 1 NOI. $394,982 / $5,382,000 = 7.34%
2. Year 5 cap on the same basis. $403,317 / $5,382,000 = 7.49%

Five full years of ownership. Capital spent. Tenants re-leased. NOI moves 2.1%, and the yield on our own basis moves 15 basis points. It goes backwards in two of those five years.

Underneath it: operating expenses of $343,620 in Year 1 become $392,840 by Year 5 on the same 46,000 SF, while base rent grows about 1% a year. Expenses compounding roughly 3x faster than income, with the tenants contractually insulated from all of it.

Notice how ordinary all of that is. No tenant defaults. No recession. No vacancy spike. Expenses just go up the way we already watched them go up, and the assessor does his job on schedule. That’s the whole downside case. When the bad scenario requires no bad luck, you are not being paid for the risk you’re taking.

Why I Made the Call

Stack the three lessons and you get a single sentence: the income is capped and the expenses aren’t.

Either half of that is survivable on its own. Flat leases on triple net paper are fine, the margin is protected even if it can’t grow. Gross leases with real annual escalators are fine, the bumps pay for the inflation you’re absorbing. It’s the combination that’s fatal, and it’s why the model comes back showing NOI going nowhere across a five-year hold. When we ran the full return, it didn’t clear our bar. It didn’t come close.

And I’ll be honest about how badly I wanted this one. A dense infill location. Very limited competing product in the submarket. Unit sizes right in our wheelhouse. 90% occupancy with a tenant base that mostly renews.

But Patriot buys where operational skill moves NOI. That’s the entire edge. We take a building, push rents to market, put escalators in leases, tighten the expense load, and create value we control. This asset offered none of those levers. Rents already at market, income frozen by contract, every expense increase landing on us. It’s outside our buy box, and on the risk we’d be taking for the return on offer, we deemed it too risky. So we walked, because we decide on the numbers, not on how much we like the deal.

Saying no to a building you want is most of the job.

“You can be the best operator in the business and the contracts still say no.” — Jeremiah Boucher, Founder & CEO, Patriot Holdings

The Lesson

A good basis does not survive bad paper. Price per foot is the first thing you look at and the last thing that saves you, because the leases decide what the building is allowed to earn and the lease structure decides who pays when costs rise. Underwrite the contracts before you underwrite the location.

And I’ll own the part that stings. We were under contract before we knew any of this. The basis looked right and we moved. Diligence is where we found the leases, the leasing history, and the expense structure. It cost us time and third-party fees to learn it. That’s the cheap version of this mistake. The expensive version is closing.

Three Questions to Ask Before You Buy an Occupied Flex Building

What has this specific building leased for in the last 12 months, and on what terms? Submarket comps tell you what’s achievable nearby. On-site leasing activity tells you what this asset actually commands. Ask for the rate, the free rent, and the escalator on every deal signed in the last year. Here the submarket said $15 to $18/SF and the building said $15.09/SF with a month free and no bumps.

How many leases carry an annual escalator, and what is the weighted average lease term? Together those two numbers tell you how long your income is frozen and whether it thaws. 21 of 23 leases with no bump and a 26-month WALT means roughly two years of flat income followed by a re-lease into the same terms.

Who absorbs the expense increases, and what has actually increased? Gross means you do. Pull the last two years of invoices rather than the pro forma. One trash contract that moved 7.4% in a year, carried forward, is a 40% increase by Year 5 with no recovery mechanism.

Verdict: KILL

46,000 SF of small-bay flex in a central Connecticut metro, 90% occupied, at a $117/SF basis below replacement cost. We put it under contract and terminated in due diligence. 21 of 23 leases carry no rent escalator, weighted average lease term is 26 months, and on-site leasing over the past year averaged $15.09/SF with free rent against $16.03/SF in place, so there is no rent spread to capture. Nearly every lease is gross, so all expense growth lands on ownership, including a real estate tax reassessment scheduled inside the hold. Modeled NOI moves from $394,982 to $403,317 over five years, a 2.1% increase, with expenses growing roughly 3.4% a year against 1% rent growth. Good basis, bad paper. We walked.

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Disclaimer

This analysis reflects Patriot Holdings’ independent underwriting assessment based on information available at the time of review, including the broker’s offering materials, diligence documents, and our own market experience. Our assumptions, projections, and conclusions may differ from those of other qualified operators, investors, or the seller, who may possess material information not available to us. Reasonable professionals can and do reach different conclusions when underwriting the same asset. This content is shared for educational and informational purposes only and does not constitute investment advice or a judgment on the seller, the broker, or any party involved in the transaction.