“Cap Rates” (or Capitalization Rate) is a way of measuring the overall value of income generating real estate. It is essentially the NOI divided by the value of the property or put another way, the NOI divided by the cap rate equals the value of the property. Cap rates are typically expressed as a percentage. Everything else being equal, the lower the cap rate, the higher the value (or price) of the property.
A discount rate is used as a way of converting future cash flows to the present time. The discount rate (expressed as a %) is the rate of return that you would expect to receive on other investments.
With all the vacancies is real estate in a depression? [back to top]
For certain types of properties, values have fallen due to high vacancies. However while the overall vacancy rate for a specific market is an important measure, in many cases individual properties or property types have more favorable market conditions and values are strong in spite of high vacancies.
What is the difference between a “net” lease and a “gross” lease? [back to top]
Under a net lease, the tenant pays for its share of operating expenses, insurance and property taxes in addition to its rent. Under a gross lease the costs are included with the rent. From an evaluation perspective, all the costs associated with the rent should still be evaluated. For instance, everything else being equal, a property that leases for $10/SF/Year (Net) with expenses of $8/SF may not be as attractive as a property with a rental rate of $17/SF (Gross). There are also variations on both Net leases and Gross leases, such as a modified gross in which a tenant pays a gross rent, but also pays for increases in expenses. In some Net leases, the Landlord may include the real estate taxes with the rent, but the tenant pays for the other costs.
A competent broker adds value to the transaction. In addition to helping you with a specific real estate transaction, brokers frequently have access to other relevant information that could be useful. Ultimately, the decision as to whether you want or need a broker is a personal choice.
The DSC or Debt Service Coverage is the amount by which available cash flows exceeds the mortgage payment. Typically lenders like to see DSC’s of 1.20 to be comfortable with making a real estate loan, i.e., the amount of funds available for debt service is 20% more than the loan payments.
Does real estate always appreciate in value? [back to top]
While properly managed real estate usually appreciates over time, there is no guarantee that values will always appreciate. There are several factors that will affect the value of real estate.
The term IRR means Internal Rate of Return. The IRR measures the annual rate of return on a real estate investment taking in such factors as upfront costs, incremental cash flows, and future disposition proceeds.
Are there any tax advantages from holding real estate? [back to top]
There are a variety of tax advantages associated with real estate investments, specifically depreciation expenses, passive losses (for those investors that qualify), capital gains tax treatment, and the ability to defer taxes. Investors should be cautious on investing in real estate just for tax advantages. The fundamental factors affecting a real estate investment should always be considered. Finally investors should always consult their tax advisor before considering tax matters associated with a particular real estate investment.
How are real estate loans typically structured? [back to top]
There is no one standard real estate loan. Depending on the borrower’s preference, lender policies, and other factors loans can be for a relatively short term interest only loans with a “balloon,” payment, long term with fixed rates, medium term (3 – 7 years), etc. In most cases, the loans will cover only a portion of the costs to acquire the property, with the buyer coming up with “equity” for the difference. Frequently loans may be for a 20 – 25 year period, a fixed interest rate for 3 – 5 years, but usually include balloon payment or a re-pricing (the interest rate can be adjusted) after 3 – 5 years. Some loans can be re-priced on a monthly basis.
Vacancy rates will vary depending on the conditions of a specific market. In a soft market, or if there are unique features specific to a particular piece of real estate that could have a negative impact on the property’ s occupancy, it may be appropriate to use a higher vacancy rate. It is usually a good idea to factor in some vacancy in your projections. For example if you own a six flat and have one year leases, and you have only 2 weeks down time between lease roll-overs, you would still end up with an 8% vacancy factor.
Investors can manage their own real estate, and in some cases, that may be appropriate. There are many issues from rent collection, property maintenance, building codes, budgets, tenant issues, etc. that may need to be managed. In many cases property management can be a time consuming process and depending on the property, it may be better to have a professional Property Manager to manage the property.
Property Management encompasses the activities needed to manage real estate. Property management usually includes all or some of the following activities: billings, collections, escalations, accounts payable, administering service contracts, building maintenance, operating budgets, reconciliations, tenant issues, etc. Frequently leasing services are also included in the scope of property management.
Asset management focuses on long term issues affecting of real estate and less on the day to day issues (which relate more to property management). Asset management includes investment analyses, operating proformas, acquisition/disposition strategies, and long term financing issues.
Real estate transactions can be quite complicated and an attorney is a useful resource and should in most cases, be retained. In selecting an attorney, it is imperative to make sure that the attorney understands your issues and your type of real estate.
A non-recourse loan is one in which the lender’s only recourse is the property against which the loan was made. The borrower’s liability is limited to the equity in the property. Typically these loans require a significant amount of equity in the transaction.
A loan guarantee is a loan that is guaranteed to be repaid, usually by the borrower, such that the lender has recourse to the borrower’s/guarantor’s other assets as well as the real estate against which the loan was placed. These loans frequently have lower interest rates than non-recourse loans, but the guarantor’s other assets remain at potential risk.
There is no one right answer as to what property is the correct one to purchase. For individual investors, it is a matter of personal preference. Industrial properties or single tenant buildings tend to be less management intensive than office buildings or residential apartments. Depending on the lease terms, there may be a good potential for upside (with percentage rents) with retail properties, but retail properties are also more cyclical than office buildings.
How long does it take to buy a building? [back to top]
The time period for purchasing a building can usually be completed within a relatively short period, typically 45 – 120 days. Factors that would affect the timing include financing, unexpected issues from due diligence, and how long it takes to get the appraisal.
How long does it take to construct a building? [back to top]
The time it takes to construct a building will vary depending on the size of the building, the condition of the land, weather conditions, local government issues, financing issues, etc. For a smaller building, if the issues are resolved the actual construction could be about 4 – 6 months. However the overall development period will in most cases be considerably longer.
The decision as to whether to lease or buy is a complicated one that has to consider several factors. Factors such as available cash, investment preference, business plans, growth, interest rates, cost of capital, which properties are available, etc. need to be considered.
When should I start looking for space? [back to top]
There is no right answer as to when a user should start looking for space to lease or even to purchase. Users should allow enough time for property tours, evaluation of proposals, construction, financing, telecommunications, etc. to be completed. More often than not, the mistake is not allowing for enough time to plan a move.
If a tenant is satisfied with their current location, a renewal may be appropriate. However if the proposed renewal rates are too expensive, the tenant’s business needs have changed, etc., looking at other spaces may be more appropriate. In many cases, tenants do not want the “market” to know that they are considering a move, the engaging a broker may be even more appropriate. Tenants have to factor the costs of relocation into their analyses and landlords should factor the costs of re-leasing the space if the tenant leaves into their analyses.
Can I cancel my lease before the expiration date? [back to top]
Unless the lease contains specific early termination terms, most tenants have to sub-lease their space. Negotiated buy-outs and early releases are also possible. Bankruptcies, defaults, and other factors also may result in the ability to terminate a lease prior to the actual expiration date.
How do I get out of my lease if my business decreases or expands? [back to top]
Unless there are specific options for early termination in the lease, it is usually through negotiations with the landlord. Many times, if a tenant is expanding and the landlord has additional space available, the landlord is more likely to allow for a restructuring of the leased premises. Subleasing is also a possibility.
Rental rates are determined by a variety of factors, mostly negotiations between the landlord and the tenant. Factors such as market vacancies, rates in other nearby buildings, build-out costs, length of lease term, credit, timing, and other issues may affect the final rental rates.
Does the Owner’s/Landlord’s insurance cover the tenant’s business? [back to top]
In most cases, the landlord’s insurance will not cover the tenant’s equipment or business.
How much and what kind of insurance should I have? [back to top]
Your actual insurance needs will be for the most part determined by your own preferences, risk tolerance, and contractual obligations. In most leases, specific insurance amounts and coverages are described in sufficient detail.
“Due diligence” is the process by which the underlying assumptions of a proposed transaction are investigated and/or verified. For example if you want to buy a property and you are told that current zoning allows for your proposed use. You may sign a Purchase agreement, but you may include a clause that states that you have the right to go to the local government officials to make sure that you can use the property the way that you planned. If the local officials inform you that your use is not permitted, in most cases you would be able to terminate the contract and get your earnest money returned to you. The due diligence period is usually relatively short and starts fairly quickly after the formal agreement has been signed.
NOI means Net Operating Income. The NOI for a particular property is the revenues less the operating expenses (insurance, maintenance, real estate taxes, etc.). Capital expenditures are usually not included in the NOI calculation, but are reflected in the cash flow statements.
An LOI (Letter of Intent) is a simple letter that is usually non-binding that spells out the basic business terms of a transaction. An LOI is usually prepared after a series of negotiations and the parties have reached a basic framework of the proposed transaction. It is from the points included o the LOI that the formal contracts are written.
Can I move in my space before the lease starts? [back to top]
Frequently, landlords allow tenant’s access to their space before the lease starts to install telephone and computer systems, or to do their own work. But if the tenant is going to interfere with the landlord’s work, the landlord may restrict access. Also, landlords usually require tenants to sign waivers and provide insurance prior to letting a tenant in before the lease starts.
Either the landlord or tenant/user will build-out the space. Even if the tenant does the build-out, the landlord usually has a right to review and approve the plans and in many cases, even the contractors. In many cases the landlord provides some of the improvements and tenants pay/provide for “extras.” Depending on the size and type of building, market conditions, length of lease term, etc., the landlord’s build-out plans may be adjusted.