Three Ways Our Investors Are Protected
Heartland Income Properties will be distinguished by the primary source of rent payments, which comes directly from the profits produced by the business operations at the real estate locations we intend to own, which we refer to as ‘unit-level profitability.’ While it is a common perception that the tenant is the primary source of the rent payment (as distinguished from the business at the unit itself), the historic pattern we have observed of tenants in corporate insolvencies vacating unprofitable locations and retaining profitable ones is the main indicator of the payment source. Because tenants historically retain profitable locations and vacate unprofitable ones in the event of insolvency, it is fundamentally important for Heartland to collect and review the unit-level financial statements of our tenants at our real estate locations, which is a key component of our business model and underwriting. Without having access to unit-level financial reporting for the business activities conducted on the properties we own, we would not have an accurate assessment of the essential nature of our real estate to our customer’s business; without this, we would be speculating about the quality of the most important, and primary, payment source.
In addition to the unit-level profitability of the business on the real estate we own, there are two other payment sources that are common to all real estate investments. One is tenant credit quality, which serves as an additional, but not primary, source of payment to unit-level profitability. The tenant’s credit can become the primary payment source if our unit is not profitable and the tenant is required to divert cash flows from its other units or other resources to pay our rents. However, tenant credit quality tends to be subject to greater volatility over time than unit-level profitability, because tenant credit quality is not only a function of the unit-level profitability of the operations at our locations, but of the profitability of potentially many other existing and new assets owned and operated by our tenant. Corporate financial health is also a function of many other decisions, such as capital structure or growth strategies, as well as conditions in the marketplace for the tenant’s products and services, which can change over time and which may have profound impacts on tenant creditworthiness.
The other payment source that is common to all real estate investments (and is the third of our three payment sources) is the residual value of the underlying real estate, which gives us the opportunity to receive rents from other substitute tenants in the event our asset becomes vacant. For Heartland, this means more than just looking at broad lease rate and transaction comparables. Studies that have been done underscore the importance of investing in properties at or below their as-new replacement costs. We also review the local markets in which our properties are located and seek to have rents that are at or slightly below prevailing market rents on a per square foot basis for comparable properties. Taking these steps protects Heartland and our investors by making it easier for us to assign, sell or sublease properties that our tenants may want to re-position or vacate as part of their capital efficiency strategy. As indicated in our underwriting standards, however, prior to purchasing an investment property, we will require that the property be currently cash-flowing and have at least five years remaining on the lease.