Common Lease types

I am not a real estate agent, nor a property management expert. Therefore this brief, simplistic summary of commercial real estate leases is taken from my experience reading the leases as we underwrite deals.

With that said, commercial and industrial properties can be leased in a variety of lease agreements. The tenant might be responsible for the real estate taxes, the insurance premiums, and the repairs; or the lessor (owner) may be responsible for all of them. Another possibility is for the owner to be responsible for taxes and insurance, and for the tenant to be responsible for the rest of the operating expenses.

In fact, there could be an endless variety of ways the lease can be structured. However, the most common lease types are as follows:

• A full service lease is a lease in which the lessor (owner) is responsible for all of the operating expenses, including but not limited to taxes, insurance, repairs, and utilities.
• A net lease (N) is a lease in which some of the operating expenses are paid by the tenant. A net-net (NN) lease is a lease in which the lessee (tenant) pays the two major expense items: taxes and insurance.
• A triple net lease (NNN) is a lease in which the tenant is responsible for “all” of the operating expenses. This includes, but is not limited to, the three most significant expense items: taxes, insurance, and utilities. A true triple net lease is one in which the lessee (tenant) pays all of the operating expenses and the lessor (owner) simply receives his one check every month. Unfortunately the term is often misapplied to leases in which the lessee pays for most, but not all of the operating expenses. You are cautioned to read the lease carefully to determine which expenses each party is responsible for.

Expenses often paid by the lessor (owner) in so called “triple net” leases are management, common area maintenance (CAM) and common area utilities.

Many Multi-tenant buildings are leased on a “triple net” basis where the real estate taxes, the insurance, the common area util­ities, and the common area maintenance expenses are prorated among the tenants on a pro rata basis. The basis most commonly used is the net rentable square footage of each tenant’s space as a percentage of the total net rentable square footage. By net rentable square footage we mean the space actually available for rent as opposed to the gross square footage which includes hall­ways, stairwells, elevator shafts, and lobbies.

With this simple overview you should be better able to analyze deals and put together useful operating statements.

The Operating Expense Ratio

In my experience it is the size of a loan that the borrower can obtain that is usually more of a sticking point than the rate or the loan fee. Now that you all know that loan sizes are gen­erally limited by the debt service coverage ratio (i.e., cash flow) rather than the LTV, the operating expense figure that the lender uses in his calculations is critical.

Whereas operating expense ratios are helpful in evaluating Multi-family properties, they are not as useful for commercial or industrial properties. This is because those spaces can be rented on a triple net basis, a net basis, or a full service basis.

Let’s suppose you have a commercial property with gross leases and the following Operating Statement: [Click here to view a PDF of the statement]

The operating expense ratio is defined as follows:
Operating Expense Ratio = Total Operating Expenses
______________________________EGI
or in our example,
Operating Expense Ratio = $159,311 = 44.7%
_______________________$356,670

Appraisers and professional property managers often keep track of the operating expenses of the buildings they appraise or manage, and publish their results. For example, the National Association of Realtors publishes the results of their surveys annually in several hardbound books including Income and Expenses Analysis – Apartments and Income and Expense Analysis – Office Buildings.

Lenders have access to these types of publications and therefore are reluctant to accept at face value operating expenses supplied by the borrower when their operating expense ratios are less than those experienced by similar buildings in the area.

It might be possible to operate an apartment building or commercial building with gross leases IN THE SHORT RUN at an operating expense ratio of less than 30%. However, in the LONG RUN the end result will be a seriously deteriorated building. It might be possible to get an operating expense ratio as low as 28% accepted on a very new building if it had fewer than 10 or so units, and if it had no pool and very little landscaping, and if you had 2 to 3 years of authentic source documents to back up your claim. But in general, it is difficult to get operating expense ratios on apartments of less than 30% accepted.

The following are factors that will influence the lender to use a higher operating expense ratio:

1. Lack of individual metering or utilities
2. Swimming pool
3. Elevator
4. Extensive landscaping
5. Low income area and/or tenants
6. Presence of families with children

In general, larger projects will require a larger required operating ratio. Large projects usually entail extensive recreational facilities and pools, and often require a full time on-site management team.

So after you are done putting together the operating statement with the information from the borrower double check the operating expense ratio to see if it will meet what most lenders are looking for.

Credit Market Crisis Counsel

This commentary from CNN Money was too good not to post. It is a little long but well worth the read:

"Stupid" investors, rejoice!
Ben Stein Economist, writer, lawyer, and actor

No one is too stupid to make money in the stock market. But there are many who are too smart to make money.

To make money, at least in the postwar world, all you have to do is buy the broad indexes domestically--both in the emerging world and in the developed world--and, to throw in a little certainty about your old age, maybe buy some annuities.

To lose money, pretend you're really, really clever, and that by reading financial journalism and watching CNBC, you can outguess the market day by day. Along with that, you must have absolutely no sense of proportion about money and the world at large.

For example, right now we are stewing over what everyone calls "the subprime mess" and going crazy, mourning all day and into the night--falling over ourselves to get all of the misery right, to paraphrase Evita. I'm writing this on Aug. 13, 2007, and in the past four or five weeks, the markets of the U.S. have lost some 7% of their value, or about $1 trillion.

But read on: The subprime mortgage world is about 15% of all mortgages, or $1.5 trillion worth, very roughly. About 10%--approximately $150 billion--is in arrears. Of that, something like half is in default and will likely be seized in foreclosure and sold. That comes to about $75 billion. Roughly half to two-thirds of that will be realized on liquidation, leaving a loss of maybe $37 billion. Not chump change by any means--but one-thirtieth, more or less, of what has been knocked off the stock market.

The "smart" investor nevertheless reads the papers, bails out, heads for the hills, and stocks up on canned foods. He gets a really big charge out of reading in the press that there are also problems in the mergers and acquisitions market and that some deals will not go through because there are problems raising the funds for the deal. He does not see that the total value of the U.S. major stock markets (the Wilshire 5000) is roughly $18 trillion. The value of the deals that have failed in the private equity world is in the tens of billions or less. The loss to investors--what the merger price was compared with the normalized premerger price--is in the billions. It's real money, and I could buy my wife some nice jewelry with it, but it's pennies in the national or global systems.

The "smart" investor also reads that the Fed has injected, say, $100 billion into the banking system in the last week or ten days, and says, "Aha! The whole country is vaporizing. Look how desperate the system is for money!" What he does not see is that the Fed is always either adding or subtracting liquidity and that recent moves are tiny in the context of a nation with a money supply in the range of $12 trillion. No, the "smart" investor is far too busy looking for reasons to run for cover and thinks he can outsmart long-term trends.

The stupid investor knows only a few basic facts: The economy has not had one real depression since 1941, a span of an amazing 66 years. In the roughly 60 rolling-ten-year periods since the end of World War II, the S&P 500's total return has exceeded the return on "risk-free" Treasury long-term bonds in all but four ten-year periods--the ones ending in 1974, 1977, 1978, and 2002. The first three of these were times of seriously flawed monetary policy that allowed stagflation, and the last one was on the heels of the tech crash and the worst peacetime terrorist attack in the history of the Western world.

The inert, lazy, couch potato investor (to use a phrase from my guru, Phil DeMuth, investment manager and friend par excellence) knows that despite wars, inflation, recession, gasoline shortages, housing crashes in various parts of the nation, riots in the streets, and wage-price controls, the S&P 500, with dividends reinvested, has yielded an average ten-year return of 243%, vs. 86% for the highest-grade bonds. That sounds pretty good to him.

The "smart" investor, in a bunker in the Montana wilderness, keeps his money in gold bullion. After all, he's heard that home prices are falling slightly nationwide and a lot in some areas (he ignores areas of rising prices like San Francisco and New York City). He says that this will discourage the consumer and lead to a severe, bottomless recession. He even has bald people on TV telling him he's right to worry.

The stupid investor, the guy who just lies on his couch, knows that the consumer is always about to stop buying and never quite does. Maybe someone in his bowling club has told him there has only been one year since 1959 when consumer spending fell--and that was barely, in 1980. Somehow, if the consumer could keep spending after the bursting of the tech bubble wiped out $7 trillion or so of wealth, maybe the consumer can keep spending even if the subprime "mess" wipes out roughly half of 1% of that tech-bubble loss and the stock market has a fit. And maybe he knows that, even if there is a recession, recessions rarely last more than two quarters, and the economy and the stock market revive mightily after that--and that buying stocks in a recession is a good idea, not a bad idea.

Now, the alert reader may at this point be saying, "Hey, that `stupid' guy who's really smart is a long-term investor. That's why he's doing so well." Correctamundo, alert reader. There used to be a saying: "Bulls make money and bears make money, but hogs get slaughtered." I am not sure that was ever true, but it sure ain't now. The real story is that long-term investors who have some sense of proportion make money. Short-term investors who live and die by the sweep-second hand of the $300,000 watch get rich fast and poor fast and sometimes are slaughtered faster. I have no advice for them except that the next train may be bringing in someone a little younger who's a little faster on the draw and a lot hungrier, so they'd better enjoy their Gulfstream while they have it.

For the rest of us, the stock market is cheap on a price-earnings basis, profits are fabulous, Mrs. Clinton and Mr. Giuliani are far from being socialists and in the long run, both here and abroad, stocks are a lovely place to be. I have no idea what the S&P will be ten days from now, but I am confident it will be a lot higher ten years from now, and for most Americans, that's what we need to think about. The subprime and private equity and hedge fund dogs may bark, but the stock market caravan moves on.

Find this article at:

http://money.cnn.com/galleries/2007/fortune/0708/gallery.crisiscounsel.fortune/13.html