Tag Archives: management

Real Estate Investing: Residential or Commercial?

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Most commercial real estate investors begin their investment careers by purchasing residential or multi-family homes.  A number of influential figures of Houston’s commercial landscape dabbled for a period of time.

Here’s how it begins…

The strategy: Residential investors typically lease their homes to stabilize the asset in the hopes of making their riches on the back end or via long-term investment.  While most residential investors usually go in with the best attitude, they quickly realize that leasing the home is a “necessary evil” for its long-term benefit:  price appreciation.  In some cases, residential investors have been willing to accept negative cash flow for this ultimate prize.  They do the “toilets, tenants, trash”, or other variation of this commonly used phrase, with the belief that tenant demand & supply of dollars will remain constant and home prices will go up.  This is the typical story of the residential investor of the past.

Fast forward to today.  The challenge of leasing and managing a home is much greater, while home prices are falling.  The old formula for residential investment no longer computes. At best, residential investors are hoping to break even. Different from a couple years ago when everything was going up!  As a result, our representation group has welcomed a new group of investors; those that are shifting their investment strategy closer to the core of business and money creation – commercial real estate.  Leaving residential investment for it’s older cousin.

These investors are looking into commercial property, such as single-tenant retail and office, shopping centers, small medical office buildings, and industrial are searching for more stability, less management, and more potential upside due to current depressed prices.  Let’s explore this paradigm shift…

  • Income: Commercial real estate generates far greater income when compared to residential properties in the Greater Houston area.  For an example: Rental income on a commercial property can range, but we are locating properties with $300,000 of net operating income (income – expenses) for a $2 Million Property.  To equate to residential, the owner would have to rent out at that 15,000 SF home for around $35,000 a month.  We say, if you can achieve this on a long-term basis, stay in residential.
  • NNN Leases: NNN-leased commercial properties remove a host of issues that are typically provided by a landlord in residential investment.  The worst fear for any tenant is deferred maintenance.  Your tenant pays good rent to receive poor, inadequate, or no service whatsoever.  Furthermore, deferred maintenance will have a negative impact on the property appeal and value.  In NNN-leased commercial properties, the tenant has control over the condition of the property.  In this type of lease, a landlord and tenant agree on a price and terms, as standard.  The difference is in a  provision that states that a tenant will pay their pro-rata share of the expenses for the upkeep of the property, among other things.  While that means lower base rent to the landlord when compared to a “no expenses to tenant” clause, it includes that the tenant is responsible for the building’s appearance.
  • Reliable Tenants: Tenants of commercial buildings are stronger – financially.  If you don’t believe that, ask them.  As commercial brokers, that is exactly what we do.  Unlike residential, financial statements and tax documents are requested to view a company’s past, present and potential future.  The greater the company’s history, the greater the lease longevity, the greater the stability and appeal of the property.  And, based on commercial real estate’s long-term lease arrangements, if a tenant leaves a  property, they will continue to pay rent.  If the tenant cannot pay,  they will need to replace themselves (via the use of a brokerage house or in-house leasing) with another tenant.  This is called subleasing.  So, no sweat to the landlord, as they are not responsible for re-tenanting, unlike residential.
  • Long-term Leases: On average, businesses usually settle into one location for 7 years.  Tenants, such as Walgreens, stay for 20.   Residential agreements last around 1 year.
  • Management: Much simpler in commercial real estate.  For an easy example, which would your choose?  10-tenant shopping center or 10 homes spread throughout the city? Management intensive investment is a waste of your time and your money.

Others….

  • Tax Ease
  • Credit Impact
  • Pride of Ownership

This article was republished from Robert S. “Bob” Lowery’s original post, “8 Reasons to Leave Residential for Commercial…Now!”

The Weakest Link in the Leasing Process

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One of the weakest links in the leasing process for new tenants can be the poor interaction or failed communication between the broker(s) and the property manager. Because property managers are paid to protect the landlord’s interests (money), while juggling so many responsibilities, and brokers are paid a commission, typically at signing of a contract, it is common for tension to arise as tenants sometimes feel as though they are left in the dark and eventually herded into their space like cattle. We feel that this situation is unacceptable for the tenant and is partly the blame of each commercial real estate servicer involved. But, there is not a clear-cut method as some managers pull out the red carpet and some do not.  This is due in part to the roles of manager and leasing brokers and their attention spent attracting new commission opportunities (broker) and making sure tenants resign with the building (manager).

We feel that providing exceptional building relations is in the best interests of the landlord and managers need to become a greater, more communicative part of the process, in essence eliminating the chance of other tenants becoming impacted by such mistakes and miscommunication. We know that tenants circulate bad news to which news and rumours about problem areas escalate quickly. This is especially the case in a B or C class office buildings.

So, all instructions and agreements made between the tenant, the landlord, the leasing manager, and the property manager should be communicated prior to potential issues may arise. It is common for disagreement and disputes to occur at the beginning of lease occupation given that so many parts are moving at the same time, thus an effective communicator of the contractual items is critical.

An organized approach to tenants moving in to a property is the best way to prepare for property stability and the future relationship between the landlord, the property manager, and the tenants. A checklist for the tenant is always productive. Because every property has unique components and special elements of occupation that need to be documented and provided for, we have provide the move-in checklist below. Feel free to modify the list and change the order to suit your property type and location.

The Lease Move-in Checklist:

1. Tenant name and full contact details sourced

2. Lease signed and copies served to all parties

3. Tenant provided with all emergency contacts and procedures for the building

4. Rent, outgoings, and all guarantees paid in accordance with the lease

5. Insurances are provided by tenant in accordance with the lease

6. Any other special conditions of the lease are complied with by the tenant and the landlord

7. Landlords works are completed as per lease agreement

8. Premises inspection and documentation is made as part of handing keys to the tenant

9. Details of build-out changes and plans provided

10. Approvals of build-out changes and plans provided

11. Lease commencement date

12. Rent commencement date

13. Anticipated move-in dates and times

14. Method of move-in and access points for goods and materials entry

15. Instructions letter to tenant explaining the move in rules and conditions

16. Building Rules and Regulations Manual is provided to tenant

17. Tenant build-out guide is provided to tenant

18. Advance notice of move is given to other tenants in proximity

19. Power, lighting, air conditioning, communications and other services to premises are operational for the tenant move.

20. Freight elevator is accessible (out of main building hours) for the new tenant to use for the move

21. Directory board changes are made to allow for the correct new tenant description and location

22. All relevant locks and keys are made available for the tenant to use to the premises

23. Security cards are organized as necessary for the building security system

24. Parking details and documentation is signed and passed issued relevant to the lease and the tenant.

25. Storage for the tenant is organized on site as required for the move and the creation of occupancy

26. Net lease – Electricity meters are read for the premises before lease occupation starts.

27. Emergency Evacuation Systems and Procedures are provided to the tenant and training provided as necessary.

28. Other tenants are advised of the new tenant name and a welcome to the building is provided.

29. Tenant is met on site by the property manager to strengthen communication and feedback.

30. When the landlord has completed build-out works, the property manager should check that the finished construction complies with the submitted and approved plans.

20 Items to Request Prior to an Investment Property Purchase

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As our group continues to provide data to corporate real estate authorities, we are finding a greater number of these decision-makers seeking potential properties to purchase in an effort to consolidate their operations, absorb vacant space in financially distressed buildings, and lease the remaining space to like-minded businesses, in essence strengthening their internal network without leaving the building or paying for employees.  Given a slowdown, one that now looks to continue for Houston business for the next few years, corporate relocation brokers are finding their clients stepping off of the sidelines and looking for solutions that will help them pare employees, as well as high-price rental space, in an effort to ‘get lean’.

So, to prepare for those looking at purchasing their own building for use and taking in some rental income to offset costs, we have provided some helpful insight into financial aspects of a commercial property. As most sophisticated business owners and investors (excluding non-traded REITS) know, forming an opinion about a price without comprehension of its parts is a multi-million dollar losing proposition. The financial aspects of the property will most likey have a significant impact on the purchase price, especially given a climate with very few bidders.

We have detailed 10 (of 20) of the major aspects for financial concern in a commercial property purchase or sale scenario. While these are not the only items that should be scrutinized, they are the most important in the majority of circumstances. We will update the second half next week.

If you are not using our services, we recommend that you create a checklist using these items for your next property review.

  1. The Asset Schedules: The property will contain many fixed, as well as moveable assets. These will normally be detailed on the asset register. A well maintained commercial property will have an up-to-date asset register for your review. Obtaining the asset register as early as possible is very productive as it will tell you, in detail, what you are being sold.  Also, it will become part of the negotiation process.
  2. Bank and Personal Guarantees: An investment property comprises of leases and other documents which support tenant occupancy. A normal leasing process would involve and create some form of guarantee to be provided by the tenant to the landlord for the duration of the lease. It is important that this guarantee has both strength and substance to reimburse the landlord in situations where the tenant defaults under the terms of the lease. At the time of property sale, these guarantee documents should have the ability to be transferred or re-issued to the incoming purchaser. This process is called an assignment of the guarantees. You should consult with the landlord’s management to identify the types of guarantees involved, as well as the ease to which it is provided.
  3. Capital Expenditures: Major items, such as the building’s air conditioning system, which are replaced in a commercial property are usually regarded as capital expenditures and are separately itemized for the purposes of taxation and depreciation over a period of time. Taxation laws will stipulate the depreciation terms as they apply to different types of capital expenditure. For example, a computer that is purchased for the building control system will depreciate far quicker than the air handling unit which was purchased for the air conditioning system. Well maintained property records will include a detailed capital expenditure register and the date at which the capital item was purchased. Purchasers to the property will be interested in the depreciation that this register provides against the cash flow in coming years.
  4. Taxation: Every property has its own unique tax issues relating to property, particularly in an investment property. In the purchase process, it is important that these matters have been handled property and are up-to-date. Sometimes, it is necessary to view the returns for the property over the last few years.  You can also seek written confirmation from the owner of the property that all taxation matters are current.
  5. Income and Rent Analysis: The income for the property is a reflection of the leases and occupancy within. It is essential to understand that the rent has been collected in accordance with the leases and that all rental matters are up to date. Part of this process will also involve checking the rent review profile and the expirations of all leases. A property with weak leases that are soon set to expire will impact the price or purchaser’s interest. When reviewing tenant occupancy, you should review the original documents and cross reference this to the tenancy schedule as well as information provided by the landlord.
  6. Independent Valuation: Many property owners will obtain a valuation regularly in support of their property financing package. It is not unusual for such valuations to occur annually. It is important they are done by a qualified and registered commercial appraiser. If you utilize an appraiser during the pricing process for the property, the landlord should consider the true independence of the valuation, when it was performed and its relevance to the current market. Some valuations for financing purposes may not be in line with the existing market conditions. It pays to sometimes seek a true independent valuation at the time of sale or in preparation for sale.
  7. Lease disputes: Rarely is there a property that does not have an existing lease dispute or has been impacted by a previous lease dispute. For this reason it pays to question the matters of lease dispute and resolution. If in doubt, seek a copy of correspondence and any subsequent agreement between the appropriate parties. Unresolved lease disputes can jeopardize, or at the very least, slow the process of property sale.
  8. Mortgaged interests: Most commercial real estate properties will have a mortgage with a lender. When a mortgage exists, it is necessary to understand how it will be handled or removed in the process of sale. The broker should consult with the mortgagee to clarify these matters for you. In a situation of distressed properties, the sale of the property may need to realize a particular price before clear title can be achieved.
  9. Operational expenditures: The management of a commercial property will involve the operational expenditures attributed to its working costs. Most of properties of particular types in the same location will have similar operational expenditures.  If a property has excessive operational expenditures, above average for the area, then the property will likely to be difficult to sell due to its high maintenance. Most brokers understand the averages of property expenditures realistic for each property type and location.
  10. Rent reviews: A significant concern in the sale of a property is the size and stability of future rent reviews. It is the rent reviews which examine the cash flow and attractiveness of the property to purchasers. It is essential that the landlord’s real estate broker read all of the leases, before any assessment of price or method of sale is given. It is quite possible that the rent reviews projected for leases will either negate or attract interest in the property.

See second half next week!