Anatomy of Commercial Real Estate Transaction

Anatomy of a Commercial Real Estate Transaction

  • Whose perspective?
  • Price
  • Cost
  • Value
  • Understanding the Underwriting Process
  • Apartments
  • Office
  • Industrial
  • Retail
  • What’s real vs. what’s not
  • IRS world versus real world.
  • Capital Items
  • Expense Items
    • Fixed
    • Variable
    • Reserves
  • Three deal killer issues
  • Reserves
  • Vacancy and Collection Loss
  • Management Fees
  • What does it really cost
  • How do you know?
  • Resources
  • Metrics and where to find them
  • What’s it worth?
  • Cap rate
  • Price/sq. ft.
  • Price/unit or door
  • Tips, Tools, Techniques, and Hacks!
  • APOD-http://commercialcamp.com/
  • National Report-ULI.org (Emerging Trends)
  • Regional Report-http://www.irr.com/
  • Market Report-http://www.irr.com/
  • The Four Sacred Questions
    • How much money goes in?
    • When?
    • How much money comes out?
    • When?
  • Conclusion
  • Cash flows…it either does or it doesn’t
  • Unless there is a really good reason…it never will
  • There is not always a “greater fool”

Class warfare!

  • Class “A”
    • Newest building in the market
    • Typically built in CBD
    • Highest quality fit and finishes
    • Amenities, concierge, health club, dining, personal shopper, valet
    • Can be any property type
    • Located in a 24 hour city
  • Class “B”
    • Older class “A” building that has “aged” out
    • Purpose built to capture the tenants that don’t want or need class “A”
    • Outside CBD
    • Fewer amenities
    • Fewer services
    • Can be any property type
  • Class “C”
    • Typically an older “B” or “A” building
    • Located in a secondary or tertiary market
    • May need work, maintenance, upgrading
    • Located in tertiary markets
    • No amenities
    • No services
    • Strictly a “value”
    • Can be any property type
  • Class “D”
    • Some experts debate the validity
    • Old building suffering from “functional obsolescence”
    • Needs work…lots of it!
    • Located in a less or un desirable area
    • No amenities, services…no nothing!
    • Could have been an “A” or “B” a long time ago
    • Can be any property type

The Basics Of Commercial Leases

  • The Bundle of Rights
  • Disposition
    • “This right permits the owner to sell, mortgage, dedicate, give away, or otherwise dispose of a portion or all of the property”
  • Use
    • “This Right entitles the owner to uninterrupted use and control of his or her land in any manner consistent with local laws”
  • Possession

“This right allows the owner to occupy the premises with the maximum legal control over entry and use of the property”

  • Exclusion
    • “The owner has the right to control access to the property and to seek damages for certain forms of trespass”
  • Leasehold Interest or Estate
  • A Leasehold estate is an ownership of temporary right to hold land or property in which the lessee or tenant holds rights of real property by some form of title from a lessor or landlord.
  • What do they get…UPE
    • Use
    • Possession
    • Exclusion
  • Assignment
  • Assignments
    • Must be done with Lessor’s consent
    • Lessee “tradesall interest in property to Assignee
    • Lessor “releases” original Lessee
    • Assignee become Lessee
    • Assignee/Lessee is now direct tenant of Lessor
  • Sub-Leasing
  • Subleasing
    • is a situation where the Lessee give a sub-tenant the right to use the property under the terms and conditions of The lease
    • The sub-lessee is the Lessee’s tenant and not the Lessors
    • The original Lessee is still responsible to Lessor
    • The Lessee “trades” less than the full lease (size, time, terms)
    • Can result in a “sandwich” lease (Lessor’s have caught on)
  • Types of Leases
  • Absolute/Bond Lease
  • Triple Net or NNN Lease
  • Double Net or NN Lease
  • Single Net or N Lease
  • Percentage Lease
  • Gross Lease
  • Modified Gross Lease
  • License
  • Absolute Net or Bond Lease
  • Lessee 100% responsible for property
    • Pays real property taxes directly
    • Pay property insurance directly
    • Maintains building at it’s sole expense
    • May even pay the mortgage directly
    • Responsible to restore or replace
    • Lessor 0% responsible
  • Triple Net Lease or NNN Lease
  • Lessee mostly responsible for property
    • Pays real property taxes directly
    • Pay property insurance directly
    • Maintains building at it’s sole expense
    • Lessor responsible for roof or structure…maybe both
  • Double Net Lease of NN Lease
  • Lessee responsible for property
    • Pays real property taxes directly…or
    • Pay property insurance directly…or
    • Maintains building at it’s sole expense…or
    • Lessor is responsible for one of the “big 3” expense items
  • Net Lease or N Lease
  • Lessee responsible for property
    • Pays real property taxes directly…or
    • Pay property insurance directly…or
    • Maintains building at it’s sole expense…or
    • Lessor is responsible for two of the “big 3” expense items
  • Gross Lease
  • Lessee pays Lessor a “gross” amount
  • Lessor is responsible for…
    • Real Property Taxes
    • Property Insurance
    • Maintenance
    • Cleaning/Janitorial
    • Utilities
    • Extreme example…GSA Lease (Lessor responsible for everything)
  • Modified Gross Lease
  • Lessee pays Lessor a “gross” amount…and pass through/CAM
  • Lessor is responsible for…
    • Real Property Taxes
    • Property Insurance
    • Maintenance
    • Cleaning/Janitorial
    • Utilities
  • Percentage Lease
    • Used predominantly in retail
    • Lessee pays base rent
    • Lessee pays a pass through or CAM
    • Lessee pays as additional base rent a percentage of sales
    • Lessor is responsible for Real Estate Taxes, Insurance
  • License
    • Temporary
    • Does not create “tenancy
    • Revocable at any time
    • For any lawful purpose
    • Lessor responsible for everything
  • Other types of Leases/Consideration
    • Industrial Gross (Same a modified gross just on Industrial)
    • Terminology varies from area to area and market to market
    • Lease paid by the square foot/year or square foot/month
    • Apartments are typically paid by the unit/month
    • Hotels and Motels do not create leases on rooms
    • Florida and Texas charge sales tax on leases and CAM
  • Defining the premises correctly
    • Address
    • Legal Description
    • Folio-Assessors Parcel Number
    • Floor Plan
    • Lease Summary

The Big 8 Investment Measures

  • GIM-Gross Income Multiplier
  • GRM-Gross Rent Multiplier
  • CAP-Direct Capitalization Rate
  • Cash-On-Cash Return
  • IRR-Internal Rate of Return
  • FMRR-Financial Management Rate of Return
  • PV-Present Value
  • NPV-Net Present Value
  • Gross Income Multiplier
  • Expresses the relationship between the annual gross income and the purchase price.
    • $1,000,000 Purchase Price ÷ $100,000 Gross Annual Income
    • Thus Gross Income Multiplier is 10
    • The property is worth 10X it’s gross annual
  • Benefits
    • It’s quick
    • Easy
    • Understandable
  • Gross Income Multiplier
  • Limitations
    • It’s nearly worthless
    • No taxes
    • No Expenses
    • No Debt service
    • Tell you nothing about longevity
    • No Cash Flow
    • Dangerously simple and short sighted
  • Gross Rent Multiplier
  • Expresses the relationship between the purchase price and the monthly rent.
    • $1,000,000 Purchase price ÷ $8,333 monthly rent
    • The Gross Rent Multiplier is 120
    • The property is worth 120 it’s Gross Monthly Rent
  • Benefits
    • It’s quick
    • Easy
    • Understandable
    • Gross Rent Multiplier
  • Limitations
    • It’s nearly worthless
    • No taxes
    • No Expenses
    • No Debt service
    • Tell you nothing about longevity
    • No Cash Flow
    • Dangerously simple and short sighted
  • Direct Capitalization Rate
  • Expresses the relationship between the purchase price and the Net Operating Income.
    • $100,000 NOI÷$1,000,000 Purchase Price
    • Equals .10 or 10% Cap Rate
  • Benefits
    • It’s quick
    • Easy
    • Understandable
    • Universal spouted by all experts
    • Direct Capitalization Rate
  • Cap Rate as an investment measure is Doo-Doo!
    • No consideration of taxes
    • No provisions for debt service
    • No duration-last day of the year
    • Illusory-what if tenant moves out?
    • What about concession-reduced rent
    • Should serve as a “snap-shot” only!
    • Cash on Cash Return
  • Measures the relationship between the Cash Throw Off and the Initial Investment.
    • a.k.a. Return on Equity
    • Initial Investment is down payment, points, fees, closing costs, inspections, survey, appraisal, all prepaid expenses required to acquire the property.
  • Benefits
    • It’s quick
    • Easy
    • Understandable
    • Considers Debt Service
  • Cash on Cash Return
  • Better than Cap Rate but not much!
    • No consideration for taxes
    • No consideration for stability of income
    • Valid for last day of year acquired…only!
    • Should serve as a “test” or “proof”
    • Internal Rate of Return
  • Internal Rate of Return measures the rate of return to the investor while the investment remains in the property.
  • Benefits
    • Calculated pre and post-tax
    • Considers debt service
    • Multiple years (Holding period)
    • Considers stability of income
    • Considers increases in rents and expenses
    • Offers a more comprehensive picture