Glossary of Commercial Real Estate Terms

Administrative Fee: Typically, a fee paid as part of the CAM expense. Usually 10% – 15% of the CAM expenses, not including real estate taxes, assessments or insurance.

Attornment: In the event a mortgage holder forecloses on the landlord, the tenant will recognize the change of ownership and the new landlord.

Build-to-suit: Method of leasing property in which the landlord makes improvements to a space based on the tenant’s specifications. The cost of construction is generally factored into the lease terms. Most build-to-suit provisions apply to long term (10-year)leases.

CAM charges: Common Area Maintenance charges including parking lot maintenance, landscaping, common area lighting, etc. Based on actual expenses and apportioned among all the tenants. CAM charges are quoted as $/SF and based on rentable square footage. Typically paid monthly based on estimated costs for the year. At the end of the year, actual CAM charges are calculated and a credit or debit is passed on to the tenants.

Capitalization Rate: Net operating income (NOI) divided by the purchase price.

Cash on Cash Return: Cash Flow Before Taxes (CFBT)/initial investment. Best indication of the quality of the investment.

Credit-tenant property: A single-tenant commercial property occupied by a tenant who has a credit rating by Moody’s or Standard & Poor of BBB or better.

Debt Coverage Ratio: NOI/loan payment. This is what your banker will want to know before lending you money for the investment.

Discount Rate: Rate of which future cash flows are discounted (devalued) per year.

Double Net Lease (NN): In addition to a fixed monthly rent, tenant pays property taxes and insurance.

Escalation clause: Clause in a lease that allows the landlord to increase rent in the future. Rent increases dictated under an escalation clause may be charged in various ways, including:
• A fixed increase over a definite period
• A cost-of living increase tied to a government index, such as the Consumer Price Index (CPI)
• An increase directly related to increases in operating the property

Estoppel: Clause in the leases that states that if the landlord sells or mortgages the property, the tenant agrees to sign an Estoppel certificate that acknowledges the tenant’s current lease. The Estoppel usually includes the rental amount, remaining time on the lease including options to renew, outstanding rental payments due, lease amendments and any other important items in the lease. Typically, when an owner plans on selling the property, the buyer’s lender will require the tenants to sign an Estoppel Certificate.

Exclusive Use Clause: Provides protection in the shopping center for their right to sell a specific product(s); the landlord may not lease space to any tenant that sells those items.

Gross Lease: Tenant pays a fixed monthly rent.

HVAC: An acronym for “heating, ventilation and air conditioning” system.

IRR (Internal Rate of Return): Calculated by setting NPV = 0 and finding out what the discount rate would be. Use a calculator to do this calculation.

Lien: Legal claim filed against a property for payment of a debt or obligation. If a property owner fails to pay a creditor, for example, the creditor can place a lien on the property. A lien can halt the sale of a property.

Liability Insurance: Tenant will be required to carry an insurance policy in an amount of generally two to four million dollars and name the landlord as additional insured.

Load Factor: If the tenant has rights to hallways, elevators, restrooms outside their space, lobby, etc., the landlord will determine how many square feet of this area exist and prorate it to the other tenants. The tenant will pay rent on their prorata share of this number when the landlord calculates minimum rent.

Management Fee: Part of the CAM expense. Calculated as a percentage of the gross rents for the space (5% – 10%).

NPV (Net Present Value): Method for calculating the present value of future cash flows. Useful for comparing different investments and their returns. Most calculators provide NPV calculations.

Optimum Holding Period: Number of years to hold a property in order to maximize ROE. After this period it’s best to sell or exchange the property.

Percentage Rent: In addition to Minimum Rent, tenant will also pay a percentage of their sales volume as additional rent. Typically, when a tenant reaches a specific sales volume, the tenant will pay the landlord an amount over and above a specific figure. Example: if a Tenant’s minimum rent is $100,000/year and they have a 6% overage clause, the calculation is: $100,000/6% = gross of $1,666,666. The tenant would be required to pay the landlord 6% of the amount that exceeds $1,666,666.If the tenant did $2,000,000 in sales, $2,000,000 – $1,666,666 = $333,333 x 6% = $19,999 additional rent paid to the landlord.

Projected Gross Operating Income: Property’s annual income if all spaces were rented and all of the rent actually collected, minus an allowance for vacancy and credit loss.

Prorata (pro rate): The percentage of space occupied by a tenant as compared to the total space available for lease in the development. Example: if the total space in the center is 5,000 square feet and the tenant leases 1,000 square feet, prorata share is 1,000/5,000 = 25%. The tenant is then responsible for 25% of the total expenses of the development.

Recapture: The right of the landlord to cancel a lease with a tenant in the event a tenant desires to sublease or assign its lease. The recapture allows the landlord to lease the space directly to a new tenant and hot have the existing tenant assign or sublease to a new tenant.

Rentable square feet: Total square feet used to calculate the rent rate; may include an apportionment of lobby, hallways and other areas in the building available to and used by all the building tenants. Expressed as a multiplying or load factor of Useable SF. Example: Rentable SF = Useable SF x 1.15 (multiplying or load factor)

Return on Equity (ROE): CFBT/equity. Equal to Cash on Cash the first year, then decreases because your equity grows faster than NOI (due to depreciation and mortgage retirement).

Right of First Offer: Before offering a space or property for sale on the open market, the landlord or owner is obligated to offer the property first to a specific party.

Right of First Refusal: Allows a tenant the first opportunity to lease space if the landlord has a qualified party ready, willing and able to lease the space. The tenant can accept the other party’s offer amount which he will pay to the landlord or decline to lease the space.

Sale-leaseback: Transaction in which an owner sells a property to an investor who then leases the property back to the original owner under prearranged terms. Sale-leaseback deals offer the original owner freed-up capital and tax breaks and the investor a guaranteed return and appreciation.

Sublease: Lease given by a tenant for some or all of a rented property. For example, if a tenant rents 20,000 square feet but ends up needing only 10,000 square feet, they may want to sublet the extra space for some or all of the remaining term of the lease, providing they continue to occupy and pay rent for the property.

Subordination: Tenant agrees that the lease is subordinate to the mortgage. If the property is sold, the new owner cannot cancel the lease and the lease is in full force and effect. The lender’s position is not affected by the change in the tenant’s lease. In the event that the property is foreclosed, the lender may either keep the lease in effect or terminate it.

Triple Net Lease (NNN): In addition to a fixed monthly rent, tenant pays property taxes, insurance and common area maintenance.

Useable square feet: Total square feet within the walls of the space being leased. Actual space available for Tenant’s exclusive use.

Utility Costs: In larger spaces, utilities are separately metered and paid by the Tenant. In small spaces, utilities may not be separately metered and are apportioned among all users.

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.

Yield Capitalization: More complex form of income capitalization which looks further into the future and attempts to estimate return over a projected holding period (typically 10 years).

Cost Segregation|Can It Cut Operating Costs on Commercial Property?

Saving money through creative financing, good management or cost segregation is always a good thing.  It doesn’t make any difference where the savings or increased value comes from, it only matters that you realize the gains.  This blog will attempt to answer your questions about cost segregation.

Here’s a video that should help you understand cost segregation and I’ve answered some specific questions below. (Please note that I’m not endorsing the company represented in the video, but am referring to them for general information purposes only.)

Cost Segregation (CS) – what is it? CS can help lower your business costs, and could also assist with jobs retention. The process involves a review of your business operations to separate items that are subject to long-term depreciation from those that are eligible for shorter-term depreciation through the IRS. For instance, your computer mainframe will not necessarily be subject to the same depreciation schedule as the ceiling, doors, fixtures, etc. Simply put, accelerating the asset depreciation on Federal taxes can save businesses money.

Depreciation through Cost Segregation is based on whether specific items (inside the building) were built pursuant to code requirements, or are for technology, service, treatment, aesthetic, or other purposes. Building-related items are typically subject to a 39-year depreciation schedule; non-code items can be eligible for five, seven, or 15-year depreciation. The result of segregating these costs could be significant for your business.

What types of properties qualify for cost segregation?

Real property eligible for cost segregation includes buildings that have been purchased, constructed, expanded or remodeled after December 31, 1986. Any size property will qualify. A study is typically cost-effective for buildings purchased or remodeled at a cost greater than $200,000.

When is the best time for a cost segregation study?

The best time for a cost segregation study is the year the property is placed in service by the current taxpayer, but it can also uncover retroactive tax deductions for older buildings which can generate significant short term benefits due to “catch-up” depreciation. Whether new construction or acquisition, it is generally most beneficial to maximize depreciation deductions from year one.

How much does a cost segregation study cost?

The classic answer is…it depends. The fee for a cost segregation study can vary greatly depending on the property type, size and complexity as well as the quality of the provider and their work product. The good news is that fees have come down considerably over the past four or five years. A study that would have cost $30,000 or more 5 years ago will probably price in the $10,000 – $12,000 range in today’s market.

How much should I expect to save with a cost segregation study?

It is not uncommon for a cost segregation study to generate hundreds of thousands or even millions of dollars in net present value savings. The average study will allocate, or reallocate in the case of a look-back study, anywhere from 20 – 40 % of the depreciable cost basis to a shorter life. For every $100,000 moved from 39-years to 5-years the 10-year net present value savings is approximately $28,000 (based on a 40% tax rate and a 6% discount rate). The 40-year net present value saving is approximately $20,000.

Hopefully, this blog has answered some of your questions about cost segregation.  If this looks like it could work for you, I suggest that you discuss this with your accountant or if he can’t help you contact a specialist in this field.  Sometimes our accountants aren’t as aggressive as we would like them to be.  As you can see, this could cost you vital money and be the difference between a money making or losing investment.

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.

10 Ways To Increase Your Commercial Property Value

If you own commercial real estate, I believe that the ten best ways to increase their value is through rent increases, operating expense decreases, making improvements to the property, adding amenities or exploring other income producing ideas, review/challenge the existing property taxes, change the management company and/or leasing company, change the zoning or use of the property, have tenants pay for the utility costs, divide the property and creatively negotiate the leases whether they expire now or later.

1. Increase Rents

  • Increase below market rents when leases expire: Review the market to determine the average rent; if you are below the average for your type of property, increase the rents accordingly. Increase the rent over time for existing tenants; however, when renting a vacancy, charge at the new increased rate. You can check rental rates by going online to search for “rent rates” or by contacting a local property manager or leasing company in the area.
  • Expand existing tenants into larger space.
  • Improve credit-worthiness of tenants when filling vacant space (improves the cap rate) by marketing vacancies to regional or national tenants.  You don’t necessarily need to increase the rent, you should be able to sell the property at a better cap rate with better credit tenants.

2. Decrease Operating Expenses

  • Compare your expenses to market: Review all of your expenses carefully and analyze them on a per unit basis and a cost per square foot basis, as these are industry standards. Compare each expense with your other properties. Talk with your property manager or a local experienced property manager to compare with other properties in the area. If some of your costs are higher than the standards, you’ll know you need to explore ways to decrease them.
  • Competitively bid all of your contracts, including insurance.
  • Convert gross leases to net, double net or triple net leases.

3. Make improvements to Your Property

For office buildings, shopping centers and industrial buildings, cosmetic improvements can make a big difference – and may enable you to increase the amount of rent you charge. Give the exterior a makeover, improve the lobby, or repave the parking lot to enhance the property.

In the case of apartment buildings, you’ll get more mileage out of fixing up the interiors, installing new appliances, or doing a landscaping face-lift.

4. Add Amenities or Explore Income Producing Ideas

Amenities you might add:

• concierge services
• a fitness center
• a conference room
• a business center with a fax machine and copier
• a coffee bar

Income producing ideas include:

• renting your roof space for cell towers
• adding a laundry room and coin operated machines to an apartment complex
• renting your common areas for art shows, car shows or kids rides.

5. Property Taxes

Get an appraisal for your property and appeal the appraised amount if the appraisal is lower. Retain a real estate attorney who specializes in tax appeals to assist you, or hire one of the companies that get paid based on the savings they get for you based on the appeal.

6. Change Management or Leasing Companies

Sometimes all that’s needed is looking at your property through a new pair of eyes. Different energy or philosophy can add value to your property. New managers or leasing agents may be able to give you ideas on increasing income, decreasing expenses and giving your property a fresh, new look and feel.

7. Zoning or Use Change

Changing the use of a property can significantly change the value of the property. Examples are:

• changing an industrial space into a retail use
• renovating a hotel to apartments
• adjusting regular office space to medical office space

8. Have Tenants Pay for the Utility Costs

If you are paying for the electricity, gas and/or water usage in office buildings or apartment complexes, look into separately metering or sub-metering the utilities, and pass the costs on to the tenants.

If you have a boiler, you may want to install baseboard heating in each unit so the tenants can control their heat and pay for it.

9. Divide Your Property

If you own land, breaking it down into smaller parcels can get you more per acre or square foot. Also, you could put in roads, add utilities, or entitle the property, all of which can substantially increase the value of the property.

10. Negotiate Existing Leases

If you are trying to sell the property or borrowing money on the property, it’s better to have long term leases in place. A five or ten year lease with rent increases is worth more to investors and lenders than a one year lease. Renegotiate or extend existing tenant leases to maximize the value of your property.  Whenever the tenant asks for something that is not your obligation, it can be a time to negotiate something out of the lease.  In other words, if they ask you for something, it’s time to ask for something back.  Improve your leases whenever you can.

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.

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.

Property Management|Hire Out or Do It Yourself

As the owner of investment property, you have the choice of hiring a professional property management company or managing the property yourself.

As an investor, you can do retail property management yourself; however, your property’s success will never go beyond your own personal development. So, educate yourself on how to successfully manage a property and improve your knowledge and skills.

When managing your own property, keep the following things in mind:

1. Don’t be friends with your Tenants – Establish a friendly business relationship with them, but don’t become best of friends. It’s difficult to evict your best friend.
2. Understand that people, not your property, cause problems – People pay late, damage properties and vacate properties, so make it a point to lease to good tenants and good companies.
3. Make sure everything is in writing – A good lease agreement is worth its weight in gold. If you’re to do something for the tenant, write it down and vice versa, if the tenant is supposed to do something, write it down and give them notices.
4. Have an in-depth understanding of your market – Knowing what your competitors are doing is a must in retail property management to make sure that your rents and your property overall meet the standards in the market or exceed the standards.
5. Don’t put anything in your name – Protect yourself and your personal assets from lawsuits by having your properties and businesses legally detached from you personally. You should form an LLC or another type of legal entity to hold your property, based on conversations with your attorney and tax advisor. Do not commingle your personal funds and the property funds.
Also, by having the property in an LLC, it allows you to tell your tenants that you’re only the property manager or managing partner and that decisions are made based on what is best for the ownership.
6. People handling skills are a must if you’re going to do retail property management youself – You not only have to manage your tenants, but you also need to handle vendors, contractors, employees, city or county government people, etc. You need to have tact and patience to succeed.
7. Understand your lease(s) inside and out – When you buy a property you’re really buying the lease(s) and getting the buildings for free. In other words, if your lease(s) is weak, then your investment is weak.
8. Always write a business plan for the property – Setting goals and understanding what needs to be done to keep the property on track is a must. A good and well thought out business plan helps you when making everyday decisions on the property. A business plan should include a property summary, a market analysis, a sales and marketing plan, a management summary and a financial plan.
9. Understand your own strengths and weaknesses – Take on those tasks that you do well and that give you joy, and hire out those functions that you don’t do well or don’t like to do.
10. Do things right the first time – Hire good help, and focus on quality, thoroughness and attention to detail.
11. In order to manage a property yourself, you need to have a basic business system that includes an accounting system, a sales and marketing system, an operations system and a maintenance system.

If you’re considering hiring a professional, there are several things you’ll want to evaluate including qualifications, duties they’ll be expected to perform, and management fees.

Here’s some additional information from the REI Club about whether you should or shouldn’t manage your own property.

Here are some reasons why you may make the decision to hire a property management company instead of doing it yourself:
1. The property is too far away – If the property is too far away it can be difficult to oversee maintenance and repairs, handle evictions, take care of emergencies and pick up rent checks.
2. The property is too big – A large property has a large amount of decisions to be made on a daily basis.
3. You want to have a life of your own – Managing property profitably takes time. Is this the best utilization of your time? Do you spend enough time on the other parts of your life?  Your management company can do your business plan, then you only have to review and approve it.
4. You simply aren’t good at managing your property – Due to your lack of skills, you may be leaving money on the table each month.
5. You don’t have any systems in place to properly manage your property – Without an accounting system, a sales and marketing system, an operations system and a maintenance system, managing properties can be a nightmare.

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 blog.