Understanding Commercial Property Management

Investing in commercial property can involve investing in multi-family real estate or in buildings that are rented out for business and industrial purposes. Commercial rental property encompasses everything from a rental house to a huge apartment building to a large industrial warehouse or office building. Any time you own a property as an investment that you do not live in and that you intend to make money renting out, this property can be viewed as a commercial property.

If you are the owner of a commercial property, you will need to understand commercial property management. Managing your property effectively is the key to making your investment pay off. Managing your property well while help you to get and keep tenants and will help you to improve your property value so you can benefit from property appreciation.

Understanding Commercial Property Management

When most people think of commercial property management, the focus is on tenant relations. This is, in fact, a key part of commercial property management. After all, you need to have tenants so you don’t have a vacant property that costs you money to operate but that doesn’t bring cash in. You need to keep your tenants happy so that they will want to stay, and you’ll need to make sure that the tenants follow the rules of the lease so they don’t do damage to your property or annoy other renters. You’ll need to respond to tenant complaints, make repairs as needed if there are problems that impact your tenants, and ensure that you are regularly collecting rent. If a tenant leaves, you’ll also need to find a new tenant to take his or her place so you do not lose your rental income.

While tenant management is the cornerstone of property management, it is not the only important aspect of commercial property management. You also need to take care of the building itself in order to make sure that your property doesn’t become run down and to make sure that it keeps pace with competitor spaces so that you can remain attractive to tenants.

This means that a part of commercial property management is doing ongoing maintenance and periodically upgrading your space. You don’t want to let problems go until they develop into big issues and you don’t want to defer maintenance until you have problems. Instead, you will want to make sure that you are always keeping up to date with the important systems and infrastructure in your building. If the systems need servicing, for example, you’ll want to have the servicing performed to keep everything operating well. The upgrades you will want to make should be done in keeping with what other similar apartments or commercial buildings are doing in your area.

Finally, the last part of property management centers on budgeting. This includes establishing an operating budget, setting rents and making sure that you have positive cash flow so that your commercial property can prove to be a good investment that brings income to you on an ongoing basis.

Investing in Real Estate – Should You Buy Residential Or Commercial Property?

We hear this often from real estate investors: “What’s the smarter move? Residential or commercial investment property?” It should come as no surprise that there isn’t a one-word answer to this question. You’ll arrive at your best choice — the one that maximizes your chances for success — by working through a decision process that includes some “global” issues, some local and some that are entirely personal.

Definitions

Let’s start with some terminology. For the purposes of our discussion, we’ll define as residential any property that derives all or nearly all of its income from dwelling units. Single-family homes, multi-families, apartment buildings, condos, co-ops are all residential. (FYI, the tax code classifies any property in which 80% or more of the gross income comes from dwelling units as residential, so many mixed-use properties can be classified as residential for tax purposes.)

For commercial property, we’ll use a typical layman’s definition: property that derives its income from non-residential sources, such as offices, retail space and industrial tenants.

Why do I say that this is the layman’s definition? Because appraisers and lenders would consider large (>4 unit) apartment buildings to be commercial investment property since they are bought and sold strictly for their ability to produce income and not as a potential personal residence for the owner/investor. However, it will suit our discussion better to treat all apartment buildings as residential properties.

Global Issues

What are the global issues that should affect your choice to buy residential or commercial property? The state of the U.S. economy certainly tops the list. If you believe we are in or are on the brink of a recession, then it makes sense to be cautious regarding commercial property. You will have to rely on businesses to occupy your commercial space, and if they’re struggling to survive or simply deferring their plans to expand, then rental rates may soften and demand for space decline. Replacing a lost tenant — especially one lost unexpectedly (in the middle of a lease, or the middle of the night) because of a weak economy — can take longer than it might in unstressed economic times. When the economy and employment are strong, of course, you are likely to see the opposite. Service businesses need more space, retailers open more stores, distributors need more warehouses.

Another issue is the cost and availability of financing. Interest rates are always important to investors, but there is one situation that may strike you as counter-intuitive. When home loans are readily available and mortgage rates drop, it’s not uncommon to see an increase in apartment vacancies, making apartment buildings less desirable as investments. The reason? Low mortgage rates and easy credit often mean that individuals can own a home at a monthly cost that is the same — or less, after taxes — than renting. So part of your potential tenant pool may be lost to home ownership.

Local Issues

In the real world, each of these global issues comes with a “however” attached. You need to stay on top of your local market because that market may contradict the national trend. For example, highly restrictive zoning regulations can mean that commercial space is always in short supply in a particular location, recession notwithstanding. And the cost of single-family homes in your community may be so high that there will always be a strong demand for rentals. Think globally but act locally (with apologies to environmentalists for borrowing their slogan).

Personal Issues

You could buy a property and then insulate yourself from it by turning over every aspect of its operation to a management company. But if you’ve never operated a property yourself, how would you know if the management firm is doing an acceptable job? Most investors begin as hands-on managers and your chances of success will be greater if you choose a type of property that you’re comfortable with.

So, at the personal level, will residential or commercial suit you better?

Unless you were raised in the woods by wolves, there is a very good chance that you’ve spent most of your life in a residential dwelling unit: a single-family house, a condo or an apartment. You have a first-hand understanding of the rights, obligations and appropriate behavior of a residential occupant. If you were a tenant, you probably also know something about the roles and responsibilities of both tenant and landlord. It is for this reason that first-time investors often lean toward buying a small residential building. You may not know the fine points of leasing and landlording, but you understand the basic ground rules. This is familiar and comfortable territory.

Of course, some novice investors come to real estate with a background in business and perhaps as a commercial tenant. If that description fits you, then becoming a commercial landlord may be an easy transition. You already have firsthand knowledge of how commercial lease deals come together, and what the parties typically expect of each other.

The Pros and the Cons

Like any of your investment choices, each type of property has its pros and cons. For example:

Residential Pros:

1. Residential units are generally easy to rent. Turnover in housing is high, so your pool of potential tenants tends to be large.
2. Leases are generally short, especially for apartments, so you can keep pace with the rental market. This means cash flow tends to be fairly strong with a multi-unit residential property.
3. Financing residential property is usually fairly straightforward. For smaller properties, the process is similar to financing a home.
4. The cost per unit tends to be lower for residential than commercial. The more units you have, the less likely it is that a vacancy will severely impact your cash flow.
5. You could live in one of the units of a multi-family property. Obviously it’s easier to keep an eye on the property if your eye is actually there.

Residential Cons:

1. Residential properties usually require a lot of hands-on management.
2. Residential properties usually require a lot of hands-on management. (That’s not a typo. I said it twice.)
3. With a single-family home, one lost tenant equals 100% lost rent.
4. Multi-family houses tend to be older and therefore may require more repairs and maintenance.
5. Residential tenants don’t keep office hours, so you can get a call or complaint at any time of day or night.
6. Larger multi-unit properties generally have a lot of traffic in common areas and will require greater upkeep.
7. Did I mention that residential properties usually require a lot of hands-on management?

Dealing with commercial tenants is quite different. Ideally, it’s business, not personal. You may require a personal guarantee on a lease, but you should expect to have more of a business-to-business relationship.

Commercial Pros:

1. Typically leases are longer, with built-in rent escalations. Five years, with options to renew is not universal but certainly quite common. Except perhaps for small offices, few businesses would be willing to go to the expense of becoming established in a particular location without a guarantee of more than just one year.

2. Many commercial leases pass through to the tenant a pro-rata share of certain expenses (or a pro-rata share of the increase in certain expenses, over a base). For example, the tenant may be obligated to pay its pro-rata share of property taxes and common-area maintenance. This helps stabilize the cash flow for the landlord and makes that cash flow more predictable.

3. Management is less hands-on than with residential. Renewals are less frequent. Many commercial leases are written to include the requirement that the tenant be responsible for interior repairs, HVAC maintenance, glass breakage, etc.

4. Depending on the type of space (i.e. more common with retail and high-end office), the tenant may fit-up the space to suit itself. The landlord may give a one-time fit-up allowance or a period of free rent, but the interior finish then becomes the tenant’s responsibility to maintain.

5. Because the property’s value is strictly a function of its income stream, you have the opportunity to create value by enhancing that income stream. In other words, you don’t need to rely on general market “appreciation” to increase the value of your property, but can take steps to do so yourself.

Commercial Cons:

1. Trying to purchase a commercial property on a shoestring may not be a realistic plan. Lenders are generally tougher underwriting commercial loans, especially if you have no experience operating commercial property. Down-payment requirements tend to be higher, as do interest rates. Loans are for shorter terms and often have a “balloon” requirement (i.e., must be refinanced before the nominal end of the term). The property will have to pass muster in terms of its projected cash flows and debt coverage ratio.

2. Leasing a commercial space can take much longer than leasing a residential unit. After a tenant is identified and basic terms agreed upon, it is usually necessary for attorneys for both sides to negotiate the language of the lease. The complexity and cost of this process can vary greatly, depending on whether you are dealing with a local or a national tenant.

3. Filling a vacancy can take much longer than with a residential unit. Commercial leases will typically require that a tenant exercise an option to renew well before the lease expires — perhaps six to as much as twelve months prior — so that the landlord can have ample time to look for a new tenant.

4. Financing commercial property can be more complex than with residential. You’ll need to demonstrate to the lender that the property will perform at a level that can can cover the debt service with room to spare.

5. If you don’t have experience being a commercial tenant, then becoming a commercial landlord may require that you get familiar with some concepts and skills that are particular to the commercial world. You’ll want to learn about “tenant mix” if you own retail space, about commercial insurance and about the billing and reconciliation of pass-through expenses.

While there is certainly no right answer to the question, “Residential or commercial?” there is probably a best answer for you. Do you want the hand-on involvement of residential? Do you have the resources for commercial? Do you want the potential for higher cash flow, and with it the possibility of greater risk? Do you prefer a more modest but more predictable return? Consider your objectives and preferences carefully, and evaluate your resources — time, money, skills — realistically. With a bit of luck, the answer should jump off the page.

How To Invest In UK Commercial Property! Exclusive Interview with Peter Bill of the Estates Gazette

Peter Bill, Editor of the Estates Gazette as well as 7 others experts in UK Commercial Property investing have teamed up to talk about how to successfully invest in UK Commercial Property.

Fiona Goldman recently interviewed Peter Bill, editor of the Estates Gazette.

Asking Peter Bill what his thoughts are on the future of the UK Commercial Property Market gives any prospective commercial property investor a real insight into where the UK market is heading in the next few years.

Fiona asked Peter “Would you say Great Britain is still a buoyant market to invest in with regards to property”

Peter replied “Yes I think it is, as we speak I think its been buoyant now for 8 or 9 years.

Is it slowing down? This we keep saying it’s going to but every year it keeps going up. If you can imagine a very tall glass filled with water on one side of the table and a very short glass filled with water on the other side of the table. The small glass for the amount of property that there is in the world and tall glass for the amount of money chasing it. At the moment there is probably 10x as more water or money as there is to property to buy. So there’s a massive over supply of money to property at the moment so that’s what has been driving it and will continue to drive it, its completely globalised now.”

This is great news for any prospective commercial property investor be they novice, intermediate or advanced investors in residential or commercial property investing in the UK.

To emphasise the benefits of investing in the UK Commercial property market right now, Stuart Law, founder of Assetz Finance, mentions his experiences in UK commercial property investing and why he thinks now is the time to invest in the market. Stuart say “Commercial property could also be new built student halls which are carved up into individual student apartments. That’s a particularly low hassle and a longterm investment and that’s generally high income as well. With commercial property, there really is two ways you can go in. You can go into commercial property by sector, so retail, shops, etc, offices or industrial. But another way of looking at is, whether or not the property is tenanted or untenanted, its very important to understand that with commercial investment its not been done before, but when you buy a property with a tenant in place, you’re paying a premium for the lease. The lease is the promise to pay, each year, four quarterly payments of rent. If you buy a building with out that promise and without that tenant in place, then you are just buying bricks and mortar. And when you buy bricks and mortar with a lease, you pay more.”

Issues such as taxation are important to consider when investing in uk commercial property. Amir Saddiq founder of the Property Tax Portal says “Say somebody purchased a property for £50,000 five years ago and its now worth £150,000 which is quite feasible, they may well have to report property values and they maybe liable to pay tax of upto 40% on the £100,000 profit. They have only got 25% left of equity on the property but they could have tax liablilitys as high as £40,000. So there the kind of areas that Daniel Feingold iin particular would start to get involved as he could help restructure people’s assets and give them the development advice they require”

Daniel Fiengold head of a leading independent tax consultancy in the UK, called Strategy Tax Planning said “Correctly structured, tax is only 22% in the UK. If you borrow to acquire a property you can offset the interest so it starts to slide down from 22% so a lot of people are effectively paying something like 10 or 11% tax on their rental income which is obviously a very attractive rate, a very low rate and in addition paying no capital gains tax. It provides a very, very exciting investment opportunity for them but its all about getting the right structure from the start. If someone comes to me saying I’ve bought a property then alarm bells normally ring but if someone comes to me saying I’m looking, I’m considering, I’m about to, then its normally the point at which I can give the right advice and get them in a position to minimise their UK tax liabilities.

Copyright 2006 Invest UK Publishing