Jun 21, 2013
David Morgan
Comments Off on Introduction to 1031 Exchanges

Introduction to 1031 Exchanges

What is an IRC 1031 Tax Deferred Exchange?

Simply put, an IRC 1031 tax deferred exchange allows owners of real or personal property to defer the recognition of a capital gains tax when they have sold their property.

They have been around in one form or another since 1921 and in its current form since 1986.

An exchange is structured just like any other sale or any other purchase, but with the inclusion of a qualified intermediary to structure the transaction as an exchange. It is very important to involve the qualified intermediary before you start your transaction.

Exchanging allows you to reinvest money into a new business or an investment property that you otherwise would have had to pay in taxes to the government.

If you prefer a video on 1031 Exchanges, please look at this one from the REI Club. Below the video is additional important information about the 1031 Exchange.

What types of properties may be exchanged?

Exchanges can involve real property or personal property. Property to be exchanged must be held for business or investment purposes and not primarily for resale purposes or personal use.

The properties that are exchanged must be “like kind” to each other. Concerning real estate exchanges, the properties do not have to be the same type. As long as they are both held for business or investment purposes they are considered like kind. Personal property like kind rules are generally more restrictive.

As an exchanger you have the opportunity to purchase replacement property of any type. As an example, you can sell vacant land and purchase a strip mall; or sell an apartment building and buy an industrial complex. Although 1031 exchanges are governed by federal law, it is state law that determines what is and what is not real property. Exchanges of real estate interests such as air rights, easements, timber, conservation easements and development rights may be possible. Thus, all property held for business or investment purposes is like kind to all other property held for business or investment purposes.

How long do I have to identify property?

When completing an exchange, an exchanger has 45 days from the date of the sale of the first relinquished property to identify potential replacement property or properties; and a total of 180 days from the original sale date to purchase the replacement property or properties.

Identification rules make it easy for exchangers to pick multiple properties that they might purchase, but the fact is that once the 45 days are up, the exchanger’s choices on that list are set in stone. The identification is a written letter or form which is signed and dated by the taxpayer, and contains an unambiguous description of the property. A property which is identified is not required to be under contract or in escrow to qualify. Exchangers acquiring an undivided percentage interest (“fractional interest”) in a property should identify the specific percentage that will be acquired.

However, there are restrictions on the number or value of the properties an exchanger can identify. To qualify for the exchange, the exchanger must comply with the following identification options:

1)  The Three Property Rule; The three property rule allows an exchanger to identify up to three replacement properties. There is no value limitation placed upon the prospective replacement properties and the exchanger can acquire one or more of the three properties as part of the exchange transaction. The three property rule is the most commonly used identification option, allowing an exchanger to identify fall back properties in the event the preferred replacement property cannot be acquired.
2)  The 200% Rule; The exchanger can identify an unlimited number of properties, provided that the total value of the properties identified does not exceed 200% of the value of all relinquished properties. There is no limitation on the total number of potential replacement properties identified under this rule, only a limitation on the total fair market value of the identified properties. In other words, if an exchanger sold relinquished property for $1,000,000 under the 200% rule, the exchanger would be able to identify as many replacement properties as desired, provided the aggregate fair market value of all of the identified properties does not exceed $2,000,000 (200% of the $1,000,000 sales price of the relinquished property).
3)  The 95% Exception Rule; The exchanger may identify an unlimited number of replacement properties exceeding the 200% fair market value rule, however the exchanger must acquire at least 95% of the fair market value of the properties identified. This rule is utilized in limited circumstances as there is a much higher risk of the transaction failing. In other words, assume an exchanger identifies ten properties of equal value. In order to satisfy the rule, the exchanger would be required to acquire all ten identified properties within the exchange period to complete a successful exchange. If one of the properties fell through, the entire 1031 exchange would be disqualified because the exchanger did not acquire 95% of the fair market value identified. This rule should only be utilized in situations where there is a high level of certainty pertaining to the acquisition of the identified properties and the other two rules do not meet the exchanger’s objectives.

In addition, to obtain a complete deferral of the capital gains tax, the taxpayer must acquire replacement property of equal or greater value, obtain equal or greater debt on the replacement property, reinvest all the net proceeds realized from the sale of the relinquished property and acquire only like-kind property.

What is the structure of a delayed exchange?

In the case of a simultaneous or delayed exchange, the exchanger first enters into a contract to sell the relinquished property or properties. Contrary to popular belief, there is no “exchange contract” for a delayed exchange. The exchanger enters into a contract that they would normally use if they were not structuring the transaction as an exchange. However, the addition of an exchange cooperation clause is recommended to secure the cooperation of the buyer or seller of the relinquished property or replacement property. A person or entity that is not a disqualified party, usually a Qualified Intermediary, thereafter assigns into the rights, but not the obligations of the contract. This assignment creates the legal fiction that the Qualified Intermediary is actually swapping one property for another. In reality, the exchanger sells the relinquished property and purchases the replacement property from whomever he wishes in an arms length transaction.

In addition to the assignment of contract, there must be an exchange agreement entered into prior to the closing of the first property to be exchanged. The exchange agreement sets forth the rights and responsibilities of the exchanger and the entity acting as a qualified intermediary, and classifies the transaction as an exchange rather than a sale and subsequent purchase. In addition, the exchange agreement must limit the exchanger’s rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property before the end of the exchange period. In other words, the exchanger may only use the exchange funds to purchase new property and to pay most of the expenses related to the sale and purchase of the properties.

Once the exchange agreement and assignment of contract are executed, the exchanger sells the property; however instead of collecting the proceeds at the closing, they are sent directly to the Qualified Intermediary. When the replacement property or properties are located, the exchanger enters into a contract to purchase same, and thereafter uses the exchange funds to complete the purchase. This, in a very basic form, is the structure of a delayed tax deferred exchange.

What should I look for in a Qualified Intermediary?

When choosing a Qualified Intermediary it is important to look for the following items:

1)  What is the experience of the person who you are speaking with? How long have they been in the industry? Are they a tax or legal professional such as an attorney or CPA? Remember, the person on the other end of the phone may be from a big company but they may only have a few months experience. It is important to ask.
2)  Does the Qualified Intermediary segregate the exchange funds into separate Qualified Escrow Accounts as provided in the Treasury Regulations or do they co-mingle the exchange funds? A Qualified Intermediary that uses internal “memorandum accounts” is not providing you with the maximum protection that the Safe Harbors of the Treasury Regulations allow.
3)  Have you received a copy of the Fidelity Bond and Errors and Omissions coverage before you have started your exchange? Is the amount of coverage for each transaction greater than the cash proceeds that you will be sending? Have you verified the Fidelity Bond and Errors and Omissions coverage are in full force and effect? Does the Fidelity Bond provide for principal liability? Many fidelity bonds only provide protection from employee malfeasance but leave the exchanger uninsured in the case of malfeasance of a principal.

It goes without saying that service is an extremely important part of an IRC 1031 tax deferred exchange and that exchanges are subject to strict guidelines and requirements. Having a financially strong, experienced and capable Qualified Intermediary is an important step in getting you through the tax deferred exchange process.

As I say throughout my blogs, if I may be of assistance with your real estate questions please contact me, I truly want to help. My way of giving back is to give away my knowledge. Thank you for reviewing this blog.

Jun 20, 2013
David Morgan
Comments Off on Buying Commercial Property|Making Offers and Negotiating Deals

Buying Commercial Property|Making Offers and Negotiating Deals

MAKING OFFERS

Most successful investors only work on deals that they feel they can close. This means that you need to have a plan in place that eliminates the deals that won’t work for you. Here’s how to develop that plan:

• Develop a qualifying system of identifying the types of properties that you want to buy using factors such as age, condition of property, upside income potential, rehab or rezoning possibilities, etc.

• Approach each offer with a strategy that will work for you such as knowing the amount of time you’ll need to do your Due Diligence, how much money you can put down, etc.

• Lastly, put together a system for making offers:

(a) Set up your parameters for the deal such as the top price you can pay to get the return you require.
(b) Have a follow-up system to make sure that your deal is moving along.

There are two methods of presenting an offer to a Seller. One method is to utilize a Letter of Intent and the other is to use a Formal Purchase Agreement. The Letter of Intent tends to save the Buyer time and can quickly tell you whether you and the Seller are on the same page. On the other hand, the Purchase Agreement tends to make the Seller feel like they are receiving a “solid” offer.

My preference – and what is used most often – is a Letter of Intent, but whichever way you go, try to present the offer in person to the Seller and/or their Broker.

If you use a Letter of Intent, make sure that you insert a clause that states that both parties will move forward in good faith toward signing a formal contract within ten days of signing the Letter of Intent so that your offer will look serious to the Seller. Also, make sure that once the Letter of Intent is signed, you write up the Contract immediately.

NEGOTIATING DEALS

A couple of very important tips to successful negotiating:

1. Always start with the end in mind so that you know where you want the deal to go.

2. Understand the Seller and what they need.

You’ll be much more successful in closing deals if you solve the Seller’s problem by understanding what they want. Those buyers who also connect emotionally with the Seller create trust and rapport which opens the Seller up to discuss what they’re really looking for. If you’re sincere and willing to truly listen to the Seller, you’ll be more successful at putting together an offer that may be acceptable to them.

And when you understand the Seller’s motivation, i.e., why they’re selling the property, you’ll be in a better position to negotiate.

Here are some examples of typical deal points that come up for negotiation, with some suggested solutions for each point:

PRICE

If the Seller has to get a certain price and can’t be negotiable on that point, you may be able to negotiate certain terms:

1. Ask the Seller to carry back part of the financing so that you put less money down.

2. Ask the Seller to guarantee income for vacant spaces or spaces coming up for renewal in a short period of time to give you time to lease the space

TIMING

To understand negotiating timing issues, you need to understand that the Seller’s position will be that he’s taking his property off the market with no assurances that you will be able to close.

Here are a couple of examples of timing issues with possible solutions:

1. Seller wants a shorter period to close than is required for you to complete all facets of the Due Diligence, i.e., Seller wants a 30 day close, but you want 30 days for Due Diligence and 30 days to close.

Possible Solution 1: Set up periodic times to waive certain issues in your Due Diligence Process. Example: If you have a list of 40 items that you need to verify during Due Diligence, you can stipulate that you will clear 10 items at the end of 15 days, 10 more items at the end of 30 days, etc. This assures the Seller that you’re moving through the process.

Possible Solution 2: If you need more time to complete certain facets of the Due Diligence process, for example, you don’t have time to have a roof inspection done, you can go ahead and close but set aside funds to pay for any roof repairs which the roof inspection discloses are necessary.

2. The building is vacant and you don’t want to close until you can find a tenant for the vacant space.

Possible Solution: Buy 2 extensions of 30 days each by putting in more hard money. (Note: The money becomes non-refundable but applicable to the sales price.) This gives you 90 days to determine whether or not you’ll be able to lease the vacant space.

By putting in more non-refundable money to extend your time, you’re giving the Seller money in his pocket to pay for taking his property off the market for that period of time. Also, he feels that you have more money in the deal so you’re more likely to close.

These are only a few of the problems and possible solutions you may run into when negotiating a deal.  Always try to listen closely and understand why the seller is selling the property or making an objection to the offer.  Remember, don’t take anything personally, it’s just a deal point that needs to be dealt with or an objection that needs to be overcome.  Try to overcome any objections, but don’t get emotionally tied up in any purchase offer and walk away from properties that do not fit your criteria.

As I say throughout my blogs, if you have any questions please feel free to contact me.  My way of giving back is to give away my knowledge.  Thank you for reviewing this blog.

Jun 19, 2013
David Morgan
Comments Off on Commercial Property Online Auctions|Why Buy or Sell on Them?

Commercial Property Online Auctions|Why Buy or Sell on Them?

AS A BUYER SHOULD I PARTICIPATE IN THEM?

As a buyer, the reason you participate in an online auction is because you anticipate getting a good deal.  If you are an experienced buyer of commercial real estate you should participate in auctions if you see a property that meets your criteria.  As a first time buyer or inexperienced buyer if you are going to participate you should get help from an experienced broker who has helped people buy through the auction process.

Buying property from an online auction requires that you put up a deposit to bid on a property and verification that you have funds to close the deal if you win the bid.  If you require financing you will need to have that set up beforehand as you will need to close the deal within 30 days.  Financing is not a contingency.  All purchases must be funded in cash at closing.

All properties are sold “As Is, Where Is With All Faults and Limitations” so you need to inspect the property prior to bidding on the property.  You need to do this process with the professionals that can help you to properly assess the property.

Once the online auction is final, you have agreed to purchase the Property, including those sales which are subject to the seller’s confirmation. That is why it is important for you to conduct all of your due diligence prior to the auction and prior to bidding on the Property. Winning bidders may be subject to liquidated damages if they fail to complete the transaction in addition to losing their bidding deposit.  Make sure your carefully review the Auction Terms and Conditions

In addition to the standard and customary costs related to the closing of the transaction such as escrow/closing fees, title updates and reports, the winning bidder will pay a Buyer’s Premium on the transaction’s closing date in an amount equal to five percent (5%) of the Winning Bid Amount   (the Buyer’s Premium is added to the Winning Bid Amount to determine the Total Purchase Price paid by the Buyer).

A successful bidder will be required to deposit additional funds with the escrow/closing agent in an amount stated in the Purchase and Sale Agreement. Such funds must be posted within 24 hours of being declared the winning bidder. The winning bidder will be required to pay the Earnest Money Deposit by wire transfer within 24 hours following the conclusion of the online auction. You will be provided with a receipt by e-mail showing that the escrow/closing agent received your Earnest Money Deposit. There are no exceptions to this requirement.

AS A SELLER SHOULD I DO THIS?

The benefits of the auction process are numerous.  The major advantages to selling on an online auction are the access to potential investors, the sales process is accelerated and has a set timeframe, there are non-negotiable seller documents, typically no fees are involved, usually there is a massive, multi-faceted marketing campaign that maximizes bidder participation and achieving a price through competitive bidding is, oftentimes, the only method available to determine an asset’s true current market value.

By having access to several potential investors the price of your property may get bid up as a bidding war may commence if two parties feel that they have to have the property.

The sale process can be greatly accelerated as a date certain is set and if you receive an acceptable offer the property is sold and closed usually within no more than 30 days.  Thus your total process of selling the property can be shortened.

The documentation is usually standard and thus non-negotiable and favors the seller in the transaction.  There are typically no fees due by the seller.  In the documentation the property is typically sold with the buyer paying all of the escrow fees.

Most online auction companies have a large list of buyers that they mail to, they run advertising campaigns to make sure that the auction is well attended, thus maximizing bidder participation.  If your property is in need of repair, the property is typically sold “as is” and the buyers at auction are typically not intimidated by doing repairs and usually feel that they can get a bargain on the property for a minimal outlay of cash for the repairs.

The biggest benefit to sellers is that you achieve a true current market value for your property as the bids set this value.  You can set a minimum value to assure that you get at least that price, however this sometimes has a way of setting a price in the buyers mind and you don’t get the bidding war that you expected and possibly the true current market value.

As I say throughout my blogs, if I may be of assistance with your real estate questions please contact me, I truly want to help.  My way of giving back is to give away my knowledge.  Thank you for reviewing this blog.

Jun 18, 2013
David Morgan
Comments Off on 9 Keys for Finding the Best Location for Your Commercial Property

9 Keys for Finding the Best Location for Your Commercial Property

One of the most important aspects of commercial real estate investing is finding the right property.  And location is a major factor in identifying that property.  Location includes many factors as you will see below.

For a retail property especially, it is a big key to its success.  A good location attracts tenants – and their customers.  The result for you as the property owner is the ability to charge higher rents and to create a higher value for the property.

The features – and benefits – of a good location are:

1.  Close to major streets and freeways – This makes driving to the property easy for customers, as well as making the property visible for your tenants and potential clients.

2.  Signalized corner – When cars stop at the traffic light, people in the cars have time to see the stores.  This also slows down traffic thus increasing the properties visibility.

3.  On or close to a busy street with high traffic volume – High traffic is important to the tenants.  Always check commercial property listings for CPD (cars per day) or ADT (average daily traffic) information.  Also, review this information and compare it to other traffic corners in the area or region.  In addition, find out if the counts are going up or down over the last couple of years.

4.  Area – Check demographics to make sure the property is located in a growing area with population growth, not in a declining neighborhood.  Demographics can also tell you the household income, racial makeup, daytime population, and the number of households in the area.  Check to make sure that the tenants match the demographics.  An example would be if there is a McDonald’s on the property, you want to make sure that the demographics show a lot of families in the area.

5.  Near anchor tenants – Anchor tenants are the major retailers like Home Depot, Best Buy, Wal-Mart, grocery stores, and drug stores.  Tenants located close to an anchor benefit from their traffic.  Also. make sure that the type of anchors line up with the mix of the other tenants in the property.  An example would be that grocery stores tend to bring daily traffic which would be good for fast food tenants such as Subway or a Wal-Mart might tend to bring a customer looking for bargains, so other tenants that are discount oriented should do well in this type of project.

6.  Easy ingress and egress – If it’s hard to make turns into the property or there are not enough entryways and exits to easily get traffic in and out of the property, the property is less attractive to tenants because they feel their customers may choose another destination.  An example of hard ingress, would be if a property is in a mid block location and there is not a left turn lane into the property and the car has to go past the property and then do a u-turn to come back to the property or you can’t make a left turn out of the property, as you might have to exit right and go down a couple of blocks and do a u-turn.

7.  Signage – Good signage – especially a large monument sign in front of the property – makes it easier for customers to find the stores.  Also, there should be a uniform signage program for the store front signs.  The program should be such that the tenants signs are highly visible from the surrounding streets or even freeways.  The signage program should also include that the signs should be illuminated.

8.  Parking – Plenty of spaces and a well-lighted parking lot are important.  A parking ratio of 4 or 5 parking spaces per 1,000 sf leasable space is preferable.  If there is only a food tenant on the parcel parking needs to be greater.  The parking lot also needs to be properly maintained with minimal potholes and cracking and with properly marked spaces and drive aisles.

9. Appearance – Properties that are well maintained – good landscaping, clean, well-lighted and buildings in good condition – attract the most customers for the tenants.  If you are looking at a property that is not well maintained or have a clean appearance, make sure that you put the costs to upgrade the property into your purchase costs.  A good appearance also attracts potential tenants.

One of the tenets that you always hear about when real estate is discussed is location, location, location.  As you can see, there are several things that make up a good location.  As you review a property you can use the above for the pluses and minuses of a sites location.

As I say throughout my blogs, if I may be of assistance with your real estate questions please contact me.  My way of giving back is to give away my knowledge.  Thank you for reviewing this blog.

Jun 17, 2013
David Morgan
Comments Off on Analyzing Commercial Real Estate|Crucial to Successful Buying

Analyzing Commercial Real Estate|Crucial to Successful Buying

To do a proper commercial real estate analysis, you must understand its market value. Long term successful investors make money when they buy, not just when they sell. You reduce risk and increase your chance for great returns when you buy properties at or (preferably) below their market values.

3 Techniques to Value Properties

Investors, lenders and appraisers rely on three techniques to value properties.

1. Cost approach:

  • Calculate how much it would cost to build a subject property at today’s prices;
  • Subtract accrued depreciation;
  • Add the depreciated cost figure to the current value of the lot.

2. Comparable sales approach:

  • Compare a subject property with other similar (comp) properties that have recently sold;
  • Adjust the prices for each positive or negative feature and/or differences of the comps relative to the subject property. Note:  It is best to have three or four properties to compare.

3. Income approach:

  • Estimate the rents you expect a property to produce;
  • Convert net rents after expenses (net operating income) into a capital (market) value amount. In other words you divide the net operating income of the property by a market cap rate for that particular type of product in the marketplace.

You evaluate a property from these three perspectives to check the value estimates of each against the others. Multiple estimates and techniques enhance the probability that your estimate reflects reality. If your three value estimates don’t reasonably match up, either your calculations err, the figures you’re working with are inaccurate, or the market is acting “crazy” and property prices are about to head up (or down).

3 Factors of Income Approach

Concerning commercial real estate analysis, the approach I put the most emphasis on is the Income approach. The three factors of the Income approach are Effective Gross Income, Operating Expenses, and Capitalization rates (Cap rates).

When looking at effective gross income and operating expenses, be careful that you’re looking at the actual numbers – not the “pro forma” numbers. Pro forma numbers are projections and you want to be dealing with actuals. Cap rates are derived from the comparable sales of comparable properties in the immediate market area and/or by the rate of return that you want on your money. If you talk about a 6 cap, then you are saying that you want a 6% return on the existing net operating income of the investment.

4 Things to Determine a Good Buy

When I analyze a property, I calculate the following four things to determine if I want to buy the property:

1.  Net operating income (NOI):   Net operating income = effective gross income – operating expenses.

2.  Annual cash flow:   Annual cash flow = net operating income – debt service

3.  Cash-on-cash return:   Cash-on-cash return = annual cash flow divided by down payment

4.  Cap rate:   Cap rate = net operating income divided by sales price

Other Important Factors

Also note that other important factors in your commercial real estate analysis are the use of/or zoning of the property, the location of the property, the credit worthiness of the tenant(s), the leases in place, the condition of the property, the contracts on the property and any possible environmental problems with the property.

1.  Use of/or zoning of the property – Make sure the current use matches the zoning of the property.

2.  Location of the property – Is it in a growth area, are there complimentary users around, is there easy ingress and egress, do the demographics match the use, what are the traffic counts around the site, what is the vacancy factor in the marketplace – These are all questions that verify a good or bad location for the property.

3.  The Lease(s) – Is it or are they NNN, NN, N, Gross, how much term left, if there isn’t much term left, what is the likelihood of renewal, are there any hidden Landlord costs, what is the entity on the lease and is it guaranteed, is it a standard lease for the marketplace or is it unusual for the area, is it assignable, does it have options, review all amendments – These are some of the things that you need to be reviewing in the lease to make sure you understand just what you are buying – Some people believe they are buying a building while others believe they are buying a lease or leases.

4.  Condition of the property – Do a thorough inspection of the property to include the roof, the mechanical systems, the structure, the electrical, the plumbing, the parking lot and all of its fixtures – Estimate the life span of each of these things and make sure that you put this into your financial picture of the property.

5.  Contracts on the property – Make sure that you review all existing contracts and the vendors so that you know your obligations and whether they go with the sale – These contracts are also an indication of whether the property has been consistently maintained – If there are no contracts, then you need to take this into consideration so that you can paint an accurate financial picture.

6.  Environmental – Are there any obvious environmental issues that need looking into and have there been any environmental notifications sent to the current owner or to any of the tenants – You should also check with the local environmental agency to not only learn about your building, but the area in general.

With careful analysis you can take away some of the risk when purchasing the property.

As I have said before, if you have any questions or I may be of assistance with your real estate questions please contact me. My way of giving back is to give away my knowledge. Thank you for reviewing this article.

Jun 16, 2013
David Morgan
Comments Off on Buying Commercial Real Estate|Closing the Deal

Buying Commercial Real Estate|Closing the Deal

In order to understand the closing of a deal when buying commercial property, let’s review the steps of the sales transaction:

1.    Buyer submits an offer to buy the property either through a Letter of Intent or a formal Purchase Agreement, any necessary negotiations are completed, and the Seller accepts the offer and executes the Purchase Agreement.

2.    Buyer opens escrow by submitting his earnest money deposit.  Typically, escrow is opened with a Title/Escrow Company or an attorney.

3.    Buyer begins the loan process by submitting documents to his lender.

4.    Buyer commences his Due Diligence process and does his physical inspection of the property.

5.    Buyer reviews title and proceeds to remove any contingencies in the contract.

6.    Buyer and Seller agree on any remaining issues in the contract.

7.    Buyer gets a loan commitment from his lender.

8.    Buyer receives the Closing Statement and gives his final closing instructions to the escrow company.

9.    At closing, Buyer and Seller sign the closing documents and Buyer submits his funds.

10.  The Deed gets recorded, the monies are applied and the Buyer takes possession of the property.

An escrow is an impartial party that serves all parties in a transaction to transfer property.  Duties that an escrow officer performs include:

•    clearing up any outstanding liens
•    ordering a title search
•    examining the title report
•    obtaining title insurance
•    handling and disbursing all monies in the transaction
•    preparing and issuing the final Closing Statements
•    recording the Deed
•    sending all loan documents to the lender

After you complete your due diligence and prior to finalizing the deal, I suggest that you go back and review your original thoughts on purchasing the property to make sure that your original assumptions concerning your plan and profit are still true:

•    Review your exit strategies again and check your goals to make sure your exit time frames still work
•    Make sure that the profit you originally projected still appears attainable after examination of the information you received during due diligence
•    Make sure your loan assumptions still work now that you have actual loan information from your lender
•    Check that your tax advisor still agrees with your tax goals.

You’ll want to review the final Closing Statement at least 48 hours prior to closing so that if there are mistakes, there’s time to correct them.  As a buyer, you should double check everything and take nothing for granted.  Some of the items that need close review include:

•    checking the loan documents to make sure that they are what you agreed to (check interest rate, loan amount, amortization period, loan term, monthly payment amount, prepay penalty, due date, impounds for taxes, insurance and maintenance reserve account)

•    the credits assigned to you

•    completed repairs by Seller

•    review rent prorations and security deposit amounts for accuracy

•    ensure that personal property is being transferred with an appropriate Bill of Sale

•    review the Deed for correct purchase price, names and dates

•    review all fee amounts for accuracy

•    verify that defects in title are cleared

•    have your down payment and closing costs ready to be wire transferred

•    make sure that you agree with the amount at the bottom of the Settlement Statement

•    verify that you are taking title in the entity that you have chosen

The sale officially closes when Buyer has paid all monies due, the escrow officer has received the signed loan documents, Buyer and Seller have signed the final Escrow Closing Instructions and a specific date to record the Deeds is chosen.  After escrow gets a check from Buyer’s lender to pay off the Seller’s loan, escrow sends the lender the closing loan documents, releases Buyer’s payment and gives the approval for the Deed to be recorded.  After the Deed is recorded, title will be transferred to you and the sale is officially closed.

Congratulations, you are now the proud owner of real estate.  Your work has just begun.  If you have bought the property right, you are on your way to financial independence.  If you have bought a rental property, it is now time to get to know your tenants or find tenants for your property.  Make sure that you treat your investment as a business., not a hobby.  You should be friendly with your tenants, but businesslike.  If it is your responsibility always take care of problems promptly and if it is the tenants responsibility let them know that so that you can keep the relationship open and communicative.

As I say throughout my blogs, if I may be of assistance with your real estate questions please contact me.  My way of giving back is to give away my knowledge.  Thank you for reviewing this blog.

Jun 15, 2013
David Morgan
Comments Off on Commercial Real Estate Appraisals|Overcoming a Low Appraisal

Commercial Real Estate Appraisals|Overcoming a Low Appraisal

The commercial real estate appraisal can be a very interesting process. You often feel that you already know what the value of the property is, but now you’re waiting for someone else to see if they validate your opinion.

At the same time, you’re relying on an appraiser who may not be an expert at valuing your exact type of property in your exact geographical location. This is because appraisers often work on valuing a wide range of properties in many different cities. So when they’re valuing one particular property, they need to become as much of an expert as they can on that one property. As a result, they end up relying on the people who really are the experts.

They end up calling the commercial real estate brokers in the area who have closed transactions on what may be comparable properties, asking these brokers details about those transactions. From this information and from their own interpretation of how it applies to the property, the appraiser arrives at his value for the property.

In the process, different appraisers can come up with a wide range of values for a property. This can depend on which comparable transactions they’re utilizing for the appraisal, how they’re interpreting the information, and how well they understand the subtle nuances between the comparable properties that they’re using and the subject property that they’re appraising.

As an example, two comparable properties that the appraiser is using could be ten blocks away from the property being appraised – but with each property being ten blocks in the opposite direction from the subject property. The appraiser, not being a full-time expert in this particular real estate market, might not recognize that one of those two comparable properties is in an area that commands lower prices. The other comparable property may be in an area that is very similar to the property being appraised. If the appraiser is unaware of the differences in these areas, it will impact the value he will give in his written appraisal.

In addition, both the underlying reason for the appraisal and the instructions given by the person paying for it can affect the final value arrived at for the property. If someone is getting a property appraised just because they want to feel good about their own net worth, the appraisal may come in at the highest value that a buyer could expect to pay for the property.

But if a lender hires an appraiser because they’re thinking about lending money on a property, the lender is going to want to get a more conservative valuation of the property, and the final value given by the appraiser will probably lean more towards the lower end of what a buyer would pay for the property.

So when it comes to getting an appraisal, recognize that it’s a very subjective process, and that there are different underlying factors that will impact the final appraised value of the property.

If you disagree with an appraisal, please note that you will need actual and verifiable facts to get it adjusted. One of your best sources to get you the information that you require are real estate brokers that specialize in your particular type of property.

If your appraisal doesn’t come in where you need it to, following are a few of the things you can do to overcome this problem:

1.  Renegotiate the sales price with the seller to get close to the appraisal or ask the seller to take a second mortgage where you may make a lump sum payment at a later date or a short term loan where the buyer makes monthly payments to the seller.

2.  Increase the down payment to come into line with the appraised value. If this presents a major hardship to the buyer, then you may try to do a combination of getting the seller to lower the price and having the buyer put up a larger down payment.

3.  Ask to see and review the appraisal. If you have some actual and verifiable facts that are different from the report, you can send them to the appraiser and ask for a meeting to discuss the differences.

4.  You can ask the lender to get a second appraisal. Usually, you will have to pay for this second appraisal if the lender agrees to do it.

5.  Apply with another lender.

Always remember that real estate always involves negotiation and compromise, so keep negotiating until you have come up with a solution.

As I say throughout my blogs, if you have any real estate questions that I can assist you with, please feel free to contact me, as I truly want to help. My way of giving back is to give away my knowledge. Thank you for reviewing this blog.

Jun 14, 2013
David Morgan
Comments Off on Triple Net Lease Definition

Triple Net Lease Definition

The definition of a triple net lease is a lease under which the tenant is responsible for paying the taxes, insurance and maintenance, in addition to the lease payments on a property. Triple net leased properties are often defined as single tenant, stand-alone retail properties such as banks, restaurants (fast food and casual dining), drugstores or dollar/discount stores, however investors have the choice of a wide variety of triple net leased properties.

Characteristics of triple net lease properties

Asset Type – They can be retail, office or industrial

Tenant Credit Quality – They can be investment grade or below

Lease Term – This varies from five to twenty-five years

Value and Size of Property – They can be from $2,000,000 to $100,000,000 or more and from 2,000 square feet to 250,000 square feet or more, as well as a single tenant to multiple tenants.

Location of Property – They can be in small towns or in major metro areas

You can define triple net properties by the ones with the strongest fundamentals as the most likely to continuously pay you income and maintain their value through any economic downturn. Fundamentals refer to being located in a prime location with a solid credit tenant on a long term lease. Prime location not only means in a good physical location for the particular type of business, but also means being in an area that matches the demographics of the tenant.

Here’s a video from EPI Properties discussing NNN properties. Below this, I continue my discussion on NNN Properties. (Please note that I’m not endorsing the company represented in the video, but am referring to them for general information purposes only.)

Benefits of triple net lease properties

Consistent cash flow – Strong credit tenants on a long-term lease give net lease investors a predictable income stream for a long period of time.

Hedge Against Inflation – These properties typically have consistent rent escalations which offer a hedge against the inflation risk.

Passive Investment – In addition to the monthly rent payment, triple net lease tenants are responsible for all operational aspects of the property (including insurance, taxes and maintenance). This makes it attractive to investors that want ease of management.

Great for Estate Planning – The ease of management, potential step up in basis, and the consistent cash flow make NNN properties a very attractive option to investors that have estate planning considerations.

Exit strategies – These are usually easy to implement, as this is a product that is in demand in good times and in bad times. You can usually sell or get financing for this type of property in any economy.

Tax advantages – As long as the IRS will allow deductions for depreciation of assets, real estate will provide you with tax advantages that can offset income from the real estate investment as well as ordinary income protection. To fully understand this, you may want to seek out a tax advisor or accountant. Only real estate can provide you with these types of tax advantages.

Risks of triple net lease properties

Vacancy risk – If the property goes vacant, it becomes 100% vacant and it is typically a single use building, thus showing you the importance of the quality of the credit of the tenant and the length of the lease term.

Bankruptcy or Default – If the tenant becomes bankrupt or defaults on the lease, it can negatively affect the cash flow and the value of the property.

Real Estate Risk – Triple net properties are not immune to risks associated with all real estate, including the potential loss in value.

Triple net lease properties are not averse to risk; however, with the right amount of homework, close scrutiny of the particulars of the deal and making sure that they align with your goals, they can be very lucrative investments with very low risk.

As I say throughout my blogs, if I may be of assistance with your real estate questions please contact me, I truly want to help. My way of giving back is to give away my knowledge. Thank you for reviewing this blog.

Jun 13, 2013
David Morgan
Comments Off on Owning Commercial Property|The Property Manager’s Role

Owning Commercial Property|The Property Manager’s Role

As an owner of commercial property, the property manager is an agent acting as a trustee on your behalf.  The property manager’s primary objective is to oversee the maintenance of rental property, rent to suitable tenants, collect rent and account to the owner.

Management Qualifications
Qualifications a property manager should have:
• Prior experience handling and reporting trust account activities;
• An adequate computer system to record and track activities on properties
• A competent staff to perform office and field duties and to quickly respond to both the landlord’s and the tenants’ needs.

Management Duties
• Handling and accounting for all income and expenses produced by the property
• Contracting for services, repairs and maintenance on the property
• Monitoring utility services provided by the landlord
• Responding in a timely manner to the needs of the tenants
• Evaluating rental and lease agreements periodically
• Serving notices on tenants and filing unlawful detainer (UD) actions as needed
• Performing regular periodic property inspections
• Keeping secure any personal property

In addition, the property manager must also:

• Confirm or obtain general liability and workers’ compensation insurance sufficient to protect the landlord, naming himself as an additionally insured
• Obligate the landlord to only authorized agreements
• Maintain the property’s earning power, called goodwill
• Hire and fire on-site employees as needed
• Comply with all applicable codes affecting the property
• Notify the landlord of any potentially hazardous conditions or criminal activities affecting the health and safety of individuals on or about the property

The “Prudent Investor” Standard
A property manager must employ a higher standard of conduct regarding the operation of a property than a typical investor might apply. This standard in commercial real estate management is called the prudent investor standard. A prudent investor is a person who has the knowledge and expertise to determine the wisest conduct for reasonably managing his property. The prudent investor standard of conduct is the minimum level of competency which can be expected of a property manager by a landlord, whether or not the landlord would apply the standard or even know about it.

A landlord’s primary business reason for hiring a commercial real estate management company is to have the property manager maintain the condition of his investment and income.

Decisions regarding the care of a property should be made by the property manager based on the need to generate a reasonable income from the property and incur expenses necessary to preserve the habitability of the property, provide a safe and secure environment for persons on the property and maintain the property’s condition so it will support the rent charged.

Management Fee
Commercial real estate management companies structure management fee schedules in several different ways:

1. A percentage of the rents collected.
The property manager is entitled to charge a set percentage of the rents collected as a fee (customarily between 5% to 10%), usually payable monthly. The percentage fee is not paid on security deposits since deposits are not rents.
2. Fixed fee
The property manager and landlord agree in advance to a set dollar amount to be charged monthly for the management services.
The amount stays constant whether or not the units are rented. This method, however, lacks the motivational incentive to induce the property manager to generate maximum rental income.
3. A percentage of the first month’s rent.
4. A front-end fee paid to the property manager is called a leasing or origination fee. If the landlord agrees, a fee can be charged for exercise of an option to renew or extend, or when a new lease is entered into with an existing tenant.

Accounting to the Landlord
All landlords are entitled to a statement of accounting no less than at the end of each calendar quarter. Most landlords will require monthly accounting in their commercial real estate management agreements.

Property Inspections by the Manager
Inspections determine the physical condition of the property, availability of habitable units or commercials spaces and the use of the leased premises by existing tenants.

Several key moments when a property manager should make an inspection include:

1. When the property manager and landlord enter into a property management agreement.
Any deferred maintenance or defects which would interfere with the renting of the property should be discussed with the landlord.
2. When space is leased to a new tenant.
A walk-through should be conducted with a new tenant prior to giving them occupancy. The property’s condition should be noted on a condition of premises addendum form and signed by the tenant.
3. During the term of the lease.
While the tenant is in possession, the property should be periodically inspected by the property manager to make sure it is being properly maintained.
4. When the tenant vacates.
The property’s condition should be compared against its condition when first occupied by the tenant. Based on differences in the property’s condition as documented by the property manager, the reasonable amount of deductions from the tenant’s security deposit for corrective repairs can be documented when accounting for the return of the deposit.
5. When the property manager returns management of the property back to the landlord or over to another management firm.
This inspection helps to avoid disputes with the landlord or tenants regarding just what the condition of the property was when management was transferred to and from the property owner.

Maintenance and Repairs
Obtaining the highest rents available requires constant maintenance and repair of the property. The property manager is responsible for all the maintenance and repairs on the property.

The property manager’s knowledge of the property’s condition prior to entering into a commercial real estate management agreement is a must in order to properly ascertain what maintenance and repairs need to be made or will be deferred.

The responsibility for maintenance includes:
• Determining necessary repairs and replacements
• Contracting for repairs and replacements
• Confirming completion of repairs and replacements
• Paying for completed repairs and replacements
• Advising the landlord about the status of repairs and replacements in the monthly report.

Usually, landlord set a ceiling on the dollar amount of repairs and maintenance the property manager has authority to incur on behalf of the landlord. If maintenance or repair work is done by the property manager’s staff or he stands to additionally benefit financially by the materials purchased or services performed, the property manager must disclose his financial involvement to the landlord.

As I have said before, if I may be of assistance with your real estate questions please contact me. My way of giving back is to give away my knowledge. Thank you for reviewing this article.

Jun 13, 2013
David Morgan
Comments Off on 14 Tips to Leasing Your Commercial Property

14 Tips to Leasing Your Commercial Property

Getting your commercial property leased is the most important thing that you can do if you own commercial real estate.  Here are the things you need to do to get your property leased:

1.    Make sure the space is ready to show and that it shows effectively.  Clean up the space itself as well as the overall property to show it in its best light.  Stage the vacant unit if needed. Staging the vacant unit can mean putting in office furniture if it is an office space or if it is a retail space you might go ahead and put a neutral color carpet into the space and and fix up the front windows as well as have some of the other tenants put some merchandise in the window along with a sign about their store and where they are located in the Center, especially if the vacant unit is a highly visible space. Help your other tenants by getting them some good exposure.

2.      If it is unlikely that you will find a tenant that can utilize the existing improvements, then take them out and put the space in a “vanilla shell” condition. (Definition of “Vanilla Shell”: Landlord provides the space with walls ready for paint, concrete slab floors, drop ceilings, lighting, air conditioning and heating, electrical panels, bathroom and electrical outlets per code in the walls. Does not include floor covering, wall covering, or any additional interior walls or improvements.)

3.    Put a professional leasing sign in the space and on the property. The leasing sign in or on the space should include your companies name, phone number, website and email address at a minimum. The property leasing sign should have the company name and phone number highly visible and should be a wood or weather proofed sign. Check with the local authorities to find out the maximum exterior sign that you can put on the property. Also, you might check to see if you can put a sign on the exterior of the building with the company name and phone number.

4.    Put a professional flyer together outlining the merits of the space and the property. The flyers should be on good stock paper with a picture of the asset and vacant space, a description of the real estate outlining the other tenants in the property, a map showing the location of the asset as well as the address of the property, a brief description of the vacancy, demographic information on the area surrounding the real estate, all of your contact information, traffic counts if a retail center, other tenants in the area around the premises as well as the highlights of the area and I always suggest putting in the asking rents and other charges, because I want the potential client to know what to expect before contacting me.

5.    Distribute the flyer to potential tenants and to the brokerage community.  You may want to put some of the flyers in a folder at the front of the property and/or by the front door of the vacant unit(s). Distribution can include email, direct mail, as well as direct contact by dropping a flyer off at a potential tenants current location or stopping by a brokers office and dropping off flyers.

6.    Advertise the vacancy on the internet through LoopNet, CoStar, Catalyst, eProperty, Craigslist or any one of the other many internet sites as well as local and regional publications.

7.    Attend local and national trade shows where you can talk to potential tenants and brokers in the area.

8.    Put a lock box on the property for ease of showings.

9.    Prepare a “Financial and Credit” form that potential tenants must fill out and return to you. Be sure that if you are going to run a credit check that you get their written permission. Do not be afraid to ask for this information upfront as you to have a good idea of your risk. Bad or no credit does not mean that you won’t lease space to them, but it lets you know about the risk you are taking.

10.    Always immediately return phone calls about the property. It is hard enough for a potential client to pick up the phone and call you, however making them wait a day or two for you to return their call makes them think that you don’t care or respect them.

11.    Qualify prospects over the phone prior to setting appointments to show the property.  Asking questions about their experience, the business that they want to put into the space, their financing and when they want to open their business will help you determine if they are, in fact, a prospective tenant for your property.

12.    Be on time for showings and ask qualifying questions as you tour a potential client through the space.

13.    Have a lease agreement that is acceptable in the community and know how to negotiate the points in the lease.

14.    Saying the right things and following up with prospects is key to leasing your property.

If you feel that you can’t do the above, contact a local commercial real estate broker who can provide you with these services.

As I say throughout my blogs, if I may be of assistance with your real estate questions please contact me.  My way of giving back is to give away my knowledge.  Thank you for reviewing this blog.

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