Commercial Real Estate – Santa Cruz
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Client Resources

REGISTERED CONTAMINATION SITES:


(The following sites will help you see if there is contamination on or near your property)

State Water Resources Control Board:  http://geotracker.waterboards.ca.gov/

Department of Toxic Substances Control (DTSC): http://www.envirostor.dtsc.ca.gov/public/

Santa Cruz County Site Mitigation List: http://scceh.com/eh/hm/SiteMitigationList.pdf

 

COMMERCIAL REAL ESTATE TERMS:


How much is Rent?

NNN Lease

When rent is quoted as a triple net lease, it means the owner of the building doesn’t pay the operating expenses (the tenant pays for building insurance, building property taxes, and building maintenance or utilities). The rent is called “base rent” and the operating expenses are either called triple nets, common area maintenance costs (CAM’s), or operating expenses. The expression “triple net” comes from the exclusion of costs related to property taxes, property insurance and property maintenance. So the rent quoted will also include triple net: building taxes, building insurance and maintenance (maintenance is water, garbage, electricity, gas, landscaping, air conditioner maintenance, etc.)

The triple net lease structure can vary, from a tenant being responsible for the entire building and site, including its structural integrity, to the landlord maintaining some limited responsibility for maintenance of perhaps the roof, exterior walls and foundation. Capital improvements are often either paid for by landlords or the costs are amortized (the payment is distributed into multiple installments over a specified period of time). These terms are subject to negotiation.

Gross Lease

When rent is quoted as a Gross lease, it means the owner of the building doesn’t pay the maintenance/utilities of the property and premises. Usually the owner pays the costs of the property insurance and property taxes.

In the case of a modified gross lease, the tenant might pay for water and electricity for the premises and their share of the garbage service and landscaping. Owner still pays for building insurance and property taxes.

Full Service

In a full service lease, the rent includes all of the operating expenses and utilities. Often the landlord also pays for janitorial service to the premises and the common area (common hallways, common walkways, shared bathrooms, etc.).

Rentable and Usable area

If a tenant measures the premises from the interior of the walls, the resulting square footage is called usable.

To determine a rentable area (one that is multiplied by the rent per foot calculate monthly rent) you measure to the center of common walls and outside of exterior walls. To this, you add an assessment for the percentage of the building that is common hallways, entrances, stairs, elevators and other “common areas”. For example if a 100 square feet of a 1000 square foot building was common area the rentable area would be 10% greater than the square footage achieved by measuring to the center of the common walls and the exterior of the outside walls.


 

TENANT IMPROVEMENTS

Market ready

When a landlord offers a space for lease, often times it is not in the ideal condition for prospective tenants. Landlords frequent try to make the space “market ready” which can include the carpeting being replaced, walls patched and painted and upgrades such as cabinets, sinks etc.

In spite of market ready improvements tenants frequently need further improvements, also known as “tenant improvements.”

Landlords expect to makes some level of improvements to the space and so the offering rent usually anticipates some expenditure toward improvements specific to a tenant. In commercial real estate rent, sales price and improvement costs are quoted on a price per foot.

Tenant improvements that don’t affect rent:

When a landlord offers a space for lease, often times it is not in the ideal condition for prospective tenants. Landlords frequent try to make the space “market ready” which can include the carpeting being replaced, walls patched and painted and upgrades such as cabinets, sinks etc.

In spite of market ready improvements tenants frequently need further improvements, also known as “tenant improvements.”

Landlords expect to makes some level of improvements to the space and so the offering rent usually anticipates some expenditure toward improvements specific to a tenant. In commercial real estate rent, sales price and improvement costs are quoted on a price per foot.

Vanilla Shell

In some instances the tenants (medical / retail usually) will want the space delivered in a vanilla shell and the tenant does the work from there. Starbucks wants the space delivered with white walls, dropped ceilings, a bathroom and certain amounts of electricity. They take it from this vanilla shell and finish the space.

When tenant improvement affect the rent:

Lets assume Tenant A will rent 5,000 s.f. and will sign a 5 year lease for office space that needs carpet and paint, otherwise it is in marketable condition. Tenant A needs a kitchen and their own bathroom. Tenants will often want their own restroom.

The cost for a restroom is roughly $8,000 to $12,000 and a kitchen is roughly $4,000 so a total of $16,000.00 needs to be installed over and above the expected carpet and paint.

The landlord and tenant would then negotiate over who pays for this and how it is paid. Frequently it is amortized by the owner over the lease term – and in many instances amortized over a longer period of time because these improvements will likely be appreciated by future incoming tenants.

This is how the math works over 10 years at a 5% cost to the landlord: Cost of extra improvements: $16,000.00

Amortization period: 10 years

Interest rate: 5%

Monthly payment: $169.00 (there is an amortization schedule in excel) Cost per foot/month: 3.3 cents ($169.00 / 5,000 sf = $ .033

If the tenant wants to add something that that is not generic like replacing new carpet with something more specific, a Landlord would negotiate who pays. Often the Landlord would add the amortized amount of this expense into the rent over the term period.

The value of extra rent:

A leased building is worth what an investor would pay for the income stream (net income, meaning rent minus all expenses associated to the property). Many buildings are leased on a triple net basis so finding value is simple (please note that many people deduct things like vacancy costs and future capital improvements – capital improvements are those that increase the useful life on the building – for example structural improvements.

When you find a rate of return investors will accept (amount of profit received over time divided by the total amount of the investment, and necessary rate of return varies depending on the financial strength of the tenant, terms of lease, cost of leverage (any loans or mortgages on the building, etc. We call the initial rate of return the cap rate as it is a capitalization rate of the income stream (first year annual rent).

The “cap rate” is the first year income divided by the asset’s value or purchase price. It is the ratio between year one net operating income and the value or purchase price expressed as a percentage. The internal rate of return is the total return on investment (cash flow for the life of the holding period including disposition amount) divided by the initial investment amount or purchase price. So while the cap rate is the ratio between the investment amount and the first year net operating income, the internal rate of return is the cap rate plus any growth. Sometimes investors will purchase properties with a current cap rate under their comfort level because they anticipate growth.

Devil in the details:

CAP rates discussions and valuations derived there from are helpful, but the estimation of a particular property cap rate is difficult to project. Active commercial brokers are the best people to estimate cap rates because they know market rents (and can speculate first year income), based on their market experience.

Rent and CAPs

If the landlord in the case above was able to get 3.3 cent a foot more in rent it affects the building value. Let’s assume the building is worth a 6% cap with the prospective tenant. 3.3 cents on a 5000 s.f. space adds $165.00 a month in income or $1,980.00 per year. If you capitalize this $1,980.00 at 6% valuation you get $33,000.00 in increased value, which substantially exceeds the cost of the bathroom and kitchen.

Many landlords are willing to improve space for credit tenants as the increase in rent (subject to negotiations) more than offsets the costs.