There is an expression that you get the good with the bad, and yes, the bad with the good. It is critical to have a complete and thorough understanding of what you’re getting before you purchase a commercial property. Such a transaction can be compared to a marriage, particularly, the vows of in sickness and in health.
As a buyer of commercial property you should always inspect the “master lease covenant” and review the individual tenant commercial leases during your due diligence time. In addition, be sure to have updated reports on vacancy rates and market rents for your area and type of property.
When commercial space is leased, a tenant will pay for more than just the actual square footage they will occupy. It is a standard operating practice for many commercial leases, and in particular retail and industrial space leases, to include extra fees in the leasing rate.
These fees, often referred to as “Common Area Maintenance” (CAM) fees or in non-industrial spaces, referred to as “Load Factor” fees function as a tenant sharing a portion of the direct costs of maintaining very specific common areas. Typically they can be fixed and may be paid monthly, quarterly, annually, or even charged from time-to-time as major repairs to the building or entire business/industrial park are required.
I have found hidden treasures in commercial deals and some pleasant surprises just by taking the time to review the property operating guidelines and the tenant lease. Here are some profitable example that I have experienced:
- Land. In several deals there was additional land which was not really counted on with the deal, but kept in the back of our minds as something of value. In two of the deals, this added $1 million in profits for each. Be on the lookout for extra land.
- Abstracting the leases. As crazy as it sounds, you would be amazed at how many times I have looked at residential and commercial leases, and the landlord or management agent was not getting the maximum value of what usually relates to what can be billed to the tenants. These can be a hidden gold mine. I would read every lease carefully and compare it to what’s really happening in real life.
- Unbilled or under billed CAM or expenses’ reimbursements: I have seen many a deal where the owners were not billing for what the lease specified. Some common examples of what I have seen are water/sewer bills and escalations in real estate taxes. Pay close attention to how the CAM is calculated and what’s in it and what’s not.
- CAM adjustments at closing: Typical CAM is adjusted after the calendar year is over. Adjustments are made with the tenants in February or March for the previous calendar year. For example, if you close on a property in August, the shortage or excess for the following adjustment period is typically yours. However, keep in mind that this can work for or against you.
- CAM. If it’s an existing lease, check the exact wording, or if you do the leasing, use a good lease and modify it. Some common items you might be able to put in the CAM are a certain percentage on top of actual repairs and other expenses such as an administrative fee which is usually 10-15% on top of the cost. You can also include in the lease the amortization of some major capital items such as roof, blacktop or HVAC work. Of course, some tenants will negotiate this or put limits on it. Of course, if your CAM is too high, you will frighten tenants away, or you will have to lower the base rent. As in anything else, be careful and do not be greedy.
- Size. In real estate, size does matter. I have seen leases in which the property is listed as a certain size, but in reality, it’s larger or smaller. Commercial rents are typically based on the square footage so as they say measure twice and cut one.
Of course, there are the not so hidden treasures, such as underpriced units where you can raise the rents, real estate tax appeals, and developing the property for more optimum income. Be on the lookout for the hidden treasures or ways to extract value from a deal for which you are not paying. It can turn a single into a home run very quickly.