Commercial Real Estate Investing E-Book

Dolf de Roos

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 352

Veröffentlichungsjahr: 2010

Beschreibung

Dolf de Roos's Commercial Real Estate Investing reveals all the differences between residential and commercial investing and shows you how to make a bundle. De Roos explores the different sectors--retail, office space, industrial, hospitality, or specialist--to help you discover which is right for you. He shares key insights on finding tenants and avoiding vacancies, financing large investments, managing property, setting a tax-smart corporate structure, and take full advantage of tax breaks.

Leseprobe

Table of Contents

Title Page

Copyright Page

Preface

Acknowledgments

Notes on Reading This Book

Introduction

CHAPTER 1 - Just What Is Commercial Real Estate?

CHAPTER 2 - People versus Contracts

CHAPTER 3 - Why Invest in Commercial Real Estate?

Lease Duration

Assignment of Lease

The Tenants Pay the Outgoings

Tenants Earn Their Income on Your Premises

Landlord Pays for Improvements to Commercial Premises

Certainty of Collecting Rent

Upward-Only Rent Reviews

Government Interference

Management Overhead

CHAPTER 4 - The Downside of Commercial Real Estate

Much More Difficult to Acquire Commercial Tenants

Banks Will Lend a Smaller Proportion of a Commercial Property

CHAPTER 5 - The True Value of Real Estate

CHAPTER 6 - How to Overcome the Disadvantages of Commercial Real Estate

CHAPTER 7 - How to Attract a Tenant

Who Wants to Run a Funeral Business?

Finding a Tenant for a Warehouse in an Oversupplied Market

The Power of the Internet

Many Prospective Tenants Know Your Building

Engage a Real Estate Firm or Property Management Company to Find a Tenant

Wait for (or Cause) a Zone Change

Split a Single Tenancy into Multiple Tenancies

Consolidate Multiple Tenancies into One

The Ultimate Way to Attract a Tenant

CHAPTER 8 - How to Increase Rental Income (and hence the Capital Value)

Helipads

Cell Phone Towers

More Rooftop Antics

Naming Rights

Air Space

Parking

The Humble Webcam

Interior Remodel

The Triple Win of Alarm Systems

Rent Reviews to Market

CHAPTER 9 - What Were the Disadvantages of Commercial Real Estate?

CHAPTER 10 - Finding Commercial Real Estate

Newspaper Advertisements

Real Estate Firms

The Internet

Keeping Your Eyes Peeled

Networking

Word of Mouth

Helping Other People

The 100:10:3:1 Rule

Summary

CHAPTER 11 - Analyzing Deals

Due Diligence

Four Questions to Ask about Any Commercial Property

Return on Investment

CHAPTER 12 - Negotiating Commercial Real Estate Deals

The Uncooperative Seller

Other Negotiations

CHAPTER 13 - Financing Commercial Real Estate

Proposal for Finance

Summary Paragraph

General Description of Property Offered as Collateral

Property Portfolio Statistics and Cash Flows

Statement of Assets and Liabilities

What to Include in the Appendix

How to Use the Proposal for Finance

Umbrella Loans

CHAPTER 14 - Structuring Commercial Real Estate Ownership

CHAPTER 15 - Managing Commercial Real Estate

Tenant Selection

Rule Enforcement

Rent Reviews

How to Get a Tradesman to Do Your Work First

Accounting

Summary

CHAPTER 16 - How to Beat the Average

Geography

Zone Changes

Proximity to Views

The Center of Town

High Technology

Leasing and Management Tactics to Beat the Average

Combining All Methods of Beating the Average

CHAPTER 17 - Raw Land

Best Choice Properties

Spring Mountain Ski Ranch

The Benefit of Having Great Partners

Getting Back to Commercial Real Estate Investing

CHAPTER 18 - Extraordinarily Odd Commercial Deals

Oil in Them Thar Hills

Marine Farms

CHAPTER 19 - Property Ventures Limited

Five Mile

CHAPTER 20 - Never Sell

CHAPTER 21 - Thirteen Golden Rules of Commercial Real Estate Investment

Golden Rule 1: Risk Is Equal to Yield

Golden Rule 2: Ensure Safety of Principal

Golden Rule 3: Control Your Liabilities

Golden Rule 4: Add Value to a Deal

Golden Rule 5: A Broker or Agent Must Bring Something to the Deal

Golden Rule 6: Real Estate Is a Long-Term Investment

Golden Rule 7: The Number of Voting Partners Is Directly Proportional to the ...

Golden Rule 8: You Are Going to Be in a Lawsuit

Golden Rule 9: It Only Takes One Deal to Go Broke

Golden Rule 10: It Only Takes One Deal to Make a Million Dollars

Golden Rule 11: The Value of a Property Is Limited by the Tenant’s Ability to ...

Golden Rule 12: Appreciation and Inflation Are Compounded Annually

Golden Rule 13: You Cannot Give Kindness Away—It Is Always Returned

CHAPTER 22 - Investing Abroad

CHAPTER 23 - Live Life to the Fullest

About the Author

Appendix - Resources

Index

This book is printed on acid-free paper.

Copyright © 2008 by Dolf de Roos. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data: de Roos, Dolf.

Commercial real estate investing : a creative guide to successfully making money / Dolf de Roos.

p. cm.

ISBN 978-0-470-22738-1 (pbk.)

1. Commercial real estate. 2. Real estate investment. I. Title.

HD1393.55.D47 2008

332.63’24—dc22

2007039477

Preface

Anyone with $20 million in his pocket can go out and buy a $20 million real estate portfolio. This book is not for those people—it is for those with little or even nothing in their pockets, who want to go out and make a fortune anyway.

Of course, if $20 million is just a little to you, you can still benefit from this book and learn how to easily acquire $200 million or more of real estate. In my experience, though, people with this kind of cash often do not have the time or inclination to do so. Therefore, those with no money and lots of drive may do well teaming up with people with lots of money and no inclination, to form a truly symbiotic investment partnership.

Beware, however, that your perception as to what constitutes a lot of money inevitably changes as you start to accumulate some. While this book focuses on how you can amass a fortune, remember that in a hundred years’ time, how much you will have made will not be of much importance to anyone. In the final analysis, how much fun you have along the way could be the ultimate reward. That is why I say, above all else, be curious, learn something new each day, help other people, be grateful, and have fun!

Successful investing!

Dolf de Roos

August 2007

Acknowledgments

My passion for commercial real estate has been inspired and fueled by many people. While my thoughts, theories, and methods have been formulated over many years, countless people have—wittingly or unwittingly—contributed to my thinking, from real estate agents, bankers, mortgage brokers, and appraisers, to tenants, members of real estate investment associations, accountants, and literally thousands of investors (both budding and experienced) who have honored me by attending my events and who have forced me to expand my thinking.

While it is impossible to acknowledge everyone, many people deserve and have my deep appreciation. If I have missed you, then I apologize in advance; know that my appreciation is real nonetheless.

Sincere thanks go to Jay Abraham, Anthony Aoun, John Baen, Wayne Bourke, James Burgin, Randy Carder, Stephen Collins, Allen and Kenina Court, Keith and Sandi Cunningham, Curt Denny, Ross Denny, Craig Donnell, Charles Drace, Cary Ferguson, Andy Fuehl, Paul Gibbard, Andrew Gibbons, Daniel Godden, Pepi Gomez, Anthony Gough, David Grose, Datuk Maznah Hamid, Laurie Harting, Paige Hemmis, Dave Henderson, Adrian Heyman, Ian Jackson, Larry Jellen, Bob Jones, Stefan Kasian, Cindy Kenney, Rich Lamphere, Patrick Liew, Dave and Vicki Lovegrove, Katie Moustakas, Nick McCaw, Wayne and Lynn Morgan, Mike Pero, Craig Peters, Neale Petersen, Kean Pitcairn, Jim Poignand, Carrie Putman, Trevor Quirk, Tony Robbins, Alex Rodriguez, Paul Roussell, Trevi Sawalich, Constantine Scurtis, Mike Sexton, Bill Shopoff, Scott Sullivan, Garrett Sutton, David and Julia Sykes, Richard and Veronica Tan, Brian Tracy, Donald Trump, Dr. Robert Tybon, Andrew Waite, Jon Ward, Tung Desem Waringin, Richard Watters, Ron Whiteley, and Paul Wright.

Notes on Reading This Book

Numerous photos are included in this book to illustrate properties being discussed or points being made. Because of printing constraints, these photos are reproduced in black and white. Full-color versions of these photos, as well as other supporting documentation, photos, and newspaper articles, can be found on the web site www.dolfderoos.com.

Many examples of real estate bought or negotiated are discussed, ranging in value from $59,000 to hundreds of millions of dollars. As this book is intended for those who are relatively new to commercial real estate, an emphasis has been placed on using modest examples of properties that hopefully are within the comfort zone of most readers. Bear in mind, however, that the effort required to complete an $80,000 deal is about the same as that required to complete an $80 million deal, so do not intend to focus on smaller properties forever.

Finally, please accept that any instances of words like he, she, his, or her, unless specifically referring to a person of known gender, are generic. Sometimes it is too cumbersome to write “he or she” or “his or her portfolio,” but the points being made apply to anyone.

Introduction

If you think commercial real estate is just like residential real estate except that you need more capital to get started, you are in for a surprise. Commercial real estate is completely different and often requires little or no capital.

If you think, like the masses, that commercial real estate is risky because you have often seen vacant commercial premises and thanked your lucky stars that you are not the owner, you are in for a shock. For reasons that I am excited to share in this book, I seek out vacant commercial buildings, as I have figured out a way of making money, huge sums of it, seemingly out of thin air, by doing something very straightforward with these vacant buildings—something that you cannot do with residential buildings.

If you think commercial real estate is too complex, too specialized, too esoteric, and too difficult for you to even consider, then let me take you on a journey to convince you that it is none of these things. In fact, I firmly believe that after reading this book, you will no longer want to even consider residential real estate as an investment option, and will focus instead on commercial real estate with both enthusiasm and confidence. The only regret you may have is that you didn’t discover this information sooner.

Consider this: Of all the wealthy ($100 million-plus net worth) property investors I have come across in over 30 years of investing and teaching real estate in more than 25 countries (I have had the privilege of working with many prominent people in real estate all over the world), at most two have made their fortune through residential property—the rest have all done it through commercial property.

Think about this. You wouldn’t choose a surgeon with a low patient survival rate when there are others with a high survival rate. You wouldn’t choose a car with a low crash-test rating over one with a high rating, or a school for your kids with a low graduation rate over one with a high graduation rate. So now that you know that nearly all wealthy property investors have achieved their wealth through commercial real estate, how can you justify even thinking of buying one more residential property? It would be like dropping your kids off at a bad school, and driving yourself in an unsafe car to a hospital to have surgery performed on you by a surgeon with a low patient survival rate. That is nuts, right? Well, in relative terms, so is investing in residential real estate.

This last fact alone should be enough to convince you to convert to commercial real estate, and you could save yourself a lot of time by not having to read the rest of this book if you converted on that basis. However, you would miss out on a lot of fun, which brings me to my next point.

If you think commercial real estate is dry and boring, and the only reason you’d even consider it is that it is lucrative, then you are in for a real surprise. Residential real estate, for reasons I explain in this book, can be repetitious and therefore somewhat bland, but commercial real estate has so many opportunities for creativity, thinking outside of the box, and coming up with wacky ideas, that it genuinely is a lot of fun. At any rate, after I present my case, you can decide for yourself.

In case you think that I am contradicting myself and the 10 books I have written on residential real estate, think again. I stand by everything I have said in those books: Residential real estate truly is, in my opinion, a much better investment than stocks, bonds, mutual funds, Treasury bills, certificates of deposit, commodities, options, futures, and unit trusts, for reasons that I have explained in some detail in those books. However, when faced with a choice between residential and commercial real estate, I would recommend commercial real estate as your way to riches. Certainly, with my own investing, I have long ago focused almost exclusively on commercial properties, for reasons that I share in this book.

There are, of course, many ways of investing in commercial real estate, as evidenced by the number of existing books on the subject. You will find this book to be different. The fact that I have a different approach, philosophy, and strategy does not, however, invalidate others. You may successfully implement the ideas in this book, and you could also successfully implement the ideas of other commercial real estate books. (You may also be unsuccessful in either case, although it is difficult to fail in real estate as the market is so forgiving of tactical errors.)

At the end of the day, it is not just knowing a strategy, but how you implement it, that can be the difference between a successful experience and a learning experience. If you have an angry, gruff, stern, and rude nature, you could go on vacation to some exotic place and conclude that all the locals are angry, gruff, stern, and rude. Similarly, if you are optimistic, happy, bright, and charming, you will more than likely conclude that the locals are just that. The reason, in both cases, should be obvious: How you act, behave, and treat others will largely determine how others act, behave, and treat you. In this way, we create our own reality.

If you believe that commercial real estate is difficult, requires huge amounts of capital, will involve you in endless trauma, and will burden you with stifling vacancies, then those beliefs will manifest themselves in your life. If, however, perhaps with the aid of this book, you believe that commercial real estate is inherently interesting, remarkably simple, an opportunity to help many people, a vehicle for releasing your latent and pent-up creativity, unbelievably lucrative, and a lot of fun on top of it all, then those beliefs will manifest themselves in your life.

Let me show you why I like commercial real estate.

CHAPTER 1

Just What Is Commercial Real Estate?

From the outset, we need to agree on exactly what constitutes commercial real estate.

We may all agree that a four-bedroom, three-bathroom residence is residential real estate, and that a block of four shops is commercial real estate, but what about a block of 10 units in an apartment complex that both the bank and broker classify as commercial real estate? The fact is, for reasons that seem to me to be entirely arbitrary, where there are four or more units in a residential complex, the building is often classified as commercial for mortgage and insurance purposes and for transaction commissions. What about industrial properties, such as an assembly plant, paint shop, or warehouse; or hospitality properties such as hotels, motels, or amusement parks? Are they in yet other categories? And what about specialist properties such as a quarry, a hospital, an airport, or a rocket launchpad?

Let me therefore make it perfectly clear what I mean by residential and commercial real estate. I know that simplifying things is not very popular these days, but for the purposes of this book, I want to make the following definitions:

Residential real estate is real estate where people live (in residences!).

Commercial real estate is real estate where commerce is conducted.

Based on this simple and sensible concept, it becomes easy to categorize any piece of real estate. Houses, individual apartments, apartment complexes, condominiums, duplexes, and triplexes are clearly all residential real estate. Conversely, shops, offices, assembly plants, paint shops, warehouses, hotels, motels, amusement parks, quarries, hospitals, airports, and rocket launchpads are all commercial real estate.

In case you want to argue that hotels, motels, and student accommodation should, by my definition, all be classified as residential real estate, as people quite clearly live there, then note the following subtle distinction. The operators of hotels, motels, and student accommodation are definitely renting out short-term residential accommodation to their clients. However, if you lease your building to a hotel, motel, or student accommodation operator on a long-term commercial lease, then from your point of view, your tenants conduct a commercial operation there, and these properties are all examples of commercial real estate.

What if three doctors operate their medical practice out of what was formerly a home? Well, they are not living there, and commerce is conducted, so it is commercial. What if a carpet factory is converted into loft accommodation? In this case, the use is for residential purposes, so it is residential. Be prepared for many more examples of blatant simplicity in this book.

Just as residential real estate can be further subdivided into categories such as freestanding single-family homes, single-story multiunits, and multistory apartment complexes, so can commercial real estate be further subdivided into categories such as industrial, hospitality, office space, retail, and specialist. The feature these categories all have in common, though, is that commerce is conducted there. The significance of that distinction will become apparent as we proceed.

CHAPTER 2

People versus Contracts

For some reason that I cannot understand, most of the people I have met or taught in the past two decades (and we are talking about literally hundreds of thousands of people) think that commercial real estate works just like residential real estate, except that the dollars involved are much larger, and that the potential risks and problems are also much larger. In order to convince you that both assumptions are wrong, we will explore real estate from a number of different angles throughout this book.

There are in fact many differences between residential and commercial real estate from legal, practical, and operational points of view, all of which, without exception, make commercial real estate a far superior investment. We discuss these differences in Chapter 3. For now, I want to highlight the biggest fundamental difference between residential and commercial real estate. Philosophically, with residential real estate, you are dealing with people, whereas with commercial real estate, you are dealing with contracts.

Before you counter by saying that you have seen a residential tenancy agreement (a contract!) and know of at least one commercial tenant who has met with his landlord (a person!), I want to stress that I am speaking philosophically. Of course there is paperwork involved with residential real estate—application forms, background check authority forms, tenancy agreements, and so forth. And of course commercial real estate involves dealing with people—brokers, property managers, leasing agents, and the like. However, in essence, when you own residential properties, as I suspect you already may, you end up spending a lot of time talking with people.

You get a call from a tenant telling you that a faucet is leaking, and you have to negotiate a time to have it repaired; 9 A.M. on Friday does not suit him, 4 P.M. on Thursday does not suit you, and bingo, you are dealing with people. You get a letter from the local council telling you that the grass is too long at one of your properties, and you have to call the tenant to get him to do something about it. The tenant, of course, swears that he just cut it the week before, so what is all the fuss about? You counter by saying that nonetheless you have this letter from the council requiring action—and, just like I said, you are dealing with people. You get a call about a blocked toilet. You tell the tenants this is the third time in two months, and what on earth are they putting in there to cause it to block, to which they reply that it’s none of your business, just fix it—and hey, presto, you are dealing with people. Residential real estate by its very nature involves dealing with people.

Now in case you are thinking, “I am a people person, I like people, so what is the big deal?” let me tell you that most people who decide to get out of residential real estate do so because they simply get fed up dealing with all the people and their incessant complaints, tardiness, whining, avoidance, carelessness, rudeness, indifference, hang-ups, foibles, idiosyncrasies, and lack of respect for other people and their property.

Furthermore, in case you are thinking, “Has Dolf not heard about property managers?” let me respond by saying that I endorse and encourage the use of property managers, especially with residential real estate. However, while they serve as a buffer between you and your tenants, the fact remains that residential real estate is a people-centric business, and now you are dependent on the interpersonal skills of your property manager (who may not have your interest at heart the way you do) to deal with all your tenant issues such as scheduling a time to fix the leaking faucet, debating whether the grass needs to be cut, or discussing what is causing the lavatory to block so often. If these issues do not get handled promptly and properly, the situation can quickly escalate out of control. The point is not whether it is you or the property manager who ends up dealing with people (the tenants). Rather, the point is that residential real estate is, by its nature and by governmental and local body regulation, essentially a people-centric operation.

Commercial real estate, by contrast, is in essence driven by contracts. The central contract is, of course, the lease document, which may run to well over 100 pages on large premises and goes into a lot of detail on every aspect of the tenancy. For instance, you will never be phoned about a leaking faucet, as most commercial lease documents have a clause stipulating that it is the tenant’s responsibility to keep the premises in a fully functioning condition and, further, that at the end of the tenancy, the premises will be handed back in exactly the same condition it was in at the beginning of the tenancy, except for normal wear and tear. Thus, most commercial tenants know and are entirely comfortable with the idea that they have to fix leaking faucets, replace burned-out light bulbs and fluorescent tubes, repair broken locks, clean carpets, and repair any damages to the property.

In fact, with most commercial lease documents, the landlord is only responsible for maintaining the building in a watertight condition (no leaking roofs or walls). Thus, painting the exterior, refurbishing the interior, and maintaining the grounds are the responsibility of the tenant. In Chapter 3 we explore why commercial tenants not only agree to this, but want to do it.

With residential real estate, you may specify that rent has to be paid on the first of every month, and you may even get away with a $25 late payment penalty in some jurisdictions, but what if they still don’t pay? Depending on where you live, your options could be severely limited. In California, for instance, you cannot take any significant action to evict them until 90 days after the rent has been in default—90 days, despite the fact that they signed a tenancy agreement to pay on the first of each month! If you fill your car’s tank at a gas station and then drive off before paying, it is considered theft; the police will be dispatched to arrest you straight away, and no one would think that the arrest was unwarranted. And yet, after signing an agreement to pay rent on time, legislators have sanctioned a tenant not paying rent for 90 days before you can take any significant action.

With commercial real estate, the lease document covers most bases. For example, it may stipulate that the rent has to be paid on the first of each month, and it may have clauses adding that if the rent is late there will be a late payment fee, plus interest will accrue at the monthly rate of 1 percent of the amount outstanding. Furthermore, if the rent is still not paid within two weeks of the due date, then (depending on the jurisdiction) the landlord shall have the right to distrain for rent—meaning you can enter the premises; seize all machinery and inventory (but not staff, of course); change the locks; and force the tenant to pay up or risk losing his seized assets, which you can sell to recover what is owed to you.

Throughout this book we uncover more examples of how residential real estate is people-centric and how commercial real estate is contract-centric. For now, just know that when you deal with commercial property, all the people aspects that have plagued you throughout your residential real estate career will be left behind, and you can deal with the clarity and certainty of contracts.

CHAPTER 3

Why Invest in Commercial Real Estate?

To understand why your real estate investing energy should be focused on commercial real estate, let’s compare specific aspects of commercial real estate and residential real estate. This comparison is a valuable exercise in that most readers are probably familiar with the residential situation but not with the commercial analogue. In fact, I predict that some of the realities of commercial real estate will be a surprise to you, and a pleasant one at that. Let us begin.

Lease Duration

A residential tenancy is often month-to-month, or it may last for six months, occasionally a year, and more rarely two years. Commercial leases, by contrast, are very rarely month-to-month—usually only at the end of a longer lease, when the two parties have not arranged to sign a new lease. Typically, a commercial lease will be for two years, or three, or five, or longer. In fact, in the city of London, lease lengths of 25 years (yes, we are talking about a quarter of a century) were common until very recently. Leases of 10, 15, or 20 years are common for large premises or companies such as banks and large retailers.

Given that lease durations are longer with commercial real estate, let’s explore the consequences for your portfolio as well as the underlying reasons why commercial tenants want longer leases, to help you understand why commercial real estate is so attractive.

The consequences for your portfolio should be obvious. Longer lease durations mean fewer lease renewals, and fewer searches for new tenants. If you have a tenant with six years remaining on a 10-year lease, then you know that for the next six years (barring the tenant going into bankruptcy) you will have an uninterrupted stream of rental income. That gives a tremendous sense of certainty. It enables you to project your finances into the future, calculate your margins, and expand your portfolio with confidence.

The sweet irony is that this benefit to you of long lease durations does not come at the expense of the tenant. In fact, most savvy commercial tenants want long leases, and until you grasp this concept, you will not fully embrace commercial real estate.

In general, commercial tenants derive their income on your premises. If there is an element of public interaction with the premises (for instance, it is a retail outlet and clients have been shopping there for years), then there is an intangible benefit called goodwill that is inherently built up in the premises. If the tenants had to shift location, they would lose a lot of their clients. Therefore, one of their fears with a lease renewal is that you as landlord will tell them that you will no longer lease the premises to them. As a result, it is the commercial tenants who are inclined to ask for long lease terms.

I commonly have tenants contact my office (or any of our property managers in various parts of the world) in the middle of a lease term, asking for—and sometimes pleading for—a longer lease. For instance, they may be halfway through a 10-year lease, and they will ask for the lease to be modified so that they still have 10 or 15 years to go before the lease comes up for renewal. Why would they want this? There are generally two reasons.

One reason is that they may be considering spending a lot of money refurbishing the premises, but they will do so only if they can be sure that they will have more than the remaining few years on the lease to get the benefit of their renovations. So the offer from the tenant essentially is, “If you let me pay you rent for at least another ten years, then I will spend a quarter of a million dollars on your property.” How can you refuse an offer like that? They are not saying, “We will spend some money on your property, but only if you cut the remaining lease length in half.” They want a long lease!

The second reason they may request a longer lease is if they are contemplating selling the business. If it is a thriving business of many years’ standing, then both the business seller (your present tenant) and the potential buyer will know that there is the aforementioned goodwill built up in the premises. If the business is to be sold with only 18 months remaining on the lease, the buyer will be reluctant to pay much for the business, just in case you as landlord do not renew the lease. With a new lease expiry date, the business will be easier to sell, and it can be sold at a much higher price. And should you be at all concerned about a new business owner being responsible for the lease? Not at all! As we will see shortly, the sale of your tenant’s business gives you one more layer of certainty that you will be able to collect the rent.

About a month ago, a tenant who operates a 24-hour convenience store in a block of shops submitted a proposal to extend his lease from 5 years remaining to a massive 20 years remaining. Whether he wants to make alterations to the building or sell the business, I am not quite sure and, frankly, I don’t really care either way. He got what he wanted (a longer lease), and in granting that, my portfolio was strengthened. This is, of course, a classic win-win situation.

Similarly, when I was negotiating the purchase of a funeral home, which I have now owned for the better part of two decades, I remember sitting down with a potential tenant and presenting my expectations as to rental per square foot on the commercial portion, on the house that came with the premises, and on the garages. He didn’t challenge me at all on the figures, but did come back, as if by counteroffer, by saying, “Well, I will only do this if you give me a long-term lease.” At the time I would have been happy with a five-year lease, but rather than propose that, I simply asked him, “How long would you like?” to which he replied, “I will only do this if you give me a ten-year lease with a right of renewal for another ten years.” He signed up for the 20 years that day.

Hopefully you are starting to get the picture that with commercial real estate, it is generally in the interest of both the tenant and the landlord to have longer, rather than shorter, lease terms.

Assignment of Lease

While on the subject of leases, consider this. If a residential tenant is partway through his one-year lease but gets a job offer in another city, he is still obligated to pay the rent until the end of the lease. If, however, he finds a substitute tenant who is willing to take over the lease, most landlords will agree to such a switch. What happens, though, if the new tenant defaults on rent payments? Can you go back to the original tenant to extract the rent? Of course not! You agreed to the substitution, and you have to pursue the new tenant for the defaulting rent.

With commercial real estate leases, if a tenant sells his business, such a sale must first of all be approved by the landlord, and second, if the new tenant is in default of his rent, you can go back to the original tenant and collect the rent from him. When a tenant sells his business, apart from the sale contract between the seller and the buyer, there is an “Assignment of Lease” contract between the seller, the buyer, and the landlord. This Assignment of Lease references the original lease, notes any modifications agreed to (more often than not there will be none), gives the landlord’s consent to the buyers taking over the position of the sellers, and still holds liable the sellers in case the buyers are in default of their obligations under the terms of the original lease.

Why do most commercial lease documents around the world allow for these rules? The answer is simply that a commercial lease is seen as a serious commitment. About the only way of getting out of paying the rent on a commercial lease is if the tenant (or business) goes bankrupt. Without these rules, if a commercial tenant wanted to get out of paying the rent, all he would have to do is sell the business to someone at random for a dollar and walk away. When the seller of a business knows that he is effectively underwriting the new business (at least as far as rent payments are concerned) until the lease expires, he has a vested interest in finding a buyer who can actually run the business profitably. So every time a business is sold during a lease term, you, as landlord, have another layer of assurance that the rent will be paid.

The business that in my 30 years of experience in this game has the highest turnover of operators is a humble fish-and-chips shop. Why the turnover should be so high I do not know—it is probably seen by buyers as a cash cow with the perks of free food, but is soon realized to be a sweatshop where you literally labor over a hot stove, serving food that you long ago lost the desire to eat, let alone savor. With one fish-and-chips shop in my portfolio, at one stage the business had been sold four times during a single lease term, resulting in four Assignments of Lease. (See Figure 3.1.) I did not mind at all! In my view, there were five parties who were each willingly guaranteeing the payment of rent. We never missed a single dollar of rent payment.

Figure 3.1Fish-and-Chips Shop with Four Assignments of Lease During a Single Lease Term

The Tenants Pay the Outgoings

With a residential property, the tenants pay only the rent. There certainly is no suggestion or expectation that the tenant pay the landlord’s property taxes, insurance premiums, or maintenance costs. So if a $200,000 home brings in $10,000 in rent, the gross returns are 5 percent, but the net returns will be diminished by the amount of the taxes, insurance, and maintenance.

With commercial leases, however, it is common for tenants to pay not only rent but property taxes, insurance premiums, and maintenance costs as well. These leases are referred to as triple net, as the quoted rents are net of those three items, meaning that the tenant has to pay them in addition to the base rent. Consequently, on triple net leases, the gross returns are effectively the net returns.

You could, of course, add the cost of property tax, insurance, and maintenance onto the base rent and come up with a single, all-inclusive rent figure. However, in this case, increases in, say, property taxes for the year would appear to the tenant as an increase in rent. By separating the base rent from the costs, you can keep the base rent amount constant until the next rent review, and any increases in costs will be seen as being beyond your control (as indeed they are).

Insurance premiums are an interesting case. You want to maintain fire insurance, for instance, so that if your building burns down, the insurance company will pay to have the building replaced. Naturally, the tenant pays the premium for this insurance. However, there is another kind of insurance called consequential loss insurance. Imagine your building did burn down, and it took four months to rebuild it. You cannot expect the tenants to keep on paying you rent during those four months—they don’t have any premises out of which to operate! Consequential loss insurance pays the rent that the tenants cannot pay you as a consequence of the building being rebuilt, thus enabling you to keep up with your mortgage payments and other financial commitments. Guess who pays the premium for the consequential loss insurance? That’s right, the tenants do.

Tenants Earn Their Income on Your Premises

While it may seem obvious to mention that commercial tenants earn their income on your premises, the psychological effect of this is enormous. Since they earn their income there, and since they want to increase their income (all other things being equal), two things happen.

Firstly, when something stops working, tenants will not want to call you, wait for you to return the call, arrange a time to meet, agree on what needs to be done, wait for you to hire a tradesman, and then wait for the work to be done. They are operating a business—they want it fixed straight away! Generally they will do it themselves, use an in-house tradesman if their business is large enough, call a friend to fix it, or get it done commercially and pay for it themselves. In general, businesspeople are entrepreneurs. They are go-getters. They want results: Just do it and move on to the next item to be attacked.

This attitude contrasts greatly with that of residential tenants, who often see themselves as the disadvantaged, picked-on victims of overindulgent landlords, and therefore when a faucet leaks, they think nothing of calling the landlord to get it fixed. I have heard of a plumber-tenant who called his landlord when the faucet leaked and, when asked if he could fix it himself (a trivial task for a plumber, after all), replied indignantly, “That is your job. You fix it.” Obviously, not all residential tenants are quite like that, but there is a definite distinction: Residential tenants tend to leave it to the landlord to fix things, and commercial tenants tend to get the job done themselves. This, of course, is reinforced by what we mentioned in Chapter 2, namely that most commercial lease documents state that the premises must be left in exactly the same condition as when the tenant took on the lease.

The second consequence of tenants earning their income on your premises is that they will always be looking for ways to enhance your property in their quest to earn even more money there. The most obvious example of this is retail stores where, in order to remain fashionable, modern, and appealing, the entire store may need to undergo a major makeover every few years. While such renovations do require your permission under the terms of most commercial leases, they do not require your funding! Here is another example of tenants voluntarily and willingly spending money to enhance their business, but in the process enhancing the building as well.

I have tenants who, of their own free will, completely paint the interiors of their premises every two years, just to keep them looking sparkling (so as to keep attracting customers). Some tenants replace fading awnings regularly, shampoo carpets, and clean windows, not to impress me but to impress their clients. One tenant who operated a restaurant trimmed the neighbor’s hedges so that his clients maintained a spectacular view of the bay below. This same tenant put in creative lighting outside and erected a canvas canopy from the road to the front door, all without asking me to foot the bill or even subsidize it.