In a recent transaction I had the opportunity to meet a man who at one time was the biggest owner of housing in the United States. This person, whom unfortunately I cannot name (due to a confidentiality agreement I signed), taught me a way of selling commercial real estate that I previously never used.
As an agent since 2003, selling multifamily in Los Angeles, I was often trained by peers to talk about deals that were highly competitive (multiple bid situations) as achievements. When speaking to other brokers, I would often hear about these stories and think "that agent is good, he/she marketed the property well and was able to achieve a high level of interest." Well, this client, after spending 2 months with him and his family (his company) selling a trophy parcel of real estate, has taught me an alternative - and it is this alternative measure that I will champion for the remainder of my career. I call it the "Top-Down Listing Strategy" and the old way, I will refer to as "Bottom Up."
In my opinion, the bottom-up strategy is good for agents, and makes properties easier to sell, and therefore is part of the broker's repertoire to consistently taut it as the "way to sell real estate." It is the top-down approach that means an agent will have to work hard, might need to cooperate fee with another agent, and is truly the best strategy for the Seller.
The top-down strategy determines the market price for a property and then prices the property as much as 10% higher on the listing (market). This is designed to tell the market that the Seller is willing to sell, but that he's looking for the top bidder in the marketplace. 10% is the maximum, you don't want to list the property higher than 10% of the actual expected price, because it could tell the market that you are not really trying to sell the property (not committed to selling).
The Seller is only looking for one offer to buy the property. He doesn't care about multiple competitive bidding.
The bottom-up strategy determines the market price for a property and then prices the property as much as 5% lower on the listing or just at the expected market price. This is designed to tell the market that the Seller is looking for many competitive bidders to drive the price up.
While some may argue that this approach only works with trophy properties where there is high demand, I believe it can work in varying degree with all properties.
The Seller is looking for many offers to buy the property. He believes competition will get him the highest price and the best terms
Brokers want Sellers to use this strategy because it strengthens the likeliness that the property will sell and the broker will be paid. But as my client so eloquently put it "if there's multiple offers, the property is under-priced."
As a commercial real estate broker for 15 years, I feel I am qualified to answer this question. That said, this article will not be biased shameless promotion; it will be based on opinion with logical reasoning.
First off, what do you want in a commercial real estate agent? Here is the list I would think any Principal would want in no particular order:
1. Market knowledge. I want a broker who can talk intelligently about the current market, the current property, the benefits to ownership, the upside and the risk associated with it. If an agent doesn't have market knowledge, the agent is no less than my voicemail system.
2. Sales Ability. I want a broker who can convince intelligently a buyer to buy based on the properties inherent value. I am not saying the broker needs to be a sales maven, or a slick talker in a sharkskin jacket, but he should know how to sell.
3. Integrity. I want a broker who tells me the truth, straight up - no bullshit and backs up what he/she says. This usually means that I trust the agent, but there may be some time constraints on trust.
Now then, with the basics covered, here's how I would go about choosing a commercial agent.
1. Altruism. While I know this is a strange thing to want in a real estate broker, the truth is I think we all want to work with people who are altruistic. In my opinion, it means there will be great value in the service we're buying. So, to this affect, I want to see what his interest level is in representing me. Does he call me often? Does he want to meet? Is he interested in helping me? Or does he just want to rope me into a high pressure sales pitch.
2. Cooperation Vs Greed. I want to see how the broker works with others. Does he cooperate with other agents, or is he trying to get as much of the commission for himself? What percentage of his transaction history were dual agency. This is important to me because I want to know if he will cooperate on my behalf.
3. Contract. I want to see what kind of listing agreement the broker presents to me. THIS IS CRUCIAL, they are not all the same. Here's what I am looking for:
a. Is the term of the listing cancellable if the agent is not working for me (LAZY)?
* why is this important?
If the contract does not have any way to be cancelled in the first 30 days, you are stuck with paying the agent the fee for the term of the agreement (even if you hire another broker).
b. Is the broker stating that he will cooperate fee 50/50 with other agents?
* why is this important?
Because an Agent's marketing which cooperates fee is going to go a lot farther than an Agent which does not cooperate fee.
c. Is the broker showing me that he will make the property public to all parties within 24 hours of the listing execution?
* why is this important?
Because I will know that the property under-priced if the market responds with many offers. Agents that aren't showing the property to the open market (think the MLS, or Loopnet) are typically trying to dish the property to another buyer and limit competition so that the buyer gets a good deal, and the Agent double ends the commission (plus will benefit from listing the property again once the Buyer has made his money).
e. Is the Broker stating (in the contract) that he gets paid for any reason other than bringing a Buyer that closes escrow?
* why is this important?
Some brokers state that they get paid if the Seller accepts an offer - even if it does not close escrow
About Our Listing Agreements
1. Standard C.A.R. or AIR Listing agreement form.
2. Fees starting at 5% or less if the property is dual agency.
3. 100% Cooperation with other agents
4. Property marketed to open market within 24 hours of execution.
5. Term of listing terminable for any reason prior to the acceptance of an offer.
6. Payment of commission is contingent on property transaction closing escrow.
7. Transparency in marketing and results via weekly reports.
Buying a single tenant net leased property is and investment property that has all the same inherent tax, leverage and hedge benefits as buying other investment properties, but it's much different than buying an apartment building.
First off, not all single tenant net leased (STNL) buildings are the same. So let's tackle some of the differences before getting into the reason to buy them.
First off, Net Leases come in various forms: there's single net, double net, triple net and absolute net. The items which are considered nets are: taxes, insurance, maintenance, and in the case of absolute net, everything else.
Absolute Net: An absolute net property is one where the TENANT pays all the expenses directly to the debts- including the rent which is paid to the LANDLORD. In this scenario, the LANDLORD gets a rent check every month and is not required to do anything else. The TENANT pays the taxes directly to the federal government, the insurance directly to the Insurance company and handles all the maintenance directly with the service contractors (including the utilities). Absolute Net is the most headache free investment in real estate and includes properties like ground-leases. Absolute Net is also sometimes called "True Triple Net."
Triple Net Properties are not much different than Absol;ute Net, except that sometimes the LANDLORD has some small expense, like being responsible for the roof or structure of the building. Usually this is not something that creates a monthly issue but being responsible means repairing or replacement when the time comes.
Double Net Properties are where 2 of the 3 nets (taxes, insurance, maintenance) are the responsibility of the TENANT and 1 of the 3 is the responsibility of the LANDLORD.
Single Net as I am sure you can imagine is where 1 of the 3 nets (taxes, insurance, maintenance) are the responsibility of the TENANT and 2 of the 3 is the responsibility of the LANDLORD.
The term Gross Leased is used when the TENANT pays one amount to the LANDLORD and the LANDLORD is responsible for paying and taking care of everything else.
Now then, once we know what type of net leased property we want to buy, the next thing to consider is the CREDIT RATING of the TENANT.
The better the credit rating of the TENANT, the lower the risk of default, the lower the CAP RATE and basically the return on investment. A 7-Eleven (who's credit rating is AA) will typically sell at a few hundred basis points lower CAP RATE than a Dollar General (who's credit rating is BBB-). Below is a chart of credit ratings. BBB- is the lowest credit rating for a category known as "investment grade." This category is really just a way of understanding what the lowest credit REITs and FUNDS will invest in - and in my opinion the lowest any investor other than high net worth investors and speculators should consider.
The last criteria to consider is the length of the lease. Some TENANTS will sign 50 year leases - but that's not what you necessarily want to buy. Typically any investor should consider 10 years as the threshold for the minimum time frame, but there are exceptions.
The benefit of a 20 year lease is that the property can be held for 10 years and essentially have a second life with another investor - meaning it's value will be higher due to the term.
So now that we've identified the key aspects of Single Tenant Net Leased properties, let's talk about why buy them?
No Headache. One of the key reasons these properties are purchased is the no-hassle passive quality of this asset. When buying Triple Net (NNN) or Absolute Net, the investment earning power is possible with little or no time-investment.
No fluctuation, very little risk. The nature of "investment grade" net leased properties is that the leases are backed by the credit worthiness of the company not to default. This means that generally a TENANT would need to go bankrupt in order to default. Many Investment Grade companies are public companies, making the default low risk.
Whether you are looking for your upleg in a 1031 Exchange or just looking for an investment to own, there are many reasons why an apartment building might be a good choice for you.
If you know that you want to invest in real estate, why choose an apartment building. As stated before, there are a number of reasons but here are the two most important from a financial point of view: low risk and upside potential.
Low Risk. Maybe you've heard the old saying "everyone always needs a place to live." That saying is never more true than when investing in apartment buildings. The idea of this plays to the risk you take when buying which is very little, because if ever you can't rent a unit, just lower the price a little. The same is not true for any other asset type.
Upside Potential. Most apartment rents raise every year, this is called compounded returns. The best investments compound even small percentages because that income potential is very powerful. Even in rent controlled areas the upside potential is what everyone looks for. If there is a large gap between the property's current rents and it's market rents even better. But without a doubt, the best buildings to buy are non-rent-controlled. This allows an investor to "ride the market up in the good times" and down in the bad times (without the risk of keeping rents where they are forever).
Real Estate is a great investment. It's just about the only type where you get to use leverage and a tax shelter at the same time, plus it's a hedge against inflation.
The more money you borrow on an asset the better the internal rate of return will be. This is why many investors want maximum leverage on every deal. The benefits to owning real estate are rare, many fold and unique:
Cash flow. This is the reason why most people buy investment property, they want their money to work for them, meaning they want their money to generate more money. Real estate is truly the opportunity to do so.
Leverage. Leverage allows you to both mitigate risk (by not using your own cash) and write off the interest payments on the borrowed money as a cost of capital expense. Leverage is a very powerful tool when investing but few investments allow it. Think about it, what other passive investments allow you to only pay a fraction of the price using your own cash? Stocks? No. Bonds? No. Precious metals? No.
Appreciation. The appreciation of your investment over time - is not guaranteed, but it is expected. This is due to the expectation that "a dollar today is worth more than a dollar tomorrow."
Tax-Free Refinance. The ability to refinance tax free is a benefit of investment property (and other properties) that very few investments offer. With other investments like companies, money can be withdrawn from an asset but not in the same way and it's often taxable.
Limited Liability. Using an LLC to hold ownership and insuring the investment property are 2 ways that an owner of investment property can limit the liability of the asset's risk.
Control. Having control is one of the most important benefits, but the one rarely stated. Using leverage extends the control to the use of other people's money.
Tax shelter. This is the ability to shelter income from the governments hands. It is derived in 4 different ways.
1) One tax shelter comes from the depreciation of the improvement value of the deal (you cannot depreciate land). When you buy a residential property, the first year you buy it begins a 27.5 year depreciation cycle - where the improvement value of the property is paid back to you in the form of a tax credit (sheltering cash flow). For other commercial buildings the depreciation schedule is a bit longer (39 years), however, an investor can achieve accelerated depreciation through an IRS strategy called Cost Segregation. Cost segregation allows an owner to break the property into the sum of it's parts - and use the individual depreciation schedules for each part instead of the property as a whole.
2) Another shelter comes from the expenses including mortgage interest that you write off against the property. Since mortgage interest is a cost of capital, using a loan not only mitigates your risk, but it essentially costs you nothing - since that amount of cash derived from the property comes back to you tax free.
3) A third tax shelter is the effect that owning a property has on your tax bracket (typically it goes down). When investors talk about real estate being "all about cash flow" this is why. With property comes deductions and with deductions come a reduction in your tax bracket.
4) The 1031 exchange rounds out the tax shelter advantage of real estate, while you can do a 1031 exchange on personal property, you cannot do it on a business. The 1031 tax deferred exchange is simply the best way to build wealth - it states that you can make a capital gain on a property but defer the payment of that gain when you sell if you buy a like kind property with the proceeds. There are rules to doing this, but it essentially allows you to leverage the money you would normally pay to the government in the form of an interest free loan on your next property.
Lastly, the benefit of the structure of an investment property (property vs loan) make is a hedge against inflation. Since the property is affected by inflation - but the loan is not (because it's amortized), the loan amount stays the same in inflationary times while the value of the property increases. This allows the property to loan ratio to be more and more beneficial to the investor over time.
To illustrate this fact; lets say that you buy an investment property for $1,000,000 and put 35% down. The $650,000 that you borrow is the hedge - because any increase in value is going to go in your pocket (the loan stays fixed or decreases). As inflation devalues the dollar, the property value needs to be worth more dollars to be of the same value - but your loan is fixed amount so the payment stays the same, while the value of it decreases. This allows your investment dollars to be unaffected by inflation.
In conclusion, there really are many benefits to purchasing investment property. To find your first property or if your considering exiting an investment property, feel free to contact me.
Peter Ciriello CCIM CBI
Peter Ciriello CCIM | CBI has been a recognized expert in brokering commercial real estate and businesses in Los Angeles since 2003.
This information has been secured from sources we believe to be reliable, but we make no representations or warranties, expressed or implied as to accuracy of the information. References to square footage or age are approximate. Buyer must verify the information and bears all risk for any inaccuracies. The future income and expenses of the Property may vary significantly during Buyer’s ownership. Buyer shall rely on Buyer’s expertise to project the future Income and expense of the Property.
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Peter Ciriello CCIM / CBI
Real Estate Broker
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