Commercial Real Estate FAQ
Common Questions with Sales & Leasing
All the information is based on what typical or market standard deal terms will be in Minneapolis/St Paul, Minnesota (MN). Everything below is explained in a crude and straight forward manner. Please remember, ALMOST everything is negotiable on an individual bases, but MUST BE KNOW UPFRONT and be included in the RFP process.
Always Working for Your Best Interests
Unlike purchase agreements, in all lease negotiations, CRE Partners recommends soliciting the first offer from the potential landlord. We submit an RFP detailing the lease term, the needed tenant improvements, expected maintenance requirements, and other legal details. Our expectation is the Landlord will then provide us with an offer on net rent, free rent, and tenant improvements.
Lease term outlines the length of the lease. A common misunderstanding is when free rent is added. In the Minneapolis/St Paul market, free rent is added outside the overall term of the lease. Example: A 5 year lease with 3 months of free rent will actually be a 63 month lease. Yes, this allows the Landlord to increase rent on the back end, but the PV of the free rent upfront greatly outweighs the increases. Free rent upfront also helps offset moving expenses. Free rent can be negotiated into the basic term if outlined early in the process.
Rent is quoted in many different ways. The most common are Gross and Net. Gross is an all inclusive number which includes: base rent, operating expenses, taxes, and utilities. Net rent requires you to add everything together. Data, phone, and security are always costs incurred by the tenant. A typical deal in this area will include rent increases. The increases are dictated by the market, but generally fall between 2 – 3%. Example: Year 1 $5.00 per square foot, Year 2 $5.10, Year 3 $5.20, Etc. Flat deals can be negotiated up front and must be outlined in the original RFP.
Free Rent – Moving Costs
There are two types of free rent: Gross and Net. As stated above, Gross free includes base rent, operating expenses and taxes, but not utilities. Net free rent still requires the tenant to pay operating expenses and taxes. Free rent is used to offset some of the Tenant’s move cost. The amount of free rent is dictated by the market.
HVAC Maintenance & Replacement
HVAC repair and replacement is always an issue. Some Landlords include this service in operating expenses and some require you to be responsible. The bottom line, you will be paying for it either way, but you should be aware of the costs. Who is responsible for replacement is on a case by case basis. If an HVAC unit needs to be replaced, most Landlords will agree to amortize the cost over the useful life and charge back the cost through operating expenses. Make sure this language is in the lease so you don’t get stuck for the full bill. For older HVAC units, we can generally transfer the responsibility to the Landlord. If the Landlord does not include maintenance and repairs in CAM, assume you will have to get a quarterly maintenance contract, replace filters, and will be responsible for repairs.
CAM/Tax is ALWAYS an ESTIMATE and will fluctuate every year (Generally Up – You can thank the State of Minnesota for our property taxes and mother nature for the snow). CAM includes, but is not limited to: Property insurance, maintenance, snow removal, landscaping, HVAC maintenance, fire monitoring, capital expenditures, and a management fee.
Tenant improvements are always a major source of contention in the deal process. The comment “The Landlord should have to do that anyway and it should not be included in my deal” is very common. CRE Partners always fights to get the highest tenant improvement allowance possible, but understanding how owners and asset managers evaluate the financial impact of improvements on the deal is very important. Keep in mind, commercial buildings are just financial instruments. Owners and asset managers are focused on capital allocation, opportunity costs with other investments, and overall portfolio vacancy. The asking rent will also dictate how tenant improvements are allocated. Many landlords price buildings assuming minor tenant improvements (Carpet/Paint/Minor Construction) for term deal (3 – 5 year deals). Major renovations will be amortized on top of the rent over the lease term. We can help reduce the effect of the amortization by evaluating which improvements will benefit the Landlord over long term. The best way to save money, is find a space as close to “as is” as possible. Below is a housing & car example:
Two houses, exactly the same, side by side. One house is listed for $400,000 and the other $300,000. The $400,000 dollar house has major interior upgrades. The $300,000 dollar house is a flash back to the 80s. The owners of the $300,000 house does not “have too” upgrade anything. If they did upgrades, the list price would go up.
When leasing/buying a new car. The car companies advertise the general cost of a base + model. Upgrades such as technology packages, wheels, leather, and performance packages will cost more. Again, this is not something they “have to do” to sell a car.
Low Voltage Wiring/Other Electrical
Low voltage wiring is always the responsibility of the Tenant and should be included in your move costs. Electrical distribution is generally the responsibility of the tenant. Occasionally, distribution can be worked into the tenant improvements.
Credit of the tenant is very important. A common misconception, it has nothing to do with your credit score. Credit is determined by the companies operating history and cash flow. At CRE Partners, we do everything possible to avoid personal guarantees and banks letters of credit. Worst case, we limit personal guarantees to tenant improvements and transaction costs. We also will ensure this guarantee will burn off over time as you pay rent in full and on time.
CRE Partners reviews a fair amount of leases. We are comfortable making changes, but will not touch certion sections. We ALWAYS recommend you use an attorney for lease review. Please note: most leases are boiler plate forms when they are submitted to the tenant for review. We help change many things including a lot of the simple mistakes.
Due at Lease Signing
Another common question, what is due at lease signing? Generally, security deposit and first months rent is due when a lease is signed. Keep in mind, first month rent is actually the first full month rent. Example: You sign a 38 month lease with 2 months free rent up front. You will end up prepaying the third month up front and in effect, months 2 & 3 will actually be free.
Vacancy time varies greatly in commercial real estate. It is not unusual for a space to be vacant well over a year and this does not always signal desperation. Commercial owners & asset manager have different motivations for leasing space. It comes down to capital allocation, opportunity costs, overall company wide vacancy, and many other factors. Example: A 20,000 SF space has been vacant for 18 months. The Landlord is currently operating at 95% occupancy across their portfolio (90% is considered very healthy). This space will not be offered at a discount regardless of the time on the market.
Another example: A small owner of 5 buildings has a two vacancies that have been on the market for 2 years. Here are three reasons they may not just give the space away. One: their loan covenants may not allow them to lease the space under a certain number. Two: If they lease at a really low number and all their other tenants find out, what do you think is going to happen? Every tenant will ask for the same deal, which will greatly jeopardize the entire portfolio. Three: If the space need significant tenant improvement, it may be better off vacant (think capital allocation and opportunity cost)
Comps/Getting the Best Deal
Comparables are very important in the commercial real estate industry. They give tenants, owners, and brokers a general baseline on what is going on in the market in terms of rent, free rent, tenant improvements, etc. However, comps can also be highly overrated. The market is constantly changing, so your deal will ultimately come down to what is available now. Example: three of the exact same buildings are available. Buildings one and two are owned by institutional investors who are operating at 95% occupancy (90% is considered healthy). Building three has an owner close to financial default. Another tenant takes space number three at a highly reduced rent, leaving only buildings one and two available. The “comp” for building three has no value, as the institutional owners are in a different financial position. Also, comps from 2009 and 2010 are no longer relevant in 2013, as the market is dramatically different. Getting the best deal is about the ever-changing supply & demand of commercial buildings. Our job is to find the most relevant options for your business, go through the bid process, and negotiate as hard possible with those options.