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Cravey Real Estate Services, Inc. 5541 Bear Lane, Suite 240 Corpus Christi, TX 78405 361-289-5168 Office 361-289-5442 Fax [email protected] A Full Service Commercial Real Estate Company www.craveyrealestate.com Check us out on: Twitter Facebook Linkedin Commercial Real Estate Investment Newsletter Lenders Need Professional Property Management October 2016 Whether times are good or bad, the lender retains an asset This publication is not lenders always have foreclosed management firm as its agent, a solicitation but is an information service from properties in inventory. During a with the firm agreeing to defer a this office. recession the inventory may be high. portion of its fees until payment One of the problems that banks can be made out of future cash and insurance companies have is flow. The relationship may be a In This Issue disposing of this real estate owned straight principal-agent one, or a • Lenders Need (REO). They are faced with the deci- new joint venture can be created Professional Property sion of whether they wish to dispose in which both the lender and the Management of the property immediately or hold management firm are partners. it for a period of time to hope for an Some lenders who want to avoid • Having Knowledge increase in value. They would like to a formal ownership position in About Commercial see the value of the REO increase to distressed property desire this Leases equal the loan amount. approach. These lenders are not professional The differences between the • Combining A real estate investors but money fee structure of a service joint Tax-Free Exchange managers. Therefore, they are reluc- venture and more traditional And A Leaseback tant to invest any additional money arrangements are as follows: in the properties. This problem is • Management fee. In a 1031 Exchange Rules compounded because a troubled service joint venture, the agent and Timelines property needs more attention than receives anything from a below- • Checking Prospective does a healthy one. It would not have market fee to no fee at all until been in foreclosure if it didn’t need the project achieves a specified Tenants For help. level of net operating income Commercial Centers The solution might be a service joint (NOI). After that, the asset • Real Estate venture. This type of contract with manager receives a designated a real estate firm allows the lender portion (for example, 50%) Investment to minimize management fees until of the NOI over the threshold Consultants the property is generating cash flow amount. By comparison, the again. traditional management firm When ideas in tax and other receives either a fixed fee or a legal areas in this publication Lenders Getting Together With seem to fit your situation, Asset Management fee based on a percent of the it is recommended that you The service joint venture is a form gross income. discuss them with your of incentive compensation by which • Lease-up fee. In a service professional advisor before ß taking action. (continued) joint venture, the agent may receive anywhere a traditional arrangement gives the agent a higher from a full leasing fee to none at all. The vari- percentage of the total sales price but no share of able relates to the type of property involved. In the amount over a designated threshold. the case of an office building, retail property, or • On-site marketing and management. Here, industrial project, the agent normally receives both the service joint venture and the conventional the full market fee because payment is usually a agent receive a fee as provided for in the property commission rather than a straight salary. On the budget. other hand, for residential properties, the fee often The value of the service joint venture is that the is deferred until a future date. management company is co-opted because it • Commissions upon sale. In a service joint receives incentives in exchange for fees. In this venture, the manager receives a substantial portion way, the management company shares the objec- of the sales price over a threshold price, together tives of the lender to maximize NOI and value as with a negotiated commission that is slightly fast as possible. o below the traditional percentage. By comparison, Having Knowledge About Commercial Leases A lease is an integral part of many real estate the tenant to make money from such an arrange- investments. It should outline all the obligations ment. For this reason, some leases do not allow of the tenant and of the landlord. This sounds subleasing. simple, but many questions arise. If, for example, Percentage Lease. The amount of rent is related property taxes increase, does the tenant pay all to a fixed amount, plus a share expressed as a of the increase or only part of it? If the property percentage of the gross or net sales or profits of must be modernized, who pays for the improve- the business to be paid as additional rent. ment? Can the tenant be moved out during the renovation? If the costs of servicing the prop- Ground Lease. Only the land is rented. The tenant erty rise, should the tenant pay none, all, or part owns the improvements. When the lease ends, of the increased costs? How should inflation provisions are made for allowing the tenant to buy be handled—with automatic rental increases? the land or the landlord to buy the improvements. With increases tied to some index, perhaps the Leasehold Estate. The value of the lease to the Consumer Price Index? tenant. If the tenant has negotiated a rent below Kinds Of Leases market the tenant has a valuable right (perhaps by subletting at market rents). If the rent is above Here are some of the variations of leases used on market the landlord has an advantage, but if the commercial and industrial properties: tenant is a strong, credit-worthy tenant the lease Flat Rate Lease. This is the traditional lease in may be subject to renegotiation. which the tenant agrees to pay a flat periodic rate Index Lease. The lease amount is related to an for the term of the lease. This might work with a index and changes as the index changes. For very short lease, say one year. example, banks located in shopping centers cannot Net Lease. Some investors try to protect their net be charged on the basis of percentage of sales income flows by requiring the tenant part (double because there are none. In such cases an index net) or all (triple net) of the expenses. For such as the Consumer Price Index might be used. example, the tenant may pay the property taxes; Renegotiable Leases. The rents are subject to or property taxes and insurance; or property review and renegotiation at a particular event or taxes, insurance, and all maintenance and opera- after a given number of years. These are usually tion expenses. When a net lease is mentioned, related to inflation measures and indices. always ask what the landlord pays and what the tenant pays. Improperly drawn leases may not produce enough income to cover the costs of owning and operating Sandwich Lease Or Subordinated Lease. The the property. And long-term leases in particular tenant leases all or a portion of the property to a present problems when prices, costs, and money third party who pays to the original tenant. The rates are fluctuating. There is no substitute for a sandwich lease may be at a rate slightly higher lease prepared by a skilled professional. o than the original lease payments, thus allowing Combining A Tax-Free Exchange And A Leaseback Here is a moneymaking transaction that can be used for the office, which will then be sold to a third party by many business owners who also own the real estate for cash. where that business is located. In any community there The real estate broker then finds a third party who is are dozens, even hundreds, of property owners who can willing to pay $120,000 for the equity in the office utilize this formula. property and assume the $30,000 loan. The office will In certain circumstances, it is possible to combine then be leased to the insurance broker on a long-term a tax-free exchange with a simultaneous leaseback. basis at current market rent. The purpose is to free up frozen equity in a property The transaction is closed via a three-party exchange. that the owner wishes to continue to use for business. The freed-up capital can then be used to acquire other Benefits income-producing property or for personal purposes. The owner of the apartment receives all cash for his By utilizing the tax-free exchange, the property owner equity. can avoid laying out any cash or paying any income tax. The insurance broker has acquired an income prop- (There will be some cash required for escrow fees and erty worth twice as much as his original property. commissions.) Assuming that the return on the apartment investment • Example: Consider the case of an insurance broker is higher than the existing mortgage, the cash flow who purchased a small one-unit office building some from the apartment property is likely to substantially years ago in his home town in which to conduct his exceed the rental payments that this owner must pay insurance business. The initial purchase price was for the office space. $75,000, of which this owner put up $25,000 in cash If the apartment property and the original office and took out a $50,000 bank loan. As the years passed, building appreciate at more or less the same rate, the the property appreciated so that it now had a market insurance broker has doubled the appreciation poten- value of $150,000, while the mortgage has been tial of his equity.

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