It happens all the time when you engage in acquiring a new property through contract, there is not much information about the property known at that stage. All you may know is the details of the financial statement and rent payroll or you've visually inspected the place by driving around the block. This is more than enough details to make a solid educated offer on the place but it does not by any mean represent the actual value. There's a lot more information you'll need to know to determine the real value.
Really this is the job of the Due Diligence process. What is the purpose of this process? Due Diligence is an analysis by which your risk is assessed. Much like discovery in a court case, you will have at least 30 days to figure out what exactly the property entails and what owning the property requires you to be responsible for. Finally, also what kind of benefit you will receive as a result of purchasing the property. What will be your cost benefit and profit?
There are four ways risk can ruin this success and by you knowing the potential risk involved, you can steer clear of these situations. The following potential risks for these transactions are: Market, Financial, Tenant, and Physical.
Commercial real estate can lead to just about any lifestyle you can dream up, but if you're not careful how you play your cards, you can find yourself living through some expensive lessons. Fortunately, even in today's housing crunch, crossing the line from multiple homeowner to one who invests in commercial real estate isn't all that difficult, as long as you plan out a realistic strategy and game plan.
Some people start out by buying a rental property, others rent out their own home, and move on from there. After acquiring a few homes this way, they branch out with a duplex or a small apartment. If this continues eventually the bank is going to put on the brakes by telling you that your portfolio is beyond their lending protocol for multiple residential properties.
If you've grown too big for your britches but want to continue expanding your mini-empire you'll have to learn the "how-to's" of commercial real estate. Possibly you acquired one commercial property and everything went off without a hitch. But the next one didn't. Suddenly you find you "hit the wall" - you're in property owners no man's land.
If you are a real estate professional then you know about the gross income multiplier, GIM or the formula that determines the value of rental real estate. It has been used for decades. 
There are many schools of thought on how to determine the value of rental property but I always use my readings as a rule of thumb. Any real estate textbook will tell you not to invest in a property with a GIM of more than 8. The formula is simple enough: divide the price by the gross annual rents to get the GIM.
With this definition in mind it seems that particular author wants me to never pay more than 8 times the annual rent for a rental property. This helps the buyer open their eyes to mow much of a rental property they can afford to buy. It makes plenty of sense really. Seems that if a property was selling for 6 times the rental income, then that was a really good deal. I mean anything higher than 8 times the rental income and that becomes a dangerous proposition. This simple method makes it easy for the average Joe to know what they are getting into.
One important aspect of due diligence is to know your documents but specifically understanding the details of the lease, insurance policy, and title policy. The lease, out of all of these is of utmost importance because it remains the roadmap for future events concerning the property. Part of the issue with the lease is language. There is a lot of strange stuff, interesting jargon presented in the terms of a lease. Really I wonder when legal ease will be common enough for an ordinary person to understand. Such examples of strange amendments to a generic lease include: First options on purchase, the right to take over adjacent space, tenant ownership of plumbing fixtures (really!), agreements for new carpet every year. Really anything is possible.
One would think that there is a cookie cutter answer to the common lease agreement. It seems very few properties have what is commonly termed as a "standardized lease template" mainly because over the lifetime of the property management, the owner is faced with signing new leases and making concessions for each individual tenant. Some tenants will be more nit picky than others. Some tenant may agree to paint the living room or include other repairs that will amount to a profit for the owner in the long run but mainly benefits the existing tenant. A lot of the time, much goes unnoticed by property managers and it is at the owner's discretion to know the lease backward and forwards.
Every word of the lease is crucial. It is important that everything remain clear for both the owner and the tenant. It is a good idea to have an outside party review the lease and compare notes. If there are questions, please ask them and be straightforward about any concerns. This process is usually so important that I do not let anyone else handle it.
It is in my best interest that I understand every detail of every lease. Otherwise I am just setting myself up for failure with these tenants and sometimes even the owners. Sometimes the owners don't even know the specifics of each lease. That is why you need to ask questions and understand each situation. It is the nature of the job that sometimes people tell me too much and I must remain objective. Still this creates a level of honesty I have come to respect of my clients.
Well as it happens with more and more questions come up things that the client remembers about the leases and something I may not have been aware of from the get go. So I cannot stress enough how important to ask lots of questions in the process. The way I see it is, this is a chance to find out about information that may not have already been discussed.
Remember to get a payment history from tenants. This does not lead to many surprises. For instance, if there is a problem tenant, someone who is consistently late with the rent, then I want to beware of that issue upfront. If it is chronic problem, I may see the need to discount the cash flow, which in turn leads to a lower price offer.
There is also the situation where the owner or property manager does not have a system to tracking the cash flow, or documentation of the rental payments, or even a way of verifying with their bank, this proves to become a much more risky situation for me and everyone involved. Here too, the risk translates to a lower bargaining price. It has been my experience that in these cases, the paperwork magically appears.
One can always tell a lot of vital information from the insurance policy, especially in the case of a building with some age. Mind you, a lot of times insurance inspectors know all the tricks of the trade and if you are able to get a hold of the last risk assessment you will be ahead in the long run. You can request this from your client usually the insured is the owner but a copy is a must. If it is at all possible, get a claims history as well. This can be a grey area because lot of times, you will have to jolt the owner's memory and this can become issue if they changed carriers every year. Here there is no real worry, people change insurance providers all the time shopping the best rate is so common but be cautious if they have failed to pay a policy. What is best in this situation is to make sure the owner can get an affidavit discussing the truth of the claims represented as being complete to the extent of his knowledge. This can be important for future possible litigation because many sellers want the warranties to survive closing.
When in doubt look to the existing title policy. This will inform you the obvious information regarding easements, rights of way, etc. Be on the lookout for any special exceptions to title. It is best to have a General Warranty deed if you can get one. A smart seller will offer a Special Warranty deed as incentive, which will only guarantee title for the time they owned the property.
To further the argument, it is also important to keep in mind the amount of resources and the type of property when completing a due diligence process because some steps may not be warranted. Really when it comes down to it, there is no other proper substitute for due diligence, but this does not stop people from not understanding its importance. No property is perfect and unfortunately there is no way of preventing this without further investigation. In the long run it protects all parties. Depending on one's needs, it is fair to say that each transaction will decide what level of due diligence is needed. There are companies out there that all they do is specializing in this practice.
For many the differences between Commercial real estate properties and residential properties can be daunting to define. It is all about assessing value. The value of a commercial property can be determined by setting an inverse proportion to the degree of risk inherent to the continuance and stability of the income stream from the property. Each type of commercial property has varying degrees of this risk to profit ratio but none more complex than the multi-tenant property, either office or retail.
The due diligence officer has the very important task to verify, verify, verify. Of course there area exceptions to the rule and one major are the true triple-net property. There's a misconception about what is a real and true triple-net property. Seems that commercial real estate professionals to the point where their definitions not only confuse the buyer but also mislead them to have thrown around a bunch of jargon and terminology.
Honestly speaking the true triple-net, multi-tenant property is an extremely rare find. What this means with a true triple-net leased property is that the tenant takes on the responsibility and expenses of operating the property and this can include a long laundry list such as property taxes; property casualty, and liability insurance; all maintenance including: structural components, mechanical systems, plumbing and drainage systems, glass, and the roof. This just does not happen with most commercial properties.
For the owner, they have a vested interest in the property, which boils down to a small amount of inclusive rights relating to real estate. The only thing this owner needs worry about is where the rent check is sent. Sounds like a property manager's dream come true. The only real way to make the property work that well for you, in the case of a multi-tenant property, is to set up a master lease for the entire building. What happens is then the lessee sublets to each individual tenant. It's almost as if the lessee acts as your agent in the continued transactions for the property.
Posted by: Elliot Barron in Analyze on
Jun 14, 2008
You can use one of a variety of approaches to analyze a real estate investment, or you can use a combination of approaches. It's just as important to choose the right way to analyze a property as it is to carefully pick the right property, since the wrong approach can mean lost profits. Below is an overview of different approaches used to assess the value and returns on a property, with notes about any drawbacks to using a particular method.
One common approach is the sales comparison approach. When you compare the property you're considering purchasing with similar properties that have been sold recently, you can come up with an estimated value per unit or per square foot.
Another approach is using a gross rent multiplier to get a working estimate of value. This is usually the approach favored by investors who buy the same types of property over and over. They take the sale price and divide by monthly potential gross rental income to determine the value of the property based on the first year's potential for rental income. The drawback is that this approach only gives you an idea of the value for the first year, and it only works if you're careful to compare properties that will have similar occupancy rates and similar expenses for operation.
Posted by: Elliot Barron in 1031 Exchange on
Jun 13, 2008
If you're considering selling an investment property and buying one or more new ones, consider a 1031 Tax Deferred Exchange. Using this section of the IRS tax code can save you a lot of money in the form of deferred capital gains taxes. Of course, checking with your tax advisor before doing one of these property exchanges is a good idea. However, once you've determined that a 1031 exchange is the right move for you, these tips will help the process go smoothly.
First, you must understand what kind of transaction qualifies under Section 1031 of the IRS code. The key here is the term "like kind." This doesn't mean that land can only be exchanged for land or that an apartment building can only be exchanged for another apartment building. What it does mean is that the investment or commercial property must be exchanged for another property that will be held for use in a productive business or investment capacity. In fact, you can use the proceeds from several property sales to buy a single property. Or you can exchange your current property for multiple new properties. Just make sure the fair market value of the new properties doesn't go above 200 percent of the value of your old property. For more information on what kind of property swap will qualify, search the term "section 1031" at the IRS's website (http://www.irs.gov/index.html).
Once you've done this, it's time to list the property you own with a real estate broker. You should make sure that the listing agreement specifically states that you intend to use the property to complete a 1031 exchange. If you do a FSBO (for sale by owner) transaction, make sure the sales contract contains the required legal terms.
The next step is a typical real estate transaction. Once an interested buyer makes an offer, you can accept it or counter it. When you're talking or bargaining with the potential buyer, make sure everyone involved is clear that you will be doing a section 1031 property exchange.
There are a wide range of deductions available for most real estate investments. Investors will often seek to purchase properties because of tax benefits available to the owner. Eligible income tax deductions for all properties include things like mortgage interest paid and property taxes. Even more deductions such as maintenance expenses and hazard insurance premiums are available on investment properties.
The obvious goal here is to protect as much of your income from taxes as possible. Knowing the available tax deductions can turn a good property investment into a great one. An informed investor can be very effective at doing this. Let's look at some of the most popular tax deductions for real estate owners in a little more detail.
One income tax deduction is mortgage interest. Any mortgage interest paid during the course of the year can be deducted from your taxable income for that year. For example, a $100,000 mortgage at 8% interest will yield an interest deduction of $8,000 during the first year of the loan. This would allow you to deduct $8,000 from your taxable income if you itemize your deductions. The deduction for mortgage interest paid is the same for all properties you might own, whether investments or otherwise.
There have been huge shifts in the real estate industry in the last few years. While the market have seen a dramatic downturn, and interest rates have tumbled, sellers and buyers are asking themselves what it all means, especially when it comes to property values. The topic of "appreciation" is one of particular interest, and I'm not talking about a broker buying you a hand-held vacuum as a gift for purchasing a home from them. Appreciation is the increase of value to a property for various reasons that can include relative value to surrounding properties, construction and improvements, or any other factor that affects the value positively.
While it may seem like a cut-and-dry topic, appreciation is actually a clouded subject and can be confusing. It gets even more confusing when you consider the following claim: properties do not appreciate in value. Are you confused yet? Well, let me explain.
Flourishing real estate markets abound, and these markets have a plethora of eager investors. Some of these same investors are confused and thwarted in making an investment despite the favorable conditions they may have stumbled upon. And yet, others are finding more opportunities than they could have ever imagined, and are enjoying much growth.
A smart way to purchase property without regrets after the sale consummates, is to put safe guards in your sales contract that give you a safety net. One of these nets is to always make any offer subject to a SATISFACORY property inspection. Now, whether you can perform this yourself or hire a professional, you still have a legal way of voiding the contract to purchase if something should be revealed that could cause potential financial risk down the road for you. Finding such an inspector is not a hard task and word of mouth within the real estate community is usually the best route. But you can also locate potential inspectors on the internet as all should be licensed with their state.
You are looking for hidden or masked areas of structural, electrical and plumbing problems that the owner is purposely or inadvertently not disclosing that could be major issues down the road for you. If you feel you possess adequate expertise to perform your own inspection, be sure to pay close attention to the following list of possible trouble areas:
Another area of concern that most home buyers take for granted, is past land use that could have caused residual soil contamination. Such as, if a gas station or industrial business that typically used gas or cleaning solvents in the past or the property was used as a dumping ground for hazardous/toxic wastes of some kind.
