Re: Need suggestions on $2.5mm fitness facility… - Posted by ray@lcorn
Posted by ray@lcorn on September 07, 2003 at 21:33:14:
Couple of thoughts…
First, any single-tenant deal has to be priced to reflect the strength and nature of the tenant.
The terms of your financing will hinge on the tenant credit quality. You don’t mention the financial capacity of your proposed tenant, but I probably don’t have to point out that a $2.65mm investment depends on that capacity. I’d want some pretty good evidence of staying power, and so will your first mortgage lender.
Separate from, but directly related to the first point, is the nature of the tenant’s business, and how it relates to alternate uses for the property. Unless this is different from the average gym, the use is not so specialized as to make the building terribly hard to convert if an alternative use has to be found.
But in addition to that, the nature of the gym business should give a landlord cause to pause. I did extensive research and feasibility work for a new fitness center a few years ago as an investor. The one number that just knocked me out of my chair, and eventually out of the deal, is the average customer attrition. The national average for annual customer loss in gyms and fitness centers is 40%… and those numbers are supplied by the centers. (Always consider the source.) The best months are Jan-Mar, then the resolutions wear off. It’s telling that the largest gym operator in the country has a 30% bad debt provision for its membership contracts, and their receivables sell at a 50% discount rate.
That means the proprietor better have a very good marketing plan, and the money to carry it out. If your tenant is an experienced operator looking to get a better or bigger location, then I’d be more comfortable than if it is a start-up. That 40% number is huge, and real. There has to be a continuous sales and marketing effort for the business to maintain just break-even revenue levels.
I’d also want to know why the last gym failed. “Poor management and I can do it better” is always what the buyer thinks, or in this case the proposed tenant. Try talking to a former customer and get a different perspective.
Assuming the tenant passes muster in experience and financial capacity, the you’ve got the basis for a deal. The key will be to draw up a very tight lease, preferrably for at least a five year intial term, ten would be ideal. If you can dictate terms, then make it triple net, with no outs for the tenant except condemnation. Play around with terms on a first mortagage at a 60-65% LTV, and add in the most liberal terms for you on the second… even to the point of no payments or interest for a few years until you can sell the lots or refinance. Structure the lease terms to provide about a 1.25 overall debt coverage ratio. That should give the first about a 1.5… that makes the loan easier to underwrite for interest risk.
As to the TI money, it depends on what it is needed for. If major structural or systems improvements are needed then you need to build a budget with a pretty tight estimate of costs and include it in your loan request. The bank may want to set that up as a separate escrow account to be paid as work is complete. That’s to your benefit actually, as it gives you the leverage of there being a higher authority when dealing with contractors.
If the money is for equipment, then that’s not TI, and the business owner should bring that to the table. (Be wary of an operation with lots of new, leased equipment. It seems to be endemic in the business to buy the latest and greatest in equipment in quantities only needed the first week of January.)
Check out that tenant,