Commercial Real Estate FAQ’s

LEASES:

1) What is a ‘Gross’ lease?
A gross lease is one where the rent factor is a gross number paid to the Landlord. The Landlord is responsible for paying the property taxes, insurance and maintenance of the property. The Tenant typically pays its own utilities under a gross lease, in addition to the stated rent.

2) What is a ‘Triple-Net’ lease?
A triple-net lease is one where the rent factor has two parts: The first is ‘base rent’, which is ‘net’ to the Landlord; the second is ‘Additional Rent’, by which the Tenant pays for its pro-rata share of (1) Property Taxes, (2) Insurance and (3) Maintenance for the property (hence, the term triple-net). The Tenant also pays for its own utility usage.

3) What are Triple-Net charges?
The annual per square foot Dollar amount of the total of: property taxes, insurance and maintenance of the property. The tenant(s) pay a pro-rata share of these costs monthly (typically) in addition to base rent, based on the percentage of space being leased at or in the property.

4) What are TI’s?
The term TI is an abbreviation for Tenant Improvements. TI’s are typically a negotiation point when trying to consummate a lease. Depending on the quality of the tenant and the length of the lease, a tenant may be able to negotiate substantial tenant improvements that are paid for by the Landlord. TI’s can be as simple as paint and carpet, or as complicated as a complete renovation of the space to be leased.

5) What is a ‘Vanilla Shell’?
A vanilla shell is the definition of a specific level of fit and finish within a lease space. Typically, it includes the following: walls that are sheet-rocked, taped, textured, and primered for paint; a store front with commercial-grade front and rear entry/exit doors; one finished unisex handicap-accessible bathroom; an acoustical lay-in ceiling with light fixtures; a heating an air conditioning system with thermostat; an electrical panel with 200-amp service; a bare floor ready for floor coverings; and broom-clean.

6) What is a ‘Sub-Lease’?
A sub-lease is one where an existing tenant (as sub-lessor) leases all or part of its leased premises to another party (the sub-lessee) for the remainder of its existing lease term (and may include extensions, if set forth in the original lease and exercised by the original tenant). If the original lease does not allow for a sub-lease, or is silent on that subject, a sub-lease may not be an available option. Typically, leases will specify whether or not sub-leases are allowable, and under what conditions they may be entered into (usually with the prior approval of the original landlord). With regard to leases, I recommend that one should consult an attorney for a review of the lease document, prior to execution.

SALES:

1) What is a ‘Cap Rate’?
A cap rate is an abbreviation of the term ‘capitalization rate’, which is a measure of return of the income stream (either actual or projected) of an investment property. The cap rate is designed to reflect the recapture of the original investment over the economic life of the improvement to give an investor an acceptable rate of return (yield) on his/her original investment, and to provide for the return on borrowed capital. A cap rate may be used to do a quick estimate of the value of an investment by simply dividing the Net Operating Income (either actual or projected) for the first year of operation of such property by the purchase price paid or payable to acquire the property. For example: If a certain investment property is producing, or projected to produce a net operating income (gross rents, less any vacancy, less any operating expenses, and prior to payment of any debt service) of $50,000 Dollars, and the purchase price is/was $500,000 Dollars, the cap rate (or capital rate of return in year 1) is 10%. However, a more thorough analysis, using discounted cash flows over a longer period of time, is the most accurate and effective way to use a cap rate to estimate value. Selection of an appropriate cap rate is influenced by the conditions under which the particular investment is being operated, as well as the availability of funds, prevailing interest rates, and so forth. Selecting an appropriate cap rate for an investment is best done by an experienced appraiser, or other qualified party, since a mere One Percent (1.0%) difference in a suggested cap rate could make a 12.50% difference in the value estimate. The cap rate measures the risk involved in an investment. Thus, the higher the risk (i.e., a restaurant) the higher the cap rate; the lower the risk (i.e., a post office) the lower the rate. While a cap rate analysis does the income, expenses and vacancies into account to derive the NOI (Net Operating Income), it does not take into account the effects of financing and taxes, as does an Internal Rate of Return (IRR) analysis.

2) What is an Internal Rate of Return (IRR)?
This is the rate of discount at which the present worth of future cash flows from an investment opportunity is exactly equal to the initial capital investment. It is also referred to as a discounted cash flow analysis. The advantage of using an internal rate of return (a sophisticated mathematical measurement), is that all types of investments (real property, stocks, bonds, business ventures, etc.) can be compared in an objective manner. One caveat however, is that not all investment opportunities have the same risk factors, and further, that the projected cash flows used to measure the investments are only as good as the information being utilized and the person preparing the projections.

3) What is the best type of property to invest in?
All real property investment types have similarities. However, there are a number of differences that need to be considered by an investor. For example: If an older couple wanted to retire and do a modest amount of travelling, they probably would not want to invest in a small multi-family apartment building. Unless one is buying an apartment complex that is large enough to support a licensed property manager, the day to day management requirements would not work well for the retirees. My point is that it really depends upon the goals and objectives of the individual investor, as well as the level of experience and sophistication of that investor. Using the earlier couple again, it might make more sense for them to buy a lower risk investment property that has a long-term triple-net lease in place, with little to no management required.

4) What is a Section 1031 Exchange?
a. This actually refers to a section in the tax code (IRC Section 1031), which allows a person to sell its investment property, and through a Qualified Intermediary or Exchange Facilitator, acquire a replacement property with the sale proceeds, with little or no capital gains tax liability. This is a complex transaction, which requires a specific level of skill and expertise. It is wise to utilize a competent Broker and also employ a competent, bonded third-party known as a Qualified Intermediary to affect a successful exchange. One has 45-days after the sale of the relinquished property to name its replacement property(ies), and a TOTAL of 180-days within which to complete the exchange by acquiring title to a replacement property.
b. What types of properties can I utilize in a Section 1031 Exchange? Any property held by a taxpayer for investment or income production may be utilized in an exchange. “Dealer’ properties, and personal residences are excluded.

5) What is a ‘non-recourse’ loan?
A non-recourse loan is one where the lender may only look to the subject property to satisfy the debt, in the event the borrower defaults in its payment of the debt. The borrower is not held personally liable for the debt. Most loans are recourse loans.

6) What is an Estoppel Certificate?
This is a form executed by tenants occupying a specific property under the terms of a lease. The form is used to confirm the validity of the existing leases, the tenant’s current status with regard to rent payments, and the basic terms of the lease (commencement date, termination, date, options available to the tenant, etc.). Typically, a buyer will set forth in a purchase and sale agreement that all of the tenants in the property being acquired shall sign an estoppel certificate. It is not uncommon for some tenants to balk at signing these forms, since it does not necessarily benefit them. Many leases, however, provide that the tenant must sign an estoppel certificate if they are asked to do so by the current landlord/seller.

General Questions:

1) Who does the Broker represent?
If a broker has a valid Listing Agreement with an owner of real property, he/she represents the Owner as his/her Agent. If a broker has a written agreement with a Buyer (a Buyer Broker Agreement), he/she represents the Buyer as the Buyer’s Agent. In the event the broker has a prior written agreement with both parties to a transaction, the broker is a Dual Agent. To make it a bit more complicated, a broker may simply have a Fee Agreement with a party, and no “Agency” relationship whatsoever, other than the general duties of a licensed Agent in the State of Washington. All of these Agency relationships is fully defined and explained in a pamphlet titled “The Law of Real Estate Agency”, which is published by the State of Washington. A copy of the pamphlet (PDF format) is found on this website and may be downloaded and printed out.

2) Who pays the Broker’s Fee?
Generally speaking, it is the seller of property, who typically enters into a Listing Agreement with a broker to market and sell the property. However, the fee may be paid by a buyer or a tenant who has hired a broker to represent them. In some instances, the fee is split between the buyer and seller.

3) Why should I list my property with a Broker?
The benefits of using a broker to represent your interests in a real property transaction are many. They include: the ability to market the property effectively; the ability to disseminate information over a variety of media platforms; an intimate knowledge of what buyers are looking for; a constant supply of potential buyers who contact the brokerage for services; the ability to secure viable buyers and pre-qualify them; the ability to negotiate with buyers and overcome objections in an objective manner; and the knowledge and ability to get the sale closed.

4) Why should I use a Broker when buying property?
They include: specific market knowledge regarding the property type being sought; knowledge regarding the documentation and processes required in a sale; knowledge of financing options available; the ability to analyze different investment options; the ability to search a variety of databases quickly and efficiently for prospective properties that may meet your criteria; and the ability to negotiate a purchase agreement to your best advantage.