Chapter 16: Commercial & Investment Properties

gross lease

the landlord pays all expenses. These include property taxes, insurance and maintenance.

the residential lease

a common example of a gross lease.

net lease

the tenant pays some or all of the expenses.

triple net lease

the tenant pays all of the expenses in addition to the rent.

A net lease, in particular a triple net lease

commonly used by commercial tenants.

example of triple net lease

A large company may have this type of lease and rent an entire office building.

Percentage Lease

A lease of property in which the rent is based upon the percentage of the volume of sales made upon the leased premises, usually provides for minimal rent.

example of A percentage lease

typically used with retail tenants.

a ground lease

a long-term lease of unimproved land, usually for construction purposes.

ground lease example

a lessee may be given a 99-year _____ lease for a large vacant property. The lessee will build a large multi-family building on the property.

At the end of the 99-year lease, the lessor (the original land owner) will take back the land and any improvements on the land (including the multi-family building).

ground lease

also known as a land lease

loft lease

for the rental of floor space this is not generally divided into rooms.

loft lease

typically for an open, unfinished space.

graduated lease

a lease in which the rent changes from period to period over the lease term.

graduated lease

The lease contract specifies the change in rental amount, which is usually an increase in stair-step fashion.

escalation clause

allows landlords to raise rents during the term of the lease.

Lease escalation clauses

call for the increased costs to the tenant for different reasons at specified times during the lease term. These clauses protect the property owner against increases during the lease term.

use clause

defines how the tenant can and cannot use the space.

Usable square footage

the area contained within a building that is actually occupied by a commercial tenant.

what does usable space typically not include

elevators, stairs, mechanical spaces, etc..

Rentable square footage

the total area of a space, some of which cannot be used.

Rentable square footage

equals the entire space, including the usable square footage and the tenant’s pro rata share of the building’s common areas, such as the lobby, hallways, and restrooms.

The difference between the rentable and usable area in a commercial space is known as

the loss factor

Pro Forma

an accounting statement that forecasts income and expenses for a period of time, typically five or more years.

Pro forma statement

typically used by investors to estimate their rate of return for a particular property.

Leverage

the use of borrowed capital (mortgage) to increase the potential return of an investment.

Leverage

known as “other people’s money”.

Debt

what the investor owes.

Equity

how much cash the investor has in the property.

Example of Debt to Equity Ratio

If a property is valued at $1,000,000, and the total debt is $600,000, then the debt ratio of 60%.

The equity ratio would be 40% ($1,000,000 - $600,000 = $400,000, which is 40% of $1,000,000).

Net Operating Income (NOI)

equal to the gross income from a building minus operating expenses.

Net Operating Income (NOI)

essentially the cash flow from a property before paying any debt service (mortgage payment) or taxes.

Capitalization Rate

the annual return that an investor expects to receive from a commercial property.

The formula for Capitalization Rate

Net Operating Income / Value = Capitalization Rate

Example of Capitalization Rate

If a property sold for $1,200,000, and the net operating income is $60,000, what is the capitalization rate for the property?

$60,000 / $1,200,000 = 0.05 or 5%

The Cap Rate equals 5%

Return on Investment (ROI)

a percentage return on money invested in a property by an investor.

Cash-on-Cash Return (COC)

usually calculated on a yearly basis, meaning you must multiply the monthly cash flow by 12 and divide it by the down payment.

Formula for Return on Investment (ROI) / Cash-on-Cash Return (COC)

Cash Flow (on a yearly basis) / Down Payment.

Liquidity

Real estate is considered an illiquid asset because it cannot quickly or easily be sold.

Time value of money

the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity.

Time value of money

It is a process that calculates the value of an asset in the past, present, or future.

Time value of money

It is based on the idea that the original investment or principal increases in value over a certain time.

Industrial investment properties include the following:

– Heavy manufacturing

– Light manufacturing

– Multi-tenant

– Owner Occupied

– Self Storage

– Special Purpose

– Warehouse / Distribution