We know that buying or leasing commercial real estate can be confusing but Jeff Edberg, a commercial real estate broker in Iowa City, and his team have compiled a list of frequently asked questions and answered them for you to help you become a more informed buyer or lessee. If you don’t see you your question below please contact us and we will be happy to answer it.
Fundamentally, it is not. Real estate leasing is real estate leasing, and real estate sales is real estate sales. The law does not provide for a special commercial real estate license, nor separate legal qualification for commercial brokers. There are many specialized aspects of commercial real estate as there are many specialized aspects of residential real estate. This specialization defines the difference. A commercial broker should be familiar with valuation, tax treatment, aspects of leasing, management, trends in the Iowa City, Coralville and North Liberty areas and the available inventory of commercial real estate for sale or lease. There are differences in financing to consider as well.
In the Iowa City, Coralville and North Liberty areas, most properties for sale or lease are listed by brokers in the Iowa City Area Multiple Listing Service, a service that area brokers subscribe to. If a broker lists a property for sale or lease, it must go into this service within 24 hours! Any agent can sell or lease any property in that listing service so pick your agent and let them do the foot work for you and help guide you through your transaction.
Real estate brokers are not required in a transaction, but they do provide a valuable service. They are a professional group with informational resources and experience to help you make the right decision in your transaction. Sellers / landlords pay brokers on properties listed in the multiple listing service, so there are no “hidden costs” for buyers / tenants in a transaction.
Commercial brokers provide a valuable service with property selection, analysis and transaction management. Most properties are listed for lease or sale in the local Iowa City Area multiple listing service. The property owner that has listed their property pays a fee to the listing broker who shares that fee with the selling / leasing broker. If the property is not listed for sale or lease, savvy clients hire a real estate broker either on a consulting, or performance contract to help them with their assignment. Sales and lease transaction normally involve brokers, so if a seller / landlord is not paying a brokerage fee, buyers / tenants are free to request that he broker’s fee is included in the transaction pricing.
Sometimes. Brokers can find and analyze properties, but another set of qualified eyes are often helpful with high liability transactions. Leases are also typically prepared by the owner’s lawyer, and not the real estate broker, for review by the tenant’s lawyer. The Iowa Supreme Court issued a ruling that brokers preparing leases “may constitute the unauthorized practice of law”. In sale transactions, lawyers are often involved in document review and title review. Brokers often use lawyers to review their own transactions and recommend that clients do the same!
The type of lease usually referrers to segregating the components of the lease payment. Customs vary, but in the Iowa City, Coralville and North Liberty area, there are absolute NNN (tripple net) leases, NNN (tripple net) leases, N (single net) leases, gross leases and full service leases. With an absolute NNN lease, the tenant pays the landlord a rent amount, plus the property taxes and insurance on the building and any exterior maintenance required. The tenant also pays for any repairs or mechanical replacements to the building including roof replacement and HVAC (heating, ventilation and air conditioning). A NNN lease provides that the tenant pay the rent plus a pro-rata share of the real estate taxes, building insurance and common area maintenance (CAM). A N lease would provide that the tenant pay the rent plus the prorated real estate taxes for the space, and a gross lease rolls the NNN or pass through expenses in with the rent and quotes just one figure. A full service lease would be a gross lease with janitorial expenses and utility expenses included. Be aware that the lease agreement, which must be in writing if it is for longer that one year, says what is says, and what it says is binding on both parties.
NNN stands for net, net, net. These pass through expenses of leasing are portions tenants or lessees pay in addition to the lease fee, or rent to the landlord or lessor. The NNN fees are property taxes, property insurance and common area maintenance. For example, the lease rate may be quoted as $15 NNN. That means the rent is $15 per foot per year plus the NNN. The taxes may be $5.00 per foot per year, the insurance may be $0.35 per foot per year and the CAM may be $2.50 per foot per year. If all that were the case, the total the tenant would pay per foot per year is $22.85 per foot per year. For a 2,500 foot shop bay the total annual rent including NNN would be $57,125 and the total monthly rent would be $4,760.42. Note that NNN are actual expenses that may increase over time, or change with the amount of snow that falls in the case of CAM.
CAM stands for common area maintenance. People often refer to all NNN fees as “CAMs”, but that is inaccurate. Common area maintenance are a set of costs for landscape maintenance, snow removal, parking lot maintenance, exterior building and common area (such as common bathrooms, lobbies and hallways) maintenance and a fee for managing the building. Capital items such as parking lot replacements, or roof replacements are not CAM items.
Commercial leases often cover longer periods of time than residential leases. I have written commercial leases for as long as 20 years. Over time real estate value has historically gone up. Therefor the value of the lease should increase accordingly. Tenants and landlords often agree to include an escalation clause stating parameters for the base rent amount to increase over time. Typically the CPI (consumer price index) is used for a guide to increase rent annually by the increase in the CPI index.
If you call an Iowa City area broker and ask what the rent is on a commercial building, you are likely to receive an answer like “the rent is $14.00 NNN) which doesn’t seem like a very helpful answer. That answer does not tell you what you will have to pay monthly for the space but it is very helpful in comparing that space with others of different size and condition. You can even use the lease rate per year to describe the condition of a lease space. If you say a space is $8.00 gross space compared to another space that is a $19.00 NNN space, you are indicating that the latter is newer and in better condition than the former. It is irritating, however that given the lease rate one still needs to compute the gross monthly rent of the space. Brokers will often do the math and quote both the comparative rate along with the actual rent a tenant will be required to pay.
Basically a tenant (lessee) is paying a landlord (lessor) for the use of their property. This would be a good spot to discuss the “bundle of rights” associated with any real estate, but I think we’ll skip it. A residential lease is typically a gross lease for a term of from 30 days to one year. A commercial lease typically has more definition in the lease agreement and typically is for a longer period of time. In the final analysis, the agreement between the parties is what is contained in the lease and can be anything the parties are willing to agree on.
Selling a business is specialized and a little different than selling a building. A business is a non-tangible asset with some tangible personal property attached. A business is listed in the same manner as a lease or a building listing, but is based on the profitability and personal property value associated with that business. Rarely will a “for sale” sign be placed on the business as that will often discourage customers and be counterproductive in the quest to sell. Consult with a business specialist to determine value.
One of the most important functions of a commercial real estate broker in the Iowa City, Coralville and North Liberty area is the valuation of a commercial or investment property. There are three basic methods of valuation and variations of those methods. The best method is the comparison method. If there are several similar properties that sold at a particular price, it is a safe assumption that the subject property would also sell at that price. If there are options, why would a buyer pay more and why would a seller accept less? Unfortunately, there are often few comparable properties in a relatively small market like the Iowa City, Coralville and North Liberty market, so the next valuation method is the capitalized approach. With this method the net operating income is examined and placed in a valuation formula to establish a final value. One needs to assume the income and expense information is accurate and at current market levels to have accurate value conclusions. The third valuation method is a cost approach to value. This method is fairly easy to determine given the broker has access to good cost data and land sales comparable data. A good real estate practitioner will use a combination of these methods and possibly all three to establish a market value.
When leasing a commercial suite, the tenant is simply leasing the shell space from the landlord. If it has been used before (second generation space) there may, or may not be some usable interior improvements, but it is the responsibility of the tenant to build out and pay for the interior of the space. Those interior improvements incidentally, become the property of the landlord when the tenant vacates unless the lease specifically has language to the contrary. If marketing conditions dictate, tenants may be able to negotiate some assistance from landlords to pay for interior improvements.
BOMA, or the Building Owner’s and Manager’s Association has published guidelines for many aspects of commercial leasing including the definition of how much of the building footage the tenant has to pay for. This is known as the BOMA standard. In many markets the usable space is the portion of the building that the tenant actually occupies. The leasable space is a greater area including hallways, bathrooms and common areas that the tenant does not solely occupy. The rentable space is often 15% to 25% greater than the usable space. The practice in the Iowa City, Coralville and North Liberty market is to ignore this BOMA standard and set a lease rate for only the usable space.
This is a good question and one that actually has a numeric answer. Some real estate users would simply rather own a building than lease it. There are good reasons to own, but there are good reasons to lease as well. Commercial brokers can do an own or lease analysis and quantify this answer based on the cash invested, the user’s tax ramifications and other financial criteria.
There are several benefits to buying investment real estate. A friend once told me that “Real estate is not something you wait to buy, you buy and wait!” The idea of buying investment real estate is that you will have an overall return from that property in the form of cash flow, depreciation and appreciation that exceeds the return from other investments. Commercial brokers can demonstrate the actual return for an investor’s individual situation.
CCIM stands for Certified Commercial Investment Member. This is a designation, or an industry advanced commercial degree earned by a meaningful and in depth course of study with testing at every course and a comprehensive test at the end. Successful candidates also are required to have a qualifying volume of commercial transactions. There are 9,500 CCIM designees in the world and it is seen as a standard of excellence within the real estate and banking industry.
SIOR stands for the Society of Industrial and Office Realtors. Like CCIM, this is a designation representing an advance course of study available to Realtors. SIOR is an invitation only society with strict educational and experience requirements. There are just 3,000 designees in the world.
Tenants want to make sure they are paying the right amount for leasing property. Just like purchase formulas there are different formulas for determining this lease rate value. The best method is the comparison method. There is enough lease data in the Iowa City, Coralville and North Liberty areas to establish some meaningful comparison numbers. If the building value is known, one can also “work backwards” and establish a capitalization rate for the building and deduce the proper lease rate. In Johnson County, Iowa area lease rates can range from $8.00 per foot per year, gross, to $26.00 per foot NNN for straight commercial space. The variation depends on the intended use, the location and the condition of the property among other variables.
Experience, integrity, volume and credentials! The commercial real estate field is specialized and dynamic. Find a broker that has lots of experience and has faced challenges like the ones you face. You will need to trust the opinions and recommendations of your broker so find someone with integrity. Volume of transactions, or market share is not a direct estimate of competency, but it does mean lots of other people have used and trust this broker. Real estate commercial designations such as the CCIM and SIOR designations indicate that the broker has taken specialized training and has been approved by an independent third party.
There are three basic types of commercial real estate leases. These leases are organized around two rent calculation methods: “net” and “gross.” The gross lease typically means a tenant pays one lump sum for rent, from which the landlord pays his expenses. The net lease has a smaller base rent, with other expenses paid for by the tenant. The modified gross lease is a happy marriage between the two. While terms vary widely building by building, this basic overview will help businesses shop for the best deal possible.
In a gross lease, the rent is all-inclusive. The landlord pays all or most expenses associated with the property, including taxes, insurance, and maintenance out of the rents received from tenants. Utilities and janitorial services are included within one easy, tenant-friendly rent payment.
When negotiating a gross lease, the tenant should ask which janitorial services are provided, and how often they are offered. Excess utility consumption beyond building standards is sometimes charged back to tenant; so if the tenant is a big consumer of electricity, this point should be clarified in the lease as well. The tenant pays his own property insurance and taxes.
A benefit of this type of lease is that it is supremely easy for the tenant, which can forecast expenses without worrying about an unexpected lobby maintenance charge, for example. The landlord assumes all responsibility for the building, while tenants concentrate on growing their businesses.
In a net lease, the landlord charges a lower base rent for the commercial space, plus some or all of “usual costs,” which are expenses associated with operations, maintenance, and use that the landlord pays. These can include real estate taxes; property insurance; and common area maintenance items (CAMS), which include janitorial services, property management fees, sewer, water, trash collection, landscaping, parking lots, fire sprinklers, and any commonly shared area or service.
There are several types of net leases:
In this lease, the tenant pays base rent plus a pro-rata share of the building’s property tax (meaning a portion of the total bill based on the proportion of total building space leased by the tenant); the landlord covers all other building expenses. The tenant also pays utilities and janitorial services.
The tenant is responsible for base rent plus a pro-rata share of property taxes and property insurance. The landlord covers expenses for structural repairs and common area maintenance. The tenant once again is responsible for their own janitorial and utility expenses.
This is the most popular type of net lease for commercial freestanding buildings and retail space. It is known as the net net net lease, or NNN lease, where the tenant pays all or part of the three “nets”–property taxes, insurance, and CAMS–on top of a base monthly rent. Common area utilities and operating expenses are usually lumped in as well; for example, the cost for staffing a lobby attendant would be part of the NNN fees. Of course, tenants also pay the costs of their own occupancy, including janitorial services, utilities, and their own insurance and taxes.
Landlords typically estimate expenses and charge tenants a portion of these expenses based on their proportionate, or pro-rata share. A tenant who leases 1,000 square feet of a 10,000 square foot building would be expected to pay 10% of the building’s taxes, insurance, and CAMS, for example.
Triple net leases tend to be more landlord-friendly, and tenants should carefully review NNN fees and negotiate caps on the amounts they can be raised annually. An NNN lease can also fluctuate from month to month and year to year as operating expenses increase or decrease, making the company’s expense forecasting tricky and sometimes frustrating.
There are tenant benefits in the NNN leases, however. Transparency is an excellent perk, since tenants can see business operating expenses in relation to what they are charged. Cost savings in operating expenses are passed on to the tenant rather to the landlord. In addition, the monthly rent in a NNN lease is potentially lower than in a gross lease, as tenants have a higher level of responsibility for the building.
This is a less common option that is more rigid and binding than the NNN lease, where tenants carry every imaginable real estate risk, for example, being responsible for construction expenses to rebuild after a catastrophe, or for continuing to pay rent even after the building has been condemned. Aptly called the “hell-or-high-water lease,” tenants have ultimate responsibility for the building no matter what.
As the gross lease is more tenant-friendly, and the net lease tends to be more landlord-friendly, there exists a compromise lease for the convenience of both parties. The modified gross lease (sometimes called the modified net lease) is similar to a gross lease in that the rent is requested in one lump sum, which can include any or all of the “nets”–property taxes, insurance, and CAMS. Utilities and janitorial services are typically excluded from the rent, and covered by the tenant. Tenants and landlords negotiate which “nets” are included in the base rental rate.
The modified gross lease is more popular with tenants, because its flexibility translates into an easier agreement between tenant and landlord. Unlike the NNN lease, if insurance, taxes or CAM charges increase, the lease rate would not change. Of course, if those expenses decrease, the cost savings is passed on to the landlord. As janitorial service and electricity are not covered, tenants can better control how much they spend compared to a gross lease.
When evaluating options for office space lease, it is important to compare the different lease options with an eye toward all expenses, and not just the base rental rates. NNN base rental rates tend to be much lower, with additional expenses added for the real monthly rate.
Market forces will tend to even out rental rates for comparable properties, regardless of type of lease. Tenants should expect to pay roughly the same amount with an NNN, modified gross, or full service lease for similar quality office spaces in the same area.
The most important rule of commercial leases is for tenants to read their leases carefully, and clarify exactly what expenses they have responsibility for. Circumstances under which additional charges will occur should be identified and caps negotiated.
Reposted from: Mike Cobb, Senior Vice President at Colliers International