Created-Lease Cap-Rate Arbitrage

The Trade That Looks Like a Gift

In thirty-nine years brokering commercial real estate, I've learned to trust the moment when a deal looks too clean. It usually means someone built it to look that way.

Every active commercial buyer gets the email. A single-tenant net-lease building, a name-brand tenant, a fresh long-term lease, an 8% going-in cap rate that grows over the term, and a price that pencils on the first pass. The spreadsheet screens clean. The instinct says move fast before someone else does.

Slow down. Some of these deals are real. Some are manufactured — engineered to screen well so that you buy the income stream rather than the asset underneath it. The mechanism has a name worth knowing: created-lease cap-rate arbitrage.

One That Crossed My Desk This Week

Here's a live example, with the identifying details stripped out.

A seller sent me a single-tenant industrial building in a smaller out-of-state market. On paper it was tidy: a national brand on the lease, a fresh multi-year term, an 8% cap growing north of 8.6%, a defensible per-foot basis, and a location off a major interstate. My analyzer screened it well. If I'd stopped there, I'd have been at the closing table.

I didn't stop there. Reading the actual lease, the "national credit tenant" turned out to be the operating subsidiary — no parent guaranty behind it. The "triple-net" lease quietly left roof, structure, and HVAC replacement with the landlord, so the real yield was lower than advertised. The "estoppel" was the seller's own rent ledger, not a document signed by the tenant. The "Phase I environmental report" was a two-sample lab result — not a Phase I ESA at all — and the site sat next to a landfill with soil and groundwater sampling already on record. The seller owned the building and had recently improved it; the whole premium rested on that one brand-new lease.

Every one of those, on its own, is negotiable. Together they told a story: I wasn't being sold a seasoned asset, I was being sold a manufactured income stream on impaired dirt in a thin market. I passed — not because the seller did anything improper (this is legal packaging), but because the deal was engineered for a buyer who underwrites the rent instead of the real estate. I underwrite the real estate.

Compare that to a stabilized asset I looked at in the same stretch — a multi-facility self-storage property with hundreds of tenants, a real occupancy history, and a broker who put the numbers on the table. One wrong assumption there costs a slice, not the whole deal. That's the difference this article is about.

What "Created-Lease Cap-Rate Arbitrage" Actually Is

The play works like this. A seller takes a marginal or special-purpose property — often one they do not even own outright yet — and wraps a brand-new lease around it. The lease is the product. Once a signed lease exists, the property is no longer priced as dirt and a building; it is priced as an income stream at a cap rate.

That repricing is the whole game. Capitalize a new lease at an 8% cap rate and the parcel is suddenly "worth" the rent divided by that cap rate — frequently a large premium over what the seller paid or built. The arbitrage is the spread between what the real estate is worth and what the manufactured income makes it appear to be worth. The buyer who underwrites the rent pays the higher number. The buyer who underwrites the real estate sees the gap.

Why It Is Dangerous: A Single Point of Failure

A diversified operating asset — an apartment building, a self-storage facility, a multi-tenant retail strip — spreads its risk across many tenants and many leases. If one assumption is wrong, you lose a slice. Occupancy absorbs it, you re-lease at market, and the asset survives.

A single-tenant net lease has one point of failure.The entire value rests on one lease, one tenant, and one set of facts. If the tenant's credit is weaker than implied, if the rent is above what the space can command, or if the building only works for one kind of user, there is nothing to absorb the miss. You do not lose a slice. You lose the deal. That concentration is exactly why a manufactured lease is worth engineering — and exactly why it is worth catching.

The Tells

No single item below condemns a deal. Patterns condemn deals. When several show up together, you are likely looking at a manufactured trade rather than a seasoned asset.

• The lease is brand new and executed right before the sale — a promise, not a payment history.
• The tenant’s name is withheld until you are “serious.” On a real credit deal, the tenant is the headline.
• “Credit tenant” turns out to be an operating subsidiary with no parent guaranty behind it.
• The “estoppel” is the seller’s own rent ledger, not a document signed by the tenant.
• A “Phase I” that is not a Phase I ESA — a lab report or a consultant letter dressed up as one.
• The rent sits above what the market actually clears, inflating the capitalized value.
• Called “NNN,” but the landlord quietly keeps roof, structure, or HVAC replacement.
• A special-purpose building in a thin market — no re-lease depth if the tenant goes dark.
• A known impairment (environmental, structural, title) sits next to the value.

The One Flag You Cannot Discount Your Way Out Of

Most of the tells above are pricing problems. No guaranty, above-market rent, a landlord-obligation clause hiding inside a "NNN" — each has a number that solves it. You lower the offer, you add a reserve, you demand a capital credit. Discipline fixes price.

A Note on Jurisdiction

Where the property sits changes the rules of the game. Most U.S. states run on common law. Louisiana is the exception — it operates under a civil-law system derived from the Napoleonic Code, and its treatment of leases, security interests, and the transfer of "immovable property" genuinely differs from the playbook that works in the other forty-nine states. A lease structure or a remedy you take for granted elsewhere may not carry the same force there. This is not a reason to avoid a state; it is a reason to underwrite the legal structure with local counsel, not just the numbers.

The Buyer's Verification Checklist

The antidote to a manufactured deal is refusing to accept any material fact from the party who benefits from it. On a single-tenant net-lease acquisition, verify each of these independently:

1. Tenant estoppel — signed by the tenant, direct. Not the seller's ledger. Confirm the lease terms, that rent is current, and that no side agreements exist, in the tenant's own signature.
2. The guaranty — read the actual entity. Confirm whether the parent guarantees or only the operating subsidiary is on the lease. Pull the guarantor's financials. A brand is not a balance sheet.
3. Your own Phase I ESA. Commissioned by you, performed to the ASTM standard, by your environmental professional. Never accept the seller's environmental package as sufficient.
4. Market rent, independently. Comp the rent against what comparable space actually leases for. If the deal only works at above-market rent, the deal does not work.
5. The seller's basis. Pull the acquisition price and date from public records. If a seller bought recently and is flipping at a large premium justified entirely by a new lease, you have found the arbitrage — and you are the exit.
6. Dark value — underwrite the downside. What is this building worth empty, re-leased at market to a realistic tenant pool? On a single-tenant asset, dark value is your real floor. If it is far below your price, the lease is doing all the work.
7. Fee title and the legal structure. Confirm the seller actually owns what they are selling, free to convey, and that the lease and remedies are enforceable in that jurisdiction.

The Takeaway

Created-lease cap-rate arbitrage is not fraud — it is packaging. The seller is allowed to build a lease and sell the income at a cap rate. Your job as the buyer is to know the difference between real, seasoned, diversified income and a single manufactured promise on impaired dirt, and to price — or pass — accordingly.

When the numbers scream and your gut hesitates, the gut is usually reading the concentration risk the spreadsheet cannot show. Underwrite the real estate, not the rent. Verify every material fact away from the party selling it. And when the flag is environmental on a single-tenant asset, remember that the right answer is often not a lower price — it is no.

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