Free Rent
You’ve probably seen signs saying ‘Free Rent’ hanging on apartment projects and even on some commercial properties. Free Rent sounds pretty good doesn’t it? Too good to be true you think? Well maybe not.
Free Rent, of course, is an incentive to attract tenants. Let’s look at it from a Landlord’s (LL) perspective. You have a building, apartment complex, etc. that is meant to generate rental income. As a matter of fact, one of the key measures of the value of commercial property is how much income a property produces. If it is sitting there empty, it obviously is not producing income. So how does he attract tenants to cure this?
One solution would be to reduce the rent. Instead of asking $16 / SF, reduce the rent to $15/SF. That should pull some folks in,right? OK, that’s good. But then, what about the other tenants that have just signed leases at $16/SF? Think they’re going to be happy? Probably not; not exactly. Think the LL’s phone is going to ring. Probably. Not such a good idea any more. Plus, you rent to one tenant for $15/SF and you can bet money everyone that comes to you looking for space will be aware of it and will be expecting the same rate. The market rate for your project just went down and because the value of your property is dependent on the income it produces, the market value of the property just went down as well. We’ll get into valuing commercial properties in another session.
The other alternative – Free Rent. Let’s say a LL has 2,000 SF space sitting vacant. He’s not able to rent it for $16/SF so as an alternative you suggest he offer some free rent as incentive. A tenant signs a lease for 39 months – 3 months of free rent and then 3 years (36 months) at $16/SF. The free rent effectively reduces the Tenants rent by approximately 8%. This is how it works. Again, the lease is for 39 months (3.25 years). The first three months are free. Rent for the remaining 36 months is $96,000 (2,000 SF x $16.00/SF x 3 years). Now $96,000 / 3 years / 2,000 SF equals $16.00 / SF. But if you do the calculation based on 39 months to include the 3 months of free rent or 3.25 years, the effective rate for the Tenant drops to $14.77 / SF ($96,000/ 3.25 years / 2,000 SF). That’s effectively an 8% reduction in rent. That is pretty attractive for a Tenant. And the LL can still show $16/SF as his lease rate. Everybody is happy. The LL can produce financials that show income for the property at $16/SF and you have managed not to antagonize the existing Tenants since your advertised rate is still $16/SF. Plus, it’s much easier to remove an incentive i.e. the free rent once the market changes than it is to increase rents.
Tuesday, September 2, 2008
Tuesday, August 26, 2008
Chapter 2 - Rents for Commercial Spaces
Rents for commercial space can be quoted many different ways and can be confusing. Gross, Net, Triple Net, Cam, Caps, Full Service. What does it all mean?
First a brief explanation of the various ways rents are quoted.
We’re all familiar with the traditional way of quoting rent: x dollars per month for a given house/apartment/or space. The rent is quoted in an understandable dollar amount and you can look at the space and see exactly what you are getting in return. Clear cut and simple. This is typically referred to as a Gross Lease and the rent is referred to as gross rent (spare me the jokes, please). Occasionally commercial space will be quoted this way as well; i.e. Suite 105, 1,000 square feet, rents for $1500 per month and is a gross lease. Unless it is specified otherwise the rent includes all amounts due the LL (landlord) for occupying the space. In an office building, the ‘gross rent’ may at times also include janitorial services and utilities. In that case, the lease may be be referred to as a ‘Full Service’ lease.
A word of caution here. Anytime someone quotes you rent and refers to it in terms of Net, Gross, or whatever; always clarify these terms to make sure you and the other person are ‘on the same page’. Although some terms are used quite commonly, occasionally people will have a different interpretation of a particular term. This is especially true if you are traveling in different markets where local practices may vary from what you are accustomed to. For that reason it is important that you always clarify exactly what someone means. Believe me, you don’t want to get to the end of a long negotiation and realize that there is a significant difference in the rent because of a misunderstanding over one of these terms. Always ask!
One more explanation before we proceed. Rent for commercial space is quite commonly quoted as a rate per square foot. Remember, this is almost always an annual rate (remember, you always ask, especially if the rate doesn’t look quite right). Thus, if rent is quoted as $18 per square foot, the $18 is an annual rate and the monthly rent would be $1.50 / SF ( $18.00 / 12).
“Why do they quote rent that way?” There are a couple of reasons. One it makes it easier to compare apples to apples if you are looking at different size spaces. It’s comparable to the $/SF people look at when buying a home. The second reason is that often times the size of the space can be modified to accommodate the needs of the tenant; walls can be moved or walls can be added etc etc. Thus, a per square foot rate makes sense.
You have also probably seen or heard Commercial rent quoted as Net Rent, or Triple Net Rent. Confusing huh? Well, of course it is. What those terms mean is that the LL is quoting an amount for rent but in addition to the rent, there will be other expenses that the Tenant will be responsible for paying as well. Thus the rent amount quoted is ‘net’ of these additional expenses. These additional expenses are commonly referred to as ‘additional rent’ or ‘pass throughs or ‘CAM’ (Common Area Maintenance). In this part of the world the term ‘CAM’ is used quite commonly to refer to additional rent or pass throughs.
“Why do they quote rent that way?” you ask rhetorically. In the past Landlords were writing long term leases – 5 years, 10 years, or more. In order to quote rates for far in the future, they had to estimate the expenses they would incur; i.e. property taxes, insurance on the building, and maintenance expenses. For many years, these expenses had increased at a fairly predictable rate so estimating future cost was not too difficult. Then in the 60’s and 70’s inflation rates started increasing rapidly. All these expenses started increasing beyond what LLs had estimated. Their leases locked in the rent they could collect from their Tenants. The increasing costs they were incurring were reducing or erasing the profits on properties and owning and leasing property was not economically feasible. To remedy this situation, at least for future leases, LLs started quoting rents ‘net’ of these expenses and requiring Tenants to pay their prorata share of the actual cost for these items. Now the LL has a way to pass these costs through to his Tenants. The LL is still liable for these items and still pays the actual bill / invoice, but now the Tenant reimburses him for these expenses through their CAM payments.
Again, when someone quotes a ‘Net’ rate for space, always clarify exactly what expenses are being ‘netted’ from the rent. It can be any combination of Taxes, Insurance, or CAM but most typically, at least in this market, it is all three
So, a LL is quoting a rate of $16/SF NNN (Triple Net). How much will your tenant’s rent be each month? To figure this, you have to know how much the CAM is. In this case we’ll use $2.00/ SF for CAM. Total rent is $18.00 / SF ($16.00 rent + $2.00 CAM). So, the rent for a 2,000 SF space will be $3,000 / month (2,000 x $18.00 / 12).
Rent Increases or ‘Bumps’ – When negotiating a multi-year lease, the Tenant and LL want to define how much rents will be for each year of the Lease. Usually LL’s will ask for an annual increase in the rent over the term of the lease. Currently the market has been seeing annual increases of 2.00% to 2.50% increases. Thus in the example we used above, rent for year Two would be $16.32/ SF ($16.00 x 1.02) and $16.65 for year Three ($16.32 x 1.02). Of course bumps or increases are all negotiable.
CAM Increases – CAM rates for future years are not given when signing a lease. The Tenant only agrees to pay his share of the expenses associated with the building / complex over the term of the lease. The CAM rate that is currently in effect will be quoted, however, the rate for future years is not specified. Those rates will be computed over the life of the lease. Occasionally a Tenant can negotiate a ‘Cap’ on CAM cost with the LL promising that CAM cost will not increase by more than X percent per year.
CAM rates are typically adjusted the first of each calendar year. The LL will consolidate his expenses and then notify the Tenants of the CAM rate that will be applicable for the coming year. The most typical way to allocate CAM cost is based on the square footage the Tenant occupies in relation to the total square footage of the complex. Let’s use the example of a tenant that occupies 2500 SF of a 10,000 SF building. The total CAM cost for the complex is $15,000 for the year or $1.50 / SF ($15,000 / 10,000). Thus, using the rate of $1.50 / SF, the Tenants share of the CAM for the coming year would be $3,750 (2,500 SF x $1.50) or $312.50 per month ($3,750/12).
If you have additional questions you would like help with, please do not hesitate to contact us. We’ll be glad to answer your questions and assist you any way we can.
First a brief explanation of the various ways rents are quoted.
We’re all familiar with the traditional way of quoting rent: x dollars per month for a given house/apartment/or space. The rent is quoted in an understandable dollar amount and you can look at the space and see exactly what you are getting in return. Clear cut and simple. This is typically referred to as a Gross Lease and the rent is referred to as gross rent (spare me the jokes, please). Occasionally commercial space will be quoted this way as well; i.e. Suite 105, 1,000 square feet, rents for $1500 per month and is a gross lease. Unless it is specified otherwise the rent includes all amounts due the LL (landlord) for occupying the space. In an office building, the ‘gross rent’ may at times also include janitorial services and utilities. In that case, the lease may be be referred to as a ‘Full Service’ lease.
A word of caution here. Anytime someone quotes you rent and refers to it in terms of Net, Gross, or whatever; always clarify these terms to make sure you and the other person are ‘on the same page’. Although some terms are used quite commonly, occasionally people will have a different interpretation of a particular term. This is especially true if you are traveling in different markets where local practices may vary from what you are accustomed to. For that reason it is important that you always clarify exactly what someone means. Believe me, you don’t want to get to the end of a long negotiation and realize that there is a significant difference in the rent because of a misunderstanding over one of these terms. Always ask!
One more explanation before we proceed. Rent for commercial space is quite commonly quoted as a rate per square foot. Remember, this is almost always an annual rate (remember, you always ask, especially if the rate doesn’t look quite right). Thus, if rent is quoted as $18 per square foot, the $18 is an annual rate and the monthly rent would be $1.50 / SF ( $18.00 / 12).
“Why do they quote rent that way?” There are a couple of reasons. One it makes it easier to compare apples to apples if you are looking at different size spaces. It’s comparable to the $/SF people look at when buying a home. The second reason is that often times the size of the space can be modified to accommodate the needs of the tenant; walls can be moved or walls can be added etc etc. Thus, a per square foot rate makes sense.
You have also probably seen or heard Commercial rent quoted as Net Rent, or Triple Net Rent. Confusing huh? Well, of course it is. What those terms mean is that the LL is quoting an amount for rent but in addition to the rent, there will be other expenses that the Tenant will be responsible for paying as well. Thus the rent amount quoted is ‘net’ of these additional expenses. These additional expenses are commonly referred to as ‘additional rent’ or ‘pass throughs or ‘CAM’ (Common Area Maintenance). In this part of the world the term ‘CAM’ is used quite commonly to refer to additional rent or pass throughs.
“Why do they quote rent that way?” you ask rhetorically. In the past Landlords were writing long term leases – 5 years, 10 years, or more. In order to quote rates for far in the future, they had to estimate the expenses they would incur; i.e. property taxes, insurance on the building, and maintenance expenses. For many years, these expenses had increased at a fairly predictable rate so estimating future cost was not too difficult. Then in the 60’s and 70’s inflation rates started increasing rapidly. All these expenses started increasing beyond what LLs had estimated. Their leases locked in the rent they could collect from their Tenants. The increasing costs they were incurring were reducing or erasing the profits on properties and owning and leasing property was not economically feasible. To remedy this situation, at least for future leases, LLs started quoting rents ‘net’ of these expenses and requiring Tenants to pay their prorata share of the actual cost for these items. Now the LL has a way to pass these costs through to his Tenants. The LL is still liable for these items and still pays the actual bill / invoice, but now the Tenant reimburses him for these expenses through their CAM payments.
Again, when someone quotes a ‘Net’ rate for space, always clarify exactly what expenses are being ‘netted’ from the rent. It can be any combination of Taxes, Insurance, or CAM but most typically, at least in this market, it is all three
So, a LL is quoting a rate of $16/SF NNN (Triple Net). How much will your tenant’s rent be each month? To figure this, you have to know how much the CAM is. In this case we’ll use $2.00/ SF for CAM. Total rent is $18.00 / SF ($16.00 rent + $2.00 CAM). So, the rent for a 2,000 SF space will be $3,000 / month (2,000 x $18.00 / 12).
Rent Increases or ‘Bumps’ – When negotiating a multi-year lease, the Tenant and LL want to define how much rents will be for each year of the Lease. Usually LL’s will ask for an annual increase in the rent over the term of the lease. Currently the market has been seeing annual increases of 2.00% to 2.50% increases. Thus in the example we used above, rent for year Two would be $16.32/ SF ($16.00 x 1.02) and $16.65 for year Three ($16.32 x 1.02). Of course bumps or increases are all negotiable.
CAM Increases – CAM rates for future years are not given when signing a lease. The Tenant only agrees to pay his share of the expenses associated with the building / complex over the term of the lease. The CAM rate that is currently in effect will be quoted, however, the rate for future years is not specified. Those rates will be computed over the life of the lease. Occasionally a Tenant can negotiate a ‘Cap’ on CAM cost with the LL promising that CAM cost will not increase by more than X percent per year.
CAM rates are typically adjusted the first of each calendar year. The LL will consolidate his expenses and then notify the Tenants of the CAM rate that will be applicable for the coming year. The most typical way to allocate CAM cost is based on the square footage the Tenant occupies in relation to the total square footage of the complex. Let’s use the example of a tenant that occupies 2500 SF of a 10,000 SF building. The total CAM cost for the complex is $15,000 for the year or $1.50 / SF ($15,000 / 10,000). Thus, using the rate of $1.50 / SF, the Tenants share of the CAM for the coming year would be $3,750 (2,500 SF x $1.50) or $312.50 per month ($3,750/12).
If you have additional questions you would like help with, please do not hesitate to contact us. We’ll be glad to answer your questions and assist you any way we can.
Chapter 1 - Commissions on Commercial Leases
One of the most common questions I get from agents is “how do you get paid on a commercial lease?”
Commissions on commercial listings, just like residential listings, are entirely negotiable between the Landlord (LL) and the Listing Agent (LA). Typically the commissions range from 10% to 6% and are based on the total rent for the Initial Term of the lease. ‘Term’ is the length of the lease, i.e. 3 years, 48 months, 5 years, etc. etc. And, just like residential property, they are commonly shared with a selling agent or cooperating broker.
Let’s say you have a listing for a property and you agree to an 8% commission for the first 60 months of the initial term of the lease. The property leases for $2,000 / month or $24,000 / year with an initial term of 3 years. The commission would be $5,760 (see below). Now if a cooperating broker is involved you will have to share this commission with him. More on that in another session.
$24,000 (annual rent) x 3 (years the initial term) x 8.00% (commission = $5,760.00
If the initial lease term is for 5 years, the commission goes up accordingly.
$24,000 x 5 x 8.00% = $9,600.00
This is fairly simple. However there could be, and most likely will be, a lot of other details involved in the listing agreement. For instance :
· Is commission paid monthly as LL receives the rent?
· Are there staggered commissions i.e. 8.00% on the first 36 months then 6% on the next 24 months?
· Are there commissions on CAM and additional rent? (More later)
· Are commissions due on options and renewals?
· If the LL sells the space to a tenant, is the broker entitled to a commission on the sale?
· What is the commission on ‘free rent’?
· If a tenant leaves the premise before the term of the lease has expired is the LL due a refund?
· What is a cooperating / tenant rep entitled to if he brings a tenant?
· Why is this so much more complicated than it was in Monopoly?
The answers to all these exciting and interesting questions plus many others will be revealed in coming installments of Zen and the Art of Commercial Real Estate. Stay tuned and watch for coming installments.
In the mean time, if you have any burning questions r.e. commercial real estate, please let me know. They might even be the subject of a future installment.
Commissions on commercial listings, just like residential listings, are entirely negotiable between the Landlord (LL) and the Listing Agent (LA). Typically the commissions range from 10% to 6% and are based on the total rent for the Initial Term of the lease. ‘Term’ is the length of the lease, i.e. 3 years, 48 months, 5 years, etc. etc. And, just like residential property, they are commonly shared with a selling agent or cooperating broker.
Let’s say you have a listing for a property and you agree to an 8% commission for the first 60 months of the initial term of the lease. The property leases for $2,000 / month or $24,000 / year with an initial term of 3 years. The commission would be $5,760 (see below). Now if a cooperating broker is involved you will have to share this commission with him. More on that in another session.
$24,000 (annual rent) x 3 (years the initial term) x 8.00% (commission = $5,760.00
If the initial lease term is for 5 years, the commission goes up accordingly.
$24,000 x 5 x 8.00% = $9,600.00
This is fairly simple. However there could be, and most likely will be, a lot of other details involved in the listing agreement. For instance :
· Is commission paid monthly as LL receives the rent?
· Are there staggered commissions i.e. 8.00% on the first 36 months then 6% on the next 24 months?
· Are there commissions on CAM and additional rent? (More later)
· Are commissions due on options and renewals?
· If the LL sells the space to a tenant, is the broker entitled to a commission on the sale?
· What is the commission on ‘free rent’?
· If a tenant leaves the premise before the term of the lease has expired is the LL due a refund?
· What is a cooperating / tenant rep entitled to if he brings a tenant?
· Why is this so much more complicated than it was in Monopoly?
The answers to all these exciting and interesting questions plus many others will be revealed in coming installments of Zen and the Art of Commercial Real Estate. Stay tuned and watch for coming installments.
In the mean time, if you have any burning questions r.e. commercial real estate, please let me know. They might even be the subject of a future installment.
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