Archive for July, 2010
Jul
31
Decide Commercial Property Market Value Before Investing
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Commercial property is often used as a source of profit for investors. It can provide great returns with a minimal amount of work. If you are interested in buying commercial real estate, it is important to determine how much the property is worth in terms of market value. This way you will know whether a certain piece of land will be a profitable investment or not.
What is a Commercial Property?
Commercial property consists of buildings and land that is specifically zoned for business uses, and not for residential living. This includes all sorts of establishments like industrial buildings, offices and hotels. Things like hospitals, malls, golf courses, self-storage units, and independent retail stores are all meant for commercial purposes. They generate profit for investors either through rental income or from capital gains, when resold at a higher price.
Use the Gross Rent Multiplier (GRM) to Determine Value
The value of a commercial property is based on several factors. For instance, more the building generates rental income the more valuable it is in general. This is affected by the location, whether it is in a busy popular area of a business district or whether it is on the outskirts of a town, easily accessible or just out of the way. The property’s worth is also determined by the value of neighboring buildings as well as how much of the similar type of real estate is available in a given area.
Certainly you can find out the market value of the commercial property by hiring a real estate professional, but you can make your own quick calculations to get a rough idea about the worth of a particular estate. This can be done by using this formula:
Market Value= Annual Gross Rent * Gross Rent Multiplier
To use this formula you will obviously need to find out some basic information about the land from the seller or from real estate agent listing the building. You will need to find out how much revenue the property brings in each year in rental income. That is the annual gross income.
The GRM is a ratio of a property’s sales price divided by its annual gross rents. To determine the GRM on your own, you need to get hold of a several listings for properties that are similar to the one you are considering. You find the GRM or each one and average them all together.
Once you have the GRM you will be able to figure out the approximate market value of an investment property. For example, if you know that the its rental incomes total is $100,000 for the year and the average GRM for similar properties is 8, than the value of your prospective investment land is $800,000. Using this formula is pretty accurate, and it will help you as you try to narrow down your selection of buildings to buy. Yet when it’s time to actually buy the building, you will need a professional appraiser to satisfy the requirements of your investment loan.
Real Estate Proffessionals
Jul
24
Every Sales and Marketing Campaign a Winner!
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The best advice I can give you at this point is to tell you to read right to the end of this article to find the gold dust.
Commercial managers sometimes forget how important the sales and marketing elements are to their success in business. They become so hide-bound by administration that they overlook this vital element of commercial life. It is always an after thought, or they just can’t or won’t find the time to manage it properly. And yet, if there are product and services to be sold, they should be doing so in the most cost effective and profitable way, maximizing the market exposure and the returns on investment. This holds true for small single owner business as much as for huge corporations.
Without customer knowledge or awareness, there can be no purchase, and where no one is buying there can be no profit. Marketing is the science of bringing the right product to the market, at the right price, in the right way, at a Nett profit. Responsibility for the effectiveness of this falls to the sales and marketing department.
Everyone has their own preferred emphasis. For some it is search engine marketing, for others it is email marketing, for many it is direct marketing. However one chooses, identifying the correct marketing strategies as part of the overall campaign is imperative. It is the very root of the success you desire for yourself and your employer.
Training seminars and events should be attended often by all those operating in the sales and marketing arena. Selling is a skill that comes naturally to some, but not to most. Yet it is possible to master these skills so they become more like drills. With the right training and strategies in place, the appropriate successful selling responses should kick in automatically. With marketing too, the responses should be creative and limitless.
There is such a choice of media now that for the marketers it can be overwhelming. The widespread use of the Internet and the increasing availability of high speed connections, along with TV,results in vast numbers of potential customers being introduced to a product or service in no time at all. A quick review of what people enter into the search engines also helps paint a picture of the market psychology. It is amazing how people type words in an almost random order. For example, one of the most searched terms is engine marketing search. It’s a funny way to do it, but more than 1 million searches do so each month. Why do they reverse the words? I can’t tell you- but I do know that it is important commercial intelligence that might be able to be used in some way when reflecting on the strategy and the campaign.
Some managers will opt to delegate everything to a marketing agency. The difficulty here is that many would like to seize the opportunity to do their own thing at your expense. They can be like architects who do the same. The point is that for an agency marketing campaign, there must be a tightly detailed and described brief and a contract that while not limiting the ideas or creative juices of the agents and their staff, keeps them firmly bound to what you require. All this of course should be underpinned by solid market research.
At its most basic level, both selling and marketing are about the art of communications and the best choice of media for the markets to be targeted. Not all potential customers require the same approach. For example, wholesale and retail markets will attract different methods of communication by the sales team. Again, if a product is to be sold in a store or shop, it is not the same approach as advertising an article to be sold at auction. The advertisements for each will appear in different magazines and other media, and the ads will vary too in design, presentation and language.
The real secret of success here is to start to do things differently. The old maxim about being surprised when there is no change in circumstances while you continue to do things in the same way stands as an eternal truth. I would encourage anyone to go and see, hear and / or read what Dan Kennedy has to say on this subject. A quick Google search will reveal a wealth of material. My best counsel is that you should note well what he has to say. Dan is one of the foremost sales and marketing consultants in America.
Rent Back
Jul
17
Comparing Residential and Commercial Property Investment
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There are important differences between owning commercial property and owning residential property. Having all the information will allow you to make an informed decision.
There is more emotional involvement in residential property as it fulfills the basic function of providing shelter. If residential tenants are unable to pay the rent, even if the non-payment covers several months, you can’t evict them at will and rent the property to another tenant.
Residential tenants have the right to disagree with a rental increase by taking their case to the Residential Tenancies Tribunal. If they can show that an increase in rent would cause hardship, there’s a very good chance the tribunal will disallow the rental increase.
With residential properties the landlord is responsible for insurances, and maintenance and repair costs. The tenant is responsible for paying the rent, contributing to consumables such as water, heating and cooling, and paying for any damage to the property. However, the lease provides for ‘fair wear and tear’ for the length of the lease.
By contrast, leasing of a commercial property is a purely commercial transaction where emotion plays little or no part. Basically, there is no standard lease for all commercial properties and the terms and conditions are included in the individual lease documentation for each individual property.
The terms and conditions of occupation of a property by a tenant are recorded in the lease documentation and, once signed by both parties, are legally binding. In a well documented lease all aspects of occupation and operation of the premises are addressed. This includes the term of the lease, the level of rent, the basis of rent reviews, and who is responsible for operating costs, and repair and maintenance of plant and equipment, such as air conditioning, etc. Once these details are documented in the lease, only in extreme circumstances can the terms be varied.Unlike residential tenants, if a commercial tenant fails to pay his rent he can be readily locked out and any goods in the premises can be sold to recover the arrears in rent and the costs of the eviction.
Some commercial properties include a higher level of plant and equipment, such as air conditioning, fire prevention, security, etc. In a single-tenant building these costs are met by the tenant. In a multiple-tenancy building, such as a strata property, these costs are met initially by the landlord, but will be recovered on a pro rata basis from the tenants.
Most residential tenants prefer a short term lease that allows them the freedom to move. Common residential leases are for 6-12 months, with an option to renew the lease. Commercial tenants usually desire a long term lease that provides stability for their business. These leases can range from 3-20 years, depending on size and type of business.When a residential tenant wishes to vacate rented premises before the end of the rental agreement he can, with the consent of the landlord, secure a replacement tenant and, at that point, the obligations between the landlord and the original tenant are terminated for both parties. The landlord then has to rely solely on the guarantee provided by the replacement tenant.
In the case of a commercial tenant finding a replacement tenant – or sub-letting part of his leased area – the landlord has the protection of the incoming tenant, that tenant’s guarantee, and also retains the protection of the guarantee provided by the original tenant. The original guarantee remains in force until the expiry of the term of the lease agreement with the original tenant.
Most financial institutions will lend anywhere from 80-100% of the value of a residential property depending on market conditions. Loan approval on a commercial property will generally be in the order of 70% - 75%.
Financial institutions rely mainly on the financial strength of the borrower for residential loans, but like to see strong, long-term leases with commercial property investments. Here loan approval is far more reliant on the strength of the secure income from a sound lease than on the personal financial position of the borrower. Having a secure, well-structured lease in place on a commercial property can greatly increase your chance of securing a loan approval.
Knowing the differences between residential and commercial property investment is important in making a good decision on which type of property best fits your investment plan.
Rent Back
Jul
03
Introduction to Commercial Leases - Part 2
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In our last article we discussed: lease objectives, the common types of leases, what makes a lease enforceable, cash flow, expense stops, common area maintenance as well as the tax benefits of improvements.
As we move on in this article, we’ll discuss additional lease types and become familiar with lease additional clause, strategies and identify common terms used in commercial leases.
Ground Lease
A ground lease is as lease for land alone, and is typically a long-term net lease. Ground leases are where land ownership is retained by the owner of the land and improvements are owned by the tenant.
These leases can typically be found in areas with a shortage in highly desirable land, and may be traditional in other areas. Following the end of the lease term of a ground lease, title to the land and improvements reverts to the lessor/property owner.
Step Leases
Step Leases allow contracted rents on long-term leases to change by preset amounts or percentages which will occur on predetermined dates. These preset amounts or percentages are called escalations.
While the lease payments vary over time and the term of the lease, the actual payments are calculated and disclosed prior to the signing of the lease agreement.
The most common types of costs involving escalations may relate to real estate taxes, insurance, utilities, operations, and maintenance.
Real estate professionals representing the tenant can provide historical trend information regarding these types of escalation so that increases can be predicted and informed decisions can be made prior to a lease signing
Indexed Leases
Indexed leases are those where the contracted rent is tied to movements of a pre-specified financial index; such as the consumer price index (CPI). Here’s an example: If the current year’s consumer price index increases by 3 percent, then the next years lease payment will increase by 3 percent.
Additional lease clauses
Several other options and clauses are designed to protect the needs and concerns of the owner and tenants and should be negotiated carefully and with diligence.
Lease Renewal Options
Commercial leases often grant a tenant the ability to renew a lease for a pre-specified period of time following the initial lease expiration. However, the rate at which the lease may be renewed is specified in the initial lease contract. A renewal option is often of value as it eliminates the need for a tenant a new location for the business prior to the expiration of the current lease. Even though the tenant is not obligated to renew the lease, hence the term ‘option’, the tenant is not bound by the lease to remain and may decide to find another location for the business if either the business requires it or the tenant so desires.
Expansion and Relocation Options
As businesses grow, it is essential to that growth commercial leases provide a tenant the right to occupy additional space in the commercial structure.
The rental rate and specified period of this space should be negotiated prior to the initial lease signing. Often, the owner will agree to give a tenant the right of first refusal as space becomes available in the building. If additional contiguous space cannot be provided in a reasonable time frame for the tenant, an owner may agree to relocate the tenant within the building or shopping center within a specified time period. These additional lease clauses should be negotiated and worded carefully.
Financial impact of lease clauses
After a decision has been made to lease commercial space a commercial real estate specialist may be enlisted to prepare a financial report which quantifies the potential tenant’s lease costs and which compares and contrasts alternative leases.
As outlined previously, the final lease terms will be dependent on current local market conditions and the negotiation skills of all parties involved.
Before analyzing the financial implications that a lease imposes on a tenant we need to upgrade our vocabulary to include commonly used terms. These terms and definitions may vary from market to market.
Base (contract) rent: This is the specified, pre-defined contract dollar amount for periodic rent (monthly payments). Escalations are based on this amount.
Total effective rent: This is the base rent once it has been adjusted to include concessions, allowances and costs that will become the responsibility of the tenant (such as operating expense pass-through).
Total effective rate: This is simply the total effective rent divided by the square footage.
Average annual effective rent: This is the total effective rent divided by the total years of the lease term.
Average annual effective rate: This is the average annual effective rent divided by the square footage.
Cost analysis
Now that we have defined some common terms we are able to understand how to analyze the financial impact and actual cost of a lease:
From the tenants perspective
In many commercial leases, the base rent does not necessarily equal the effective rent. An in-depth analysis of this will include all costs to the tenant such as concessions, allowances and other additional costs.
Here then is a basic formula for calculating a tenant’s effective rent:
The base (contract) rent + (Additional Costs - Concessions and/or allowances) = The Total effective rent paid which will be paid by the tenant.
From the owner’s perspective
This same analysis is covered from the owner’s perspective and will also include all costs to the owner:
Here then is a basic formula for calculating effective rent from the owner’s perspective:
Base (contract) rent - (Net additional costs - Concessions and/or allowances) = The owner’s Total effective rent as income.
Alternative Strategies
We’ve seen how the negotiation of a commercial lease can not only affect a prospective tenants’ and owner’s cash flow but also how complicated the process may be. When a prospective site located and analyzed correctly, the site may or may not satisfy the financial requirements of a prospective tenant.
With that in mind, let’s look at some alternative strategies for commercial leasing:
Sublease
A sublease is a separate lease in which the tenant may lease all or part of the leasehold interest to another tenant while retaining liability for the property and primary lease to the owner.
There are however risks to subleasing which an owner may not be willing to accept. These risks include:
Re-lease risk: The length of time it will take to find a sublease is unknown. Rental rate risk: It may be necessary to sublease at below-contract rent. Tenant quality risk: It may not be possible to find a high-quality tenant. Lease-term risk: A sub-lessee may want a shorter or longer lease than that of the primary lease. Lease agreement risk: A sub-lessee may want concessions, allowances, and other features that are not provided in the primary lease. Tenant improvement risk: The sub-lessor may have to pay build out costs for the sub-lessee.
Assignment
An assignment of lease is where all of a tenant’s leasehold interests in a property are transferred to a third party. In general this will release the original tenant from any and all responsibility of the remaining terms of the lease at the time of assignment.
Build to Suit
Build-to-suit development as those in which an owner agrees to develop or finish a property built to the specifications of the prospective tenant.
The costs for the improvements may in part be assumed by the prospective tenant and may be in the form of an increased effective rent.
A build-to-suit strategy will most likely involve a prospective tenant with significant financial capacity and strong creditworthiness.
Sale-Leaseback
A sale-leaseback is a strategy in which an owner purchases land, builds a structure on the land for their own use and in turn sells the entire property to an investor, and retains a long-term net lease.
Many companies use this strategy to convert their equity in real estate to working capital where it hopefully can generate a higher return from the operation and cash flow of the business.
Summary
While this article, appropriate title Introduction to Commercial leases does not encompass every aspect of all commercial leasing implications, it hopefully has provided those with a less then working understanding of commercial leases the knowledge and information needed when dealing with a commercial lease entity.
There are many different ways to structure lease transactions, clauses and financial implications in commercial real estate leasing.
An important item to remember is that many lease clauses will be applied to a cost to either the prospective tenant or the owner.
Commercial leases should be reviewed carefully by trained professionals or others fully qualified to negotiate and analyze both the short and long term implications of the lease and the financial responsibilities of all parties concerned.
Careful and diligent lease negotiations and analysis will provide both a prospective tenant as well as an owner the ability to profit and be successful in their individual endeavors.
© Copyright 2008 Jennifer MacKay. All Rights Reserved.
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