Commercial Real Estate Investing From A-Z

By Steffany BoldriniBusiness Education Investing How To

Commercial Real Estate Investing From A-Z episodes

August 08, 2019 How to Prepare for a Possible Recession and How to Underwrite Deals With That in Mind
Today we are reviewing how to make investments with a possible recession coming up, and how do you underwrite deals with that in mind. We are interviewing Hunter Thompson, the founder and managing principal of Asym Capital.

You can read this full interview here: http://montecarlorei.com/how-do-you-prepare-for-a-possible-recession-how-to-underwrite-real-estate-deals-resistant/

I am personally very excited about this topic, from my observation living in Silicon Valley, I think that the signs on an upcoming recession are everywhere:
1. One of the companies that I used to work for is currently losing $130 million per year, and they’re valued at almost $10 billion in the stock market.
2. I dabbed into angel investing, and so much money being thrown at startups that don’t have any customers
3. There’s a lot of money being thrown in real estate. Cap rates are very low, interest rates are at an all time low, and the government is not raising rates for some strange reason.
These signs all happened right before 2000 and right before 2008, and now is a great opportunity for us to jump into why we should be looking at session resistant properties and how to underwrite these deals.

How do you prepare for a potential downturn and how do you underwrite real estate deals with this in mind?
My thesis is that all types of real estate are going to perform if the capital markets are booming and the economy is really heating up. If you can raise rents aggressively, you can fill occupancy, you can complete capital expenditure and expect to be able to raise rents, etc. But only some types of real estate do well when the economy is contracting, so even if you have a portion of your portfolio that’s focused on the types of real estate that do well when the economies are contracting, it really significantly increases the overall risk profile of your portfolio and increases the favorability of the risk profile.

A significant portion of our business is focused exclusively on things that cater to people that are making $35,000 – $55,000 a year, somewhere in that range. The mobile home park business, for example, is probably the most clear example of a recession resistant asset because the worst the economy does, the more demand there is for the product. Think about it like this: if everyone that’s making $100,000 moves down to making $60,000, and everyone that’s making $60,000 moves down to $40,000 and everyone that’s making $40,000 moves down to $30,000, there’s always demand for that bottom product. Now that doesn’t paint the whole picture, which is something we can get into from a big picture perspective, though the mobile home park business is very compelling because the demand is stable.
A similar case can be made for something like self storage where people use the product when they’re going through some kind of life change. Let’s think about things like downsizing, which is very common during recessions, people change jobs, people have to move in order to stay employed, things like that are all very common during recessions, and also you have people moving home from college unexpectedly, but all of them spur demand for the product of self storage. From a downside protection standpoint, it’s very compelling. And also looking at the historical data, this isn’t something that just sounds reasonable. It’s very compelling and not just something that makes sense from a big picture.

Hunter Thompson
Email: [email protected]
Website: https://asymcapital.com
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21 min
August 02, 2019 What is Due Diligence? What are Some Items You Should Cover When Purchasing a Property?
In this episode, we will review what is due diligence, what types of questions you should be asking during the due diligence period, and what documents you should be getting from the seller. I won't go over the entire due diligence checklist because that is a very long checklist. This is just a very brief overview of some of the items that you will need as you're going through the due diligence report.

You can read this podcast here: https://montecarlorei.com/what-is-due-diligence-what-are-some-items-you-should-cover-when-purchasing-a-property/

What is Due Diligence?
It’s a term that you will learn when you are buying your first commercial property, it happens after your offer was accepted and that means that you have a specific number of days to review all the documents that the seller has on the property, schedule all types of inspections and reports, compare rental rates that are ongoing in the market, as well as sales comps to make sure that you are paying the right price for the property. If you Google what is due diligence, Google says that due diligence is the “reasonable steps taken by a person in order to satisfy a legal document, especially in buying or selling something”. It’s a comprehensive appraisal of a business undertaken by you (the prospective buyer) to make sure that the assets and the liabilities are correct, and make sure that this is an actual good deal for you to purchase or not. You typically have, depending on the market, 15 days at the very, very minimum to do all of your due diligence, all the way to 30 days, 60 days, sometimes 90 days. If the deal is really, really complex, it can take six months, nine months, or even one year. If you get in contract to purchase a property and you get 30 days to do your due diligence, and then you realize that you need more time because you were not given all of the paperwork on time, you can always ask for an extension, which is what we did on my first offer.

What are some example items that you need to cover during the due diligence process?
- Who is going to escort everyone to the property? You will have contractors coming over to do inspections and some reports, so you need to know who will be helping these people get in the property.
- The seller’s agent should provide you with a contact sheet for who is the escrow agent, who is the escrow officer, their phone numbers in case you need to get in contact with any one them.
- You are going to be asking for referrals for structural engineers, architects, roof inspectors and this could be from your own real estate agent because they are familiar with that city and they can refer you to the right people that they have used in the past.
- Sales comps for the area from your real estate agent, and this is for you to understand if you are paying a fair price for the property. How you determined that is by looking at the price per square feet. Prices can vary greatly based on location, so you need to take that into consideration as well. For instance, one of the sales comps can be three blocks away from your property.
- You'll need a copy of all of the leases that have been signed for this property. If you're buying an office building or a retail building, you really want to make sure that your read every single lease and all of the red lines. If you have two national tenants there for example, let's say you have a Starbucks and you have a Chick-Filet, they will likely require the owner of the property to use their own leases, so Chick-Filet and Starbucks will give their own lease to the owner of the property and they will negotiate from that.
- A breakdown of every single expense that the property has, and for most of these expenses you will want a two year history of all of the bills.
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16 min
July 25, 2019 Should You Buy a Home or Invest in Commercial Real Estate? Project Updates and Lessons Learned
Today we’re going to do a very basic analysis around the question: should you buy your own place, or should you invest in a commercial property? I’ll also going to update you on what I have been up to for the last couple of months, and how are my projects going.

Read this entire episode here: https://montecarlorei.com/should-you-buy-a-home-or-invest-in-commercial-real-estate-my-project-updates-and-lessons-learned/

Should you buy your own home, or rent and put the down payment in an investment property?
I am not providing any financial advice, this is my personal opinion based on the things that I have learned, you should always do your own homework and ask a professional for advice. Here’s my personal opinion on the question around buying a home to live in, or not buying it and putting that money towards an investment property.

If I were to buy a one bedroom apartment in San Francisco, I would be paying around $1.2M and I would have to put 20% down, so I would be putting $240,000 as a down payment and my mortgage would be $960,000, the interest rate could be around 4% in today’s market, that’s $960,000 at 4%. My monthly payment would be $4,500 per month plus property taxes of $1,000 per month (1% of the property value in California), and we have another $1,000/month in HOA fees (Home Owners Association). My total payment would be $6,500 per month if I were to own my one bedroom condo. On the other hand, I can be a tenant and rent that one bedroom apartment in today’s market for $4,500 per month. That’s a $2,000 difference – $4,500 if I am renting from someone vs $6,500 if I am the owner of that apartment. On top of that, if I am the owner, I just put $240,000 as a down payment, so I’m not making any money on that $240,000.

Now, let’s say you’d take that $240,000 to invest in a commercial property, and we are going to round this up to make things very simple: let’s say that you are making a 10% return every single year on that $240,000, which is very acceptable for real estate investing. At $240,000 that you were putting as a down payment, you’re instead getting a basic return of 10% every single year. That’s $24,000 that you’re making every year, plus, as a renter, I am saving $2,000 from the $6,500 that I would be paying if I was a homeowner or a condo owner in this case. That’s another $24,000 that I am saving by being a renter every single year, and another 10% on my $240,000 which is another $24,000 that I’m making every year in my commercial real estate investment. That’s a total of $48,000 every single year, that’s almost half a million dollars over ten years.

How much should you save to buy a home, and to buy a commercial property?
If you are going to own your own house, you typically should put a 20% down payment, there are all kinds of loans that you can get to nowadays, you could probably only have a 10% down payment, and sometimes even less depending on the type of loan that you find. For commercial properties you should have around 30% down payment. This number can also change depending on the property income and the type of loan that you get. This is a very standard number: 20% down for your own home, 30% down for a commercial investment, or you can join a syndication where you are investing with quite a few people and you buy a small part of that property. Typically the minimum amount to invest in a syndication is around $25,000 (it could also be much higher than that), and in a syndication you would own a percentage of that property.

Linkedin: https://www.linkedin.com/in/steffbold/
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21 min
July 18, 2019 What is Cost Segregation, How Can it Help You Save Taxes, What’s Bonus Depreciation, and How Much Would a Cost Segregation Study Cost?
In this episode you will learn a tip for tax deduction when you buy a property, it’s useful even if you have already bought some properties: cost segregation. What types of properties can benefit from cost segregation, we’ll go over an example of how much you’ll be able to deduct on your taxes, why it’s important to have cash on hand today versus in five years, what is bonus depreciation and how much a cost segregation study would typically cost. We're interviewing Yonah Weiss, a Business Director at Madison SPECS, a national Cost Segregation leader.

You can read the interview here: https://montecarlorei.com/what-is-cost-segregation-what-types-of-properties-can-benefit-from-it-whats-bonus-depreciation-and-how-much-would-a-cost-segregation-study-cost/

What is cost segregation?
It’s a tax benefit for real estate investors and it has to do with depreciation. When you own a property, you get a tax deduction called depreciation. Where cost segregation comes into play is the fact that the IRS determined that things in the property have different useful lives, anything that is not part of the structure of the building depreciates over five years. Then you have another category of things called land improvements and this can be anything like pavement, asphalt, parking lot, landscaping, fencing, anything outside the building actually depreciates over 15 years instead of 39 years. You break out the components of the property into their cost, and depreciate them at a faster rate.

What type of properties qualify for this?
Any type of property, as long as it’s not your personal residence, it can be commercial, residential and multifamily, office, assisted living, hotels, hospitality, self storage, industrial, shopping malls, golf courses, mobile home parks, etc.

What is the main benefit of doing cost segregation?
The cashflow. When you have more deductions than you have income, you don’t write a check. We’re not talking about getting free money, what we’re talking about is keeping the money that you made and paying less taxes, or no taxes. In many cases, the main benefit is the cashflow, you’re able to use that money to invest. The second thing is the time value of money because you can take huge deductions early on and make sure that you’re using that money to invest. The time value of money means money today is worth more than it is five years from now. If I were to offer you $50,000 today or $10,000 a year or five years, what would you take?

What is bonus depreciation?
It used to be a rule that when you developed a new property, you could take 50% of the depreciation of that property in the first year of that new construction. The law changed in that it’s now for any property that you buy, not just new developments. All the depreciation that is less than 20 years (in the example that we gave, the five-year personal property and 15 year land improvements) all of that cost segregation is eligible for bonus depreciation, you can actually take 100% of that depreciation in the first year of ownership, instead of spreading it over five years. You have a choice of 100% or 50%, which really gives you a much added benefit to take, to knock off your entire income tax liability in the first year.

How much would it cost to do a cost segregation study in our example property, 30,000 square feet office that was purchased for $3 million?
At our firm and for that property, it could cost around $5,000-$6,000.

Yonah Weiss
https://www.linkedin.com/in/cost-segregation-yonah-weiss/
[email protected]
(732) 298-9002
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22 min
July 11, 2019 Making a Case for Self Storage Investing
In this episode we're learning why you should invest in self storage, how to select the location to invest, what are the biggest challenges with self storage and how to select and hire the best property manager for your locations. We're interviewing Ryan Gibson, a co-founder of Spartan Investment Group.

You can read the full interview here: https://montecarlorei.com/making-a-case-for-self-storage-investing/

Why should real estate investors invest in self storage?
Self storage is something that we looked at back in 2016, we made a pivot from investing in residential real estate, we were building condos, new houses, flipping houses, and we landed in self storage for a couple of reasons: 1. We liked how straight forward it was, how operationally easier it was to manage than a multifamily property. We looked at vacancy trends, rent growth, saturation and all the things that people like about self storage. It is also one of the least foreclosed upon asset classes during the last recession.

How do you guys go about deciding where to invest in self storage?
We focus on 150 MSA’s across the United States. And those MSA’s have a key component of population growth. Population growth is the number one driver of self storage utilization, overall market saturation, job growth, demographics of our ideal consumer, income levels, job placement, migration trends, and we look for cities and areas, or an MSA that are trending positive and have a good outlook for population. We look at rental rates as well. We have a hard time justifying building in certain markets, brand new storage, if the rental rates are, say less than $6 a square foot, it would be difficult to do that.

What are some of the biggest challenges with self storage?
I would say the number one challenge is finding the right projects. We looked at 880 projects last year, we put out six offers, and we bought three. It's a very institutionalized asset class. A lot of projects that are over $5 million are getting all cash offers, so it’s very difficult to compete with a lot of the institutional capital, and larger players in the market because they have a lower cost of capital than we do. Because we're offering our investors a market rate return on equity and they have a good team of folks that can find the same data that we're finding.

Moving on to property manager, how do you select and hire the best property manager and what do they do all day long? Some folks will hire third party property management companies like Cubesmart, Extra Space, West Coast Self Storage, Public Storage. They might hire a company like that to come in and do the property management for them, but they're still going to have to hire somebody that works at the desk, that the owner is responsible for covering that expense. The property management companies will take a fee, usually 6% of gross revenue, to manage that facility. We do the property management asset management in house.

What is your second favorite asset class after self storage and why?
We own an RV park in west Texas and that has been my favorite deal ever. Very similar in characteristics to a mobile home park in that the tenants are there full time and they live there right now, rent is about $800 a month (and utilities are included in that). Not to have a whole lot of amenities and have the lowest entries for housing, we just collect a lot rent and the folks bring in their own RVs and mobile homes, they purchase their own homes, it does well in good times, and in bad times.

Ryan Gibson
www.spartan-investors.com
[email protected]
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18 min
June 28, 2019 Should You Invest in Silicon Valley? What Does the Future of Office Space Look Like? What Happened to Office Spaces During the Last Downturn?
In this episode we'll learn if investing Silicon Valley could be a good idea, what happened to office spaces during the last downturn, things an investor should cover when looking at purchasing an office, what types of leases are standard for office space, and what does the future of office space could look like. We're interviewing Eduardo Zepeda, an asset manager and leasing director of a family's holdings, he manages north of $100M in combined assets comprised of multi-tenant office and retail property.

You can read the full interview here: https://montecarlorei.com/should-you-invest-in-silicon-valley-what-does-the-future-of-office-space-look-like-what-happened-to-office-spaces-during-the-last-downturn/

Making a case for investing in Silicon Valley: Why do you like this area?
It’s the perfect storm of supply and demand economics where you have a finite fixed amount of land and a very strong demand not only for housing but also for space to occupy, whether it’s office, industrial or just land to develop and improve. The macroeconomic factors for the Bay Area are very compelling, whether you’re looking for a short term value add project with an exit, or a long term hold, there’s a compelling argument in both cases for investing in this area even during this economic times. The challenge is that prices are very lofty.

What was the vacancy rate like during the 2008 recession and what were some of the major issues that the properties that you were managing were facing?
We were doing deals somewhere in the $20’s/yr/sf, sometimes even in the high teens and there was a lot of inventory space back then. The demand was pretty low, especially compared to now where the vacancy rate in San Francisco is around 5% for office. The demand didn't stay very strong throughout, on a rental rate basis it was quite different than what it is now, from $20/sf back then.

What are offices charging per square foot nowadays?
It depends on the building type, within our portfolio we have multi-tenant, and class B and C properties. Depending on the part of town and the part of the Financial District, or South of Market, anywhere from the high $40’s/sf/year all the way up to the high $60’s- low $70’s for a class B. For a high rise, you can go anywhere from the mid $70’s-low $80’s all the way up to $100’s or higher, depending on the building and the area.

What should investors look for when buying an office building?
1. Get a working knowledge of the building systems: the HVAC , boilers, chillers, electrical, and those types of systems that depending on the way that the leases are structured could be an expense of the landlord, or they could be expensive to the tenant. 2. Having some working knowledge as to the way that they are operating at that property.
3. Have a working knowledge as to the different types of leases that are active in the market, or typical for this kind of building.
4. Know the difference between a full service gross lease, an industrial gross lease, a net lease, or any variation thereof. That's pretty important because it will dictate how much is going to be an expense to you as a landlord.
5. If it's a building that has some vacancy, or that has some holes in the leases in the next one to three years - know what the market is doing in order for you to able to accurately predict what you're going to be able to lease those spaces for on a per sf basis.

Eduardo Zepeda
[email protected]
https://www.meetup.com/SFREConnection/
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21 min
June 20, 2019 What are Opportunities Zones, How to Hire the Best Team, What Types of Asset Classes to Invest in Today’s Market
In this episode we’ll learn how to manage multiple companies at the same time, how to hire and inspire the best people, what types of asset classes and what markets are interesting to invest in today’s market, and we will also learn what are opportunities zones and how you can leverage OZ's in your investments. We’re interviewing Greg Dickerson, a serial entrepreneur, real estate developer, coach and mentor. Over the last 20 years he has bought, developed and sold over $200 million in real estate.
You can read this full episode here: https://montecarlorei.com/what-are-opportunities-zones-how-to-hire-the-best-team-what-types-of-asset-classes-to-invest-in-todays-market/

How do you make sure that you're successful when you're doing everything from fundraising to investing in all kinds of asset classes? You have done multifamily, retail, medical center, offices, how do you make everything move forward?
Education. I didn't go to college but I am very highly self-educated, I've always developed myself personally and professionally. I've never owned one song, only audio books and courses. Business and personal professional development are important in order to accomplish things. You need to be a visionary, a leader. What is it that you're trying to accomplish? Create the vision, communicate that vision in a way that people understand it and can see it even though it's not there. Put together the right team, inspire the results out of that team, delegate, motivate, and lead.

Is now a good time to invest in commercial real estate? What are your favorite markets?
It’s always a good time to invest in commercial real estate, but it's not always a great time to invest in every asset class. And every market is specific. Everybody says that real estate is local, I call it hyperlocal, real estate is local down to the block of the neighborhood within the city and the subdivision you're investing in. You could say that multifamily is a great, safe place all across the country, which it is, it's the safest bet from a real estate investment standpoint, especially at the low A, high B level. That's an asset class that's probably never going to go away, people need housing, so when you start going down in the B, C, D classes it can get a little risky in certain areas, but they can be slam dunks in other areas.

What are Opportunity Zones, and how can people leverage them within their own investments?
The Tax and Jobs Act from 2017 gave governors of all the states in the US the ability to designate certain areas as opportunities zones. The idea behind it was to incentivize investment into lower areas, primarily in business and in real estate assets. Each governor was able to go through their state and pick zones within cities of the state as opportunities. It was created to spur investment in businesses and in real estate in lower income, distressed areas. With opportunity zones, you get to defer capital gains, let's say that you sell stock, art, or property - anything that generates capital gains. You then can invest into an opportunity zone fund, and for the first five years 10% of that gain is a written off. After seven years you get an additional 5%, and an after ten years anything that you make on that gain is tax-free. You can also refinance, sell assets and reinvest in another opportunity zone within a year and roll it over. You could invest $1 million, make $10 million within a year, reinvest that gain and keep on going.

Greg Dickerson
gregdickerson.com
Cel: (434) 326-3903
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20 min
June 13, 2019 How to Start Real Estate Investing With Zero Money
In this episode you’re going to learn how to get started in real estate investing with zero money down. If you’re feeling a little overwhelmed by the fact that you need a lot of money to get started in real estate investing, fear not! There are opportunities out there where you can partner up with people. We interviewed Ellis Hammond to find out how he got started in real estate investing with no money down.
Read this podcast here: https://montecarlorei.com/how-to-get-started-in-real-estate-investing-with-no-money/

What are some things that you did to get to where you are, and what are some things that you wish you did when you were starting?
Build your network before you need your network is the best advice I can give to someone who wants to get started into real estate. That’s really how I went from owning no real estate to doing a $2 million deal last year, and we have two deals right now that will be over $15 million in real estate. I found a mentor, and that mentor opened me up to his network and other networks. I showed up at conferences that have people that you want to connect with.

What are some ways that people can get into real estate investing without any money?
It’s finding the deals or finding the money. That’s essentially what it comes down to. Which one of those can you begin to play a part in? I think the nice thing about commercial real estate is that it’s a team sport and there are multiple roles within commercial real estate. That’s why I like it. That’s why I really got out of the single family space because commercial real estate allows you to specialize in what your superpower is. What is your superpower? What are you really good at doing? I’m really good at networking. I’m really good at building relationships.

If our listeners were to raise all of the funds, or raise 50% of the funds for a particular deal, how much would they own of that deal?
For big commercial deals, the person who raising the capital can normally get paid 2-3% on the money that they raise. If you raised $1 million, you could make 2-3% or right off the get go on that million dollars you bring into the deal. So that’s nice to get some money right away. But you want to be a partner in the deal and with the people that you’re investing with. For syndications there are two sides of the deal: the general partner who’s the sponsor, or the operator, the ones who are putting together the deal. And then there are the investors, which is it called the limited partnership. So you then negotiate for a percentage of the general partnership and the equity so that you have consistent cash flow throughout the life of the project. If you’re raising all of the money, you would look to have about 10% of the deal or 25-40% of the general partnership equity.

There is another side to this that you could also start with: finding deals. Can you elaborate on that?
If you don’t like asking people for money, the best thing you can start doing is looking for deals. In this market, if you get really good at finding deals, you’re gold. People will pay to find good deals because good deals are hard to find, especially in this market. This is a super power, it takes a ton of follow up, it takes a ton of detailed work. I tried to do both sides and I just realized that a lot goes into this one. So to get started learning how to find deals, go to a website called listsource.com – it’s a database website where you can filter real estate by asset class.

Ellis Hammond
[email protected]
https://www.linkedin.com/in/ellis-hammond-435b40156/
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19 min
June 06, 2019 What is a Syndication, How to Underwrite Deals for a Recession, What is Replacement Cost
Today we'll learn what is a real estate syndication, what types of asset classes are safer so we can be prepared when we go into a recession, how do to underwrite and pick deals, as well as what does replacement cost mean. We're interviewing Matt Shamus, the founder of Driven Capital Partners, a real estate private equity firm based in California.

Read this episode here: https://montecarlorei.com/what-is-a-syndication-how-to-underwrite-deals-what-is-replacement-cost/

What is a syndication?
A syndication is pooling assets together to achieve something that neither of us could achieve on our own. That term is used very commonly, especially today in real estate investing for a structure where you have the sponsor who is outsourcing the deal, underwriting the deal, packaging it together, and then raising money from individual passive investors, that structure is called syndication. I actually don’t love the term syndication or syndicator, and I don’t really apply that to what we do because it has a bit of a connotation. In fact, one of our investors recently told me that he considers our group a little bit more like an investing club than a syndication, and I think that’s the approach that we’re taking.

Is there a particular asset class that you prefer today?
“Today” is a very important modifier to the question because we are in May, 2019 and in the middle of a trade war between the United States and China, there’s a lot of uncertainty in the stock market. There’s a lot of uncertainty with regard to when are we going into a recession, and our belief is that we will be entering a recession at some point. What that means as a real estate investor is that you have a choice: Do I stay on the sidelines and see what happens and forgo potential gains for the sake of being “conservative” and waiting it out? Or do I take the approach that everything that I’m investing in, I’m looking at a little bit more closely, specifically through the lens of “we’re going to enter a recession at some point”. Our investors want the benefits of investing in real estate, but they don't have the time or expertise.

Can you elaborate on what does it mean when a property is below replacement cost?
I’m writing an offer today on an industrial warehouse, it’s 86,000 square feet, it’s mostly warehouse in a great location appealing to someone that needs a distribution center, high height space, which is essentially space that a large truck can back up into and you can stack the merchandise very high so you can maximize the square footage, and also has office space. That combination is very appealing in this particular market. We are looking at buying this property for less than $60 a square foot.
If I were to build this exact same property on a similar parcel, I couldn’t build it for $60 a foot. I’d have to pay more just to build the property and then I would have a vacant property sitting there waiting to be leased. So the risk associated with the development is meaningful. What we look for is where can we buy something that is below the cost to replace it. That’s one way of determining if it’s undervalued, and it’s one way that a lot of brokers will use if you look at an offering memo. One thing to watch out for is that brokers are salespeople. It’s easy to say that this asset is below replacement cost, but what they will never they tell you is “this actually would be replacement cost, and here are the real numbers that we used”. Below replacement cost is a term that is used very loosely with a lot of brokers.

Matt Shamus
[email protected]
www.drivencap.com
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22 min
May 30, 2019 Office Leases: Lease Negotiation Points, What Makes for a Good Landlord, What Does "Base Year" Mean on a Lease
In this episode we cover what does the base year mean in office leasing, what are specific things that startups want to negotiate on a lease, what happens when a startup goes out of business, LOI’s, lease negotiation & TI’s (also called lease concessions), and lastly, what makes for a good office landlord.

You can read this episode here: https://montecarlorei.com/office-leases-lease-negotiation-points-what-makes-for-a-good-landlord-what-does-base-year-mean-on-a-lease/

For offices, are the leases typically NNN?
No. It's typically what's called a "full service lease" where you pay your rent, and it's pretty much in all in rent. The landlord covers the utilities, the janitorial, the operating expenses, and real estate taxes. The way that it works is you get what's called a base year. So let's say we completed our lease in 2019 and we do a three year term. You get a "base year" and 2019 is your first year, you don't need to pay any real estate taxes and operating expenses. But in the following year you are responsible for paying your proportionate share of the increase in operating expenses and real estate taxes. So let's use round numbers, for example let's say that you occupied 10% of a building. The operating expense in real estate taxes were $100 in 2019 and they went up to $200 in 2020, a $100 increase. All you need to pay is your proportionate share of $100, in this case $10. But as you do a long term lease, 7-10 years, it's growing every year, and that number can become significant. So a lot of companies will renegotiate their lease, they will do what's called an extension, or they'll expand and renegotiate the lease to get a brand new base year so that they don't have to incur those costs.
Has it ever happened that a startup went out of business, and what happened to that contract? What are the recourses for the landlord?
They go into what’s called a default and the landlord eventually ends up needing to collect their money. This situation has come up numerous times and what we do is find a new tenant to sublease the space. We market it for sublease, and once you come to an agreement on terms, the landlord will say “Okay, instead of subleasing from this company who has gone bankrupt, we’ll wrap up that lease and do a new direct deal with this new tenant”. So we’re able to bring a new tenant into the space and, by doing that, cut our client out of any rent responsibility moving forward.

What are some specific things that startups want to negotiate in a lease that we haven't covered yet?
The few things that we've covered so far are the big items such as rent, term, free rent, tenant improvement allowance, and the security deposit. Things we haven't talked about yet are: let's say a landlord is forcing us into a five year deal, but we know we're not going to be able to make it for the full five years. We try to negotiate a termination option where after three years we can terminate with no penalty, or a very small penalty such as two months rent. Another item is sublease rights, a landlord will generally give you the right to sublease, but any profit that you get for that sublease is split 50-50 between the tenant and the landlord since they want to discourage tenants to take space and sublease for a profit. When you're in rapid expansion mode we try to negotiate what's called a right of first refusal, where if a space becomes available in the building, the landlord is required to present it to the startup first at a fair market value.

Reuben Torenberg
[email protected]

Steffany's Linkedin: https://www.linkedin.com/in/steffbold/
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20 min

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Getting started with Commercial Real Estate Investing, or an experienced investor? This is a weekly podcast on the steps that I take to make my Commercial Real Estate investments (Retail, Office, Self…