In commercial real estate, whether it be for a retail, office or industrial lease, the terms “triple net” and “gross net” come up often.
Learning the difference between the two could make all the difference in reaching an agreement that is mutually beneficial for the tenant and property manager.
Often referred to as a net-net-net (NNN) lease, the triple net is a common structure for commercial leasing these days. With this lease structure, tenants agree to pay, in addition to the base rent, a cost covering Common Area Maintenance (CAM), real estate taxes and insurance as well as other property expenses.
Essentially, charges included under a triple net lease often cover everything except for the floor, foundation and roof of the property. As a landlord, you’re not burdened with direct expenses that result from owning a property.
Let’s look at an example. If you take a small retail building with three tenants, each taking up a third of the space and you have expenses that equate to $12,000 per year, or $1,000 per month, tenants will pay $333, or 33 percent, each month on top of base rent.
Sophisticated tenants often resort to capping their triple net lease, which is often quoted annually by the property manager. After about 90 days pass in the new year, tenants typically reconcile expenses from the previous year and set a new budget for the next.
I’ll note that this is not always the case. Hybrid forms of the triple net and gross lease exist. A double net lease acts as a prime example. With a double net, the tenant could be paying all expenses with the exception of property taxes, for example. It’s that simple.
Conversely, a gross lease requires the owner to pay all variable expenses associated with the property while the tenant agrees to pay a singular rate through the year. In this scenario, fluctuations in taxes or insurance, for example, have no impact on the tenant.
Surely, the safety of knowing exactly what is required each month through the contract provides a sense of comfort for tenants, but for landlords, it gets a bit more complicated when the property is in need of repair or tax or insurance costs creep up.
In this scenario, landlords can consider the cost of property when determining rental cost. With this, monthly rental fees can cover a variety of costs associated with maintaining the property.
These days, real estate investors are increasingly looking to multi-family properties to generate high rates of return. With demand for apartments and similar units on the rise, learning to weather fast market conditions is an imperative to getting the best value for your property.
With years of experience as a commercial broker, I’ve developed three key strategies for maximizing profit when selling a property in a tight market.
Prior to selling a property, or even listing it, you want to be informed.
Prepare records from the current year to date, referencing profit, loss, net income and capital expenses. Remove irregularities, such as infrequent need-based repairs, to form a standard income and expense list.
Records should prove that you’ve been able to maintain a steady growth of income — if that’s not the case, you’ll need to be prepared to clearly tell potential buyers why.
Once this step is complete and your offering memorandum and supplemental literature is prepared, it’s time to list the property.
Talk with tenants and get ready to host an open house after the listing has been out for one week. Let the listing grow interest and don’t take the first, or even the second offer.
I recommend scheduling just one open house during a two-hour time slot. Of course if it’s a larger property, space it out between two days, if necessary.
The value in hosting one open house is immeasurable, in my experience. A large crowd indicates to everyone in attendance that the property has sparked widespread interest and creates a sense of urgency amongst buyers. It’s also important to keep in mind that one open house, as opposed to many, reduces impact on existing tenants.
Keep in mind that this is the prime time to reference details you’ve prepared about the property prior to listing it on the market. If potential buyers have any remaining questions, be sure to get back to them within two to three days with an answer.
Five days after the open house, call potential buyers for an offer. Details about the property are still fresh in their mind and they’ve had some time to think about the investment.
If you’re doing your job right, you should expect to generate between 5 and 15 offers. After that, you’ll just need to make a choice and move forward with the deal.
By Troy Muljat, Certified Commercial Appraiser & Broker
The process of selling commercial real estate can be the easy part. Difficulty comes knocking in the form of due diligence, the sometimes long investigative process done before the purchaser is legally bound to acquire the commercial property of interest. Choosing the right due diligence steps not only helps with the discovery of issues your purchasing client could face, but builds loyalty and eliminates extra hours of research.
As a commercial broker and appraiser with over 25 years of experience in the industry, I have helped clients with their due diligence for a variety of commercial property types, sizes, and budgets. Here is my process for a successful due diligence that saves time, identifies the concerns, and has clients coming back to work with you again. I used the steps below to help me close an $8 million deal and other seven-figure properties since.
1. Annual Profit & Losses
Analyze the past three years and current year-to-date financials using a spreadsheet to categorize the percent changes between each year. Depending on the type of property, you will be able to catch irregular expenses by analyzing line by line. Remember to look at the cost of insurance each year, taxes, and utilities.
2. Monthly Cash Flow Statements
Study the month-by-month cash flow statements for the past three years. This will allow you to know which tenants are paying on time and who has a reputation of paying late. These items do not show up on annual financials.
3. Study the Rent Roll
Make sure you look at multiple years of the property’s historic rent roll. Look for significant changes or rental modifications. This is a good cross-check for the lease analysis.
4. Analyze the Leases
This task can take the most amount of time. In many cases, items in the lease have been forgotten, like a lease cancellation clause with 90-day notice. These clauses can substantially impact the value of the property. If lease abstracts are provided, then verify each item. If they are not, create your own one-page lease abstract for each lease. Consider having your client hire an attorney to review leases and provide your client with the summary of the pertinent issues. This will also shift the responsibility to a third party.
5. Contact the City/Fire Department
Countless times, tenant improvements are constructed without a final occupancy permit or even a permit at all! Check to see if anything has been “red tagged” by the city. Verify all spaces and units have received a final occupancy permit. It’s better to find out that you are missing permits and $5,000 worth of work needs to be completed before your client buys the property.
6. Interview the Tenants
You can discover a lot about a property and any unknown issues by interviewing the tenants. Try to do this without the current owner or property management company with you in order to get information about any conflicts or issues the tenants have had with them. Ask the tenants the following questions:
7. Hire an Inspector/Contractor
I typically will have the client hire a local contractor (I don’t like typical “home inspectors”) to “inspect” the property. You want to rely on a professional that knows construction and can give you an unbiased assessment of the current condition of the property. I have yet to see a property without some hidden defects – even new properties.
8. Review All Capital Expenditures for Past 5 Years
Capital expenditures will give you insight into the work the current or previous owners have done to the commercial property. Analyzing these expenditures will help you determine if the owner has put any money into the property, if he or she chose “cheap” solutions to problems, or if problems were fixed correctly as the issues arised. Ask to see actual receipts and bids for all of the work the owner did and talk to the companies who completed the work. Then contact the companies who bid on the job but did not do the work. Ask them why their bid wasn’t chosen.
9. Complete a Market Survey
Make sure you have completed a detailed market survey of the current rental income as compared to the competition. Is the property above market? Why? If the leases are triple net, how do they compare to the completion? Make sure you look at access, exposure, and traffic counts to the comparables. Why will the subject property be competitive in the future? What new product is coming online to compete with the subject
10. Everything Else
Other items to consider reviewing: Tax returns, balance sheets, title policies, insurance policies, current appraisal, loan documents, copies of all utility bills, current service contracts, deeds, current environmental reports, wetland reports, surveys, bank statements, litigation history, and mortgage estoppel letters.
At the end of the day, the goal is to verify all the information you receive from the seller. Make a request list up front in the purchase and sale agreement. Having a complete list of these items and letting your client know how you handle these things will give you a competitive advantage in representing buyers and sellers of commercial property. Some commercial brokers have even charged a fee to clients that they do not represent to do the due diligence for them. Due diligence can be difficult, long, and frustrating. But, when done right, you will help represent your clients well, eliminate problems quickly in the process, and gain a unique competitive advantage in the market.