It’s the latest in a run of bets on single-tenant buildings with long-term leases by Fundamental Income, a 2-year-old venture backed by real estate investment giant Brookfield Asset Management that specializes in buying properties and leasing them back to the sellers. Such deals have been popular amid the uncertainty of the COVID-19 pandemic as sources of long-term, stable income.
Fundamental Income made a similar Chicago wager in October, when it paid nearly $45 million for the historic Gold Coast building that houses Restoration Hardware on a long-term lease.
For Sterling Bay, selling the building wraps up a project it took on in 2014, when it bought the property for $11.5 million from the operator of Castle, the nightclub in the building at the time, according to Cook County property records. The building was then vacant for a few years as a joint venture of Sterling Bay’s hospitality offshoot Four Corners and Tao Group spent another $25 million transforming the former Chicago Historical Society building into Tao Chicago, which opened in 2018.
Tao Group owner Madison Square Garden inked a 20-year deal at the time with no termination or contraction options to operate the restaurant and pay rent to the building’s owner through September 2038, according to marketing materials from Cushman & Wakefield, which brokered the sale.
The Tao brand cachet attracted Fundamental Income, which saw the purchase as “a really good opportunity to be in a property that we think will be successful,” said Alexi Panagiotakopoulos, the firm’s chief investment officer. “Obviously there have been COVID impacts on restaurants and entertainment as a whole, but in a post-COVID world, operators like Tao and experiential assets like this are going to thrive.”
Fundamental Income has been aggressive with sale-leaseback deals since its April 2020 inception, picking up more than a dozen properties with a total value of more than $230 million, according to data from research firm MSCI Real Assets.
Such long-term, single-tenant properties—known as net lease deals in real estate parlance—have recently encountered a big enemy in inflation, which has reduced the value of the long-term rents that landlords locked in. That’s historically a risk of net lease deals, as well as the possibility that the tenants could fold and leave landlords with big empty properties.
Panagiotakopoulos acknowledged the inflation headwind, but said his firm has been especially careful not to lock in leases with rents that rise too slowly, while others that have flocked to the sale-leaseback sector over the past 24 months have. “A lot of people are buying real estate in a net lease space that maybe they don’t truly understand.”
Financial details of Tao’s lease are unclear, but the deal comes with 6% escalations in rent every three years, according to Cushman. The property at the northwest corner of Dearborn and Ontario Streets also benefits from a Class L property tax designation that Sterling Bay won for refurbishing a Chicago landmark. The incentive reduced the owner’s property taxes by $2.5 million over a 12-year period.
Sterling Bay initially put the building up for sale in 2018 shortly after the restaurant opened and had a deal lined up to sell it in early 2020, but that fell apart with the onset of the pandemic, according to a source familiar with the property.
The developer, which built its reputation in Chicago by redeveloping vintage properties, has been unloading properties tied to the hospitality sector during the pandemic. Other Sterling Bay ventures recently sold the Talbott Hotel in the Gold Coast and the former Ace Hotel in the Fulton Market District.
Cushman & Wakefield Managing Director Michael Marks marketed the Tao Chicago property on behalf of Sterling Bay.