Investing in commercial real estate can offer lucrative opportunities, but it’s not without risks. One such investment avenue is purchasing a property leased to the United States Postal Service (USPS) with a purchase option rider. While these properties may seem attractive, it’s essential for investors to understand and navigate the potential risks associated with such investments.

In this blog, we delve into the two different types of purchase option riders, the risks of acquiring a USPS leased property with a purchase option rider, case studies, and how investors can mitigate their risk.

Understanding the Purchase Option Rider:

A purchase option rider grants the lessee (USPS) the right, but not the obligation, to purchase the property at a predetermined price or at fair market value (FMV) within a specified timeframe (at the end of the base lease, after the first renewal option, and etc.).

The difference between a predetermined price and FMV purchase option is below:

Predetermined Price: Is a fixed dollar amount that is built-in your lease, that permits the USPS to purchase the property at a specified timeframe.

FMV: “The purchase price will be the market value of the Property unencumbered by the Postal Service Lease, as determined by a current and independent appraisal obtained by the Postal Service. The appraised market value shall be reduced by any prepaid rent Landlord has received and the cost of any unamortized capital improvements made to the Premises by the Postal Service. If Landlord disagrees with the purchase price offered by the Postal Service, the Landlord shall have a period of 30 days from the date of the Postal Service’s written notice of the exercise of the purchase option to obtain an appraisal, at the Landlord’s expense, from an appraiser designated by a national professional appraisal organization or society by The Appraisal Foundation and deliver the same to the Postal Service upon receipt. The Purchase price shall then be determined as follows:

1. If Landlord’s appraisal amount is within 10% of the Postal Service’s purchase price offer, then the purchase price shall be the arithmetic average of the two amounts. The Postal Service shall then be entitled to purchase at that arithmetic average.
2. If the difference between the two amounts is greater than 10%, Landlord and Postal Service shall attempt to agree in writing on the purchase price during the 30-day period following delivery of the Landlord’s appraisal to the Postal Service (the “final negotiation period”). If the parties reach agreement on the purchase price, the Postal Service may acquire the property at such purchase price. If the parties are unable to reach agreement during the final negotiation period, then Landlord shall provide the Postal Service with a list of three Qualified Appraisers within 10 days after request from the Postal Service. The Postal Service shall select one appraiser from this list to perform an appraisal review (or, if Landlord fails to provide a list, the Postal Service shall select an appraiser) (the “Third Appraiser”). Within 30 days, the Third Appraiser shall review both the purchase price offered by the Postal Service and the Landlord’s appraisal; establish an appropriate purchase price for the Property and forward copies of the completed determination of purchase price to both the Postal Service and Landlord. The Postal Service then may, but shall not be obligated to, purchase the property for a price equal to 95% of the purchase price amount determined by the Third Appraiser. Landlord and Postal Service shall share equally the cost of the Third Appraiser, as follows. The Postal Service shall contract for the Third Appraiser using its standard Contract for Real Estate Services. Landlord shall reimburse the Postal Service 50% of the cost of the Third Appraiser within 60 days of presentation of the Third Appraiser’s invoice(s). If Landlord fails to pay this 50% share within said time period, the Postal Service may deduct that amount from the next installment of rent then due, without further notice to Landlord.”

Often times, Purchase Option Riders are found in the “newer vintage” properties – properties that were built in the 1990’s till today. Typically, developers of these properties have amortized the cost of construction in the base 20-year lease, which is why the rent per square foot is above the market rents.

Risks of Purchasing a USPS Leased Property with a Purchase Option Rider:

1. Potential of Declining Rental Income
   As indicated above, often times, properties with purchase option riders, have above market rents during the base lease period. Depending on who negotiated the lease, you may find that the rent in the built in renewal options decline significantly. Additionally, even if you have a built-in renewal option in your lease that has escalations or declines, as mentioned above, the USPS may determine that the rent is above-market and will try to renegotiate the renewal option to what they believe the market is. This may affect investors who purchased the property based on the rental income during the base lease term, and want to sell the property later on.
2. Capital Appreciation Constraints:
   The purchase option rider may limit the property’s capital appreciation potential, as the predetermined purchase price may not reflect its true market value at the time of sale.

Case Studies:

1. Greenlawn, NY – Main Office
   In or around July 2023, the USPS purchased the Greenlawn, NY – Main Office, which is a 6,681 square foot building in an affluent area of the suburbs of Long Island, NY by exercising the purchase option for $1,600,000.
2. Westlake, LA – Main Office
   In or around November 2023, the USPS purchased the Westlake, LA – Main Office, a 6,309 square foot building by exercising its purchase option for $310,000.
3. New Milford, CT – Main Office
   In or around November 2023, the USPS purchased the New Milford, CT – Main Office, a 9,390 square foot building by exercising the purchase option, which the previous owner litigated. Eventually, the previous owner and the USPS settled for $800,000.

The above-referenced case studies are just some examples of recent purchase option riders that the USPS had exercised.

Mitigating Risks and Making Informed Decisions:

Thoroughly evaluate the property, lease agreement, and market dynamics to assess potential risks and returns associated with the investment. Historically, the USPS has exercised the option to purchase the property when the rent multiple is 8X or below. In addition to the rent multiple, if the in-place annual rent is significantly below market, then the USPS may exercise the purchase option.

If your lease with the USPS has a purchase option at or below an 8X rent multiple, then we suggest not making any major capital improvements, such as; replacing the roof, as you approach the notice period that the USPS has to provide the Landlord that they plan on exercising the purchase option.

Conclusion:

Purchasing a USPS leased property with a purchase option rider presents unique opportunities and challenges for investors. While the potential benefits, such as above-market rental income and tenant stability, may be appealing, it’s crucial to understand and mitigate the associated risks effectively. By conducting thorough due diligence and seeking professional guidance, investors can make informed decisions and navigate the complexities of investing in USPS leased properties with confidence.