From A Field Guide to Commercial Real Estate Investment by Robert A. McComb.

Tenants do not object to this, under the theory that they will pay the rent if they are doing sufficient volume to be making plenty of money. Under those conditions they will share some percentage of the gross with the landlord. As a general principle, tenants can make enough profit to justify operating a store without ever reaching percentage rent. If they do reach a level of gross sales sufficient to pay percentage rent, they have no objection to parting with some of it in favor of the landlord.

The percentages will vary depending on the type of operation involved. Low-volume, high-profit operations (furniture, jewelry, liquor) pay high percentages, whereas high-volume, low-markup operations such as discount stores, off-price stores, supermarkets and giant drugs pay relatively low percentages. The amount of percentage rent to be paid is occasionally a subject of negotiation between a landlord and a tenant, but not often. There are industry standards to which the parties usually will conform, although these standards are subject to inroads from the largest and best of the tenants in each category, which might be able to bargain for lower percentages.

Excerpt from Negotiating Commercial Real Estate Leases by Martin Zankel.

At the time, I was appalled at the number of rules and regulations I would have to observe. But the persons who drafted that lease did not have my interests in mind. They had the interests of the landlord in mind. There is nothing offensive about this; landlords need protection. Tenants are not a sanctified class of beings. They are no different from other human beings. They are full of faults, even as landlords are.

What I have since discovered is that all forms of leases can and should be negotiated. What I have further discovered is that those people who slap so-called standard form leases in front of you and ask for execution fully expect that you will respond with requests for changes.

This is not always true, however. Regional mall landlord leases are among the most difficult for a tenant to negotiate. Since a substantial portion of my practice involves the representation of both landlords and tenants, I have negotiated on both sides of lease transactions involving regional shopping mall space. I remember an early experience that I had with a regional mall lease. I was approached by a small tenant who knew of some work our firm had done representing larger tenancies. We also had negotiated several small tenant leases in regional malls without any dramatic success. Our new client asked if we would represent him in the negotiation of his lease for a camera shop in a large regional mall. I told him to turn to the signature page at the back of the lease, sign it, and return it to the leasing manager of the mall with a letter stating that he had signed where he was asked to because he was sure that the lease incorporated all of the understandings he and the leasing manager had reached. I thought he would be better off with this approach than wasting his time trying to get changes the mall would not make for a small tenant.

Every large landlord has its own form lease. I represent one landlord that has 12 form leases. Every large tenant has its own form lease. There are gross leases, industrial gross, net, bond net, retail, industrial, office, full-service office, and short and long forms of each depending on term. All of these leases can be negotiated — some more than others. A form lease is like a cube of clay. Push on it and its form changes. Pull on it and its form changes again. A lease negotiation is about pushing, pulling, tugging, and pressing that cube of clay until it emerges into a shape that both parties can be comfortable with.

Excerpt from Negotiating Commercial Real Estate Leases by Martin Zankel.

And after that? There are two approaches that are most common. The first is simply to start at the beginning of a lease and negotiate your way to the end. This is how my book (Negotiating Commercial Real Estate Leases) is organized. I have simply followed the order of the lease clauses in the standard lease forms (can I still use that expression?) in my office.

A second technique often used is to take the most critical legal clauses, the business provisions having already been negotiated, and deal with them first. After that, proceed in order. For example, I have a tenant client who insists that the assignment and sublet issue be resolved along with the operating covenant, before any time is wasted haggling about other legal issues. The disadvantage of this technique is that if you obtain what you are seeking for the so-called critical issues, it may lead the other side to think, perhaps in error, that it can have the benefit of everything else because you apparently don’t value the other clauses so dearly.

Excerpt from Negotiating Commercial Real Estate Leases by Martin Zankel.

Always remember that the loan to value ratio is a maximum, or ceiling, on the amount of the loan. Unlike single family residential loans, it is not a given that you can get this maximum amount. Commercial lenders often show rate sheets touting loan to value ratios of 75 to 80 percent of the purchase price. As an investor , you must bear in mind that this is the maximum percentage that you will be able to obtain. In the end, the income and expenses associated with a property will strictly determine the actual amount you can obtain.

To figure out how much you can reasonably expect to borrow on a commercial property, we need to go back to the net operating income calculation and make a couple of adjustments.

First of all, in most cases, all calculations of the maximum loan amount are based on actual income and not projected income. If the rents are less than the market price, that provides more of a cushion for the lender because it might increase the return on investment for the investor; however, this usually will not help the borrower get a larger loan. 

Earlier we took the gross scheduled income and reduced it for vacancy based on either market, actual, or historical vacancy rates. We now need to adjust the gross income downward again by somewhere between 2 and 5 percent for reserves. Lenders require these reserves to ensure proper operation of the investment property (for example, to finance unexpected repairs or a higher than anticipated vacancy rate, etc.). To calculate the reserve rate for your property, contact a few lenders and ask what reserve rate they are currently applying to loans for your type of property.

Now our formula looks like this:

Gross Scheduled Income –  Vacancy Rate  +  Income from Other Sources (parking, laundry, etc.) – Reserves (the percentage dictated by lender requirements)  = New Adjusted Income

As before, we added in income from other sources (parking, laundry, etc.) and deducted the operating expenses to determine the net operating income. This NOI is what is available to service or pay down a loan and provide a return on the investment to the buyer. Most often, however, lenders will not allow 100 percent of the NOI to be used to service the loans. They apply a debt service ratio (DSR) to the NOI to provide a cushion for the loan on the property. This helps to ensure that if the net income for the property drops, the borrower can still pay the mortgage.

Debt service ratios are expressed as 1.2 or 1.15 percent. We simply divide the NOI by the DSR to get the amount the lender will use to calculate the maximum amount the lender will permit to be used for the mortgage payment.

NOI (maximum mortgage-paying portion of NOI)  ÷   DSR

Once we have adjusted the NOI to account for both the reserves required by the lender and the debt service ratio, we can calculate the maximum loan obtainable using an amortization calculator.

Many Internet sites offer free amortization calculators. Using any form of standard financial calculator, we take quotient in the above formula and divide it by 12 to convert to monthly payments; then, with a quoted loan rate from the lender and the amortization period, we can solve for the maximum loan amount. This must be under the loan to value ratio, because, as stated before, this is the maximum amount the lender will go in on the investment.

The formula is simple; just punch in the following numbers:

            Monthly payment

            Interest rate of the loan

            The amortization period (usually stated in months)

            Solve for loan amount that this payment will satisfy 

 Once we understand the level of financing that can be obtained for a particular property, which, as we have just seen is a function of income, we can then calculate the amount of cash needed to acquire the property. The elements of this sum are the down payment, which is derived by subtracting the maximum loan that is obtainable and adding in other acquisition costs (which we will address in the following section.

From A Field Guide to Commercial Real Estate Investment by Robert McComb.

There is a tremendous amount of money to be made in commercial real estate. How much you make really depends on how hard you work. Consequently, commercial real estate attracts hard working and aggressive people — people who want to get ahead in the world, not people looking for a safe place and a steady paycheck. It comes as no surprise then that it is a highly competitive business in which many fail. The old adage in commercial real estate is that 10 percent of the brokers make 90 percent of the money.

The profession of commercial real estate essentially involves selling and leasing commercial property. In order to accomplish this, a commercial broker must engage in a wide range of activities including listing and marketing property; providing real estate advice; representing principals to find suitable property; evaluating property for listing purposes; writing up offers to lease or sell; and negotiating deals. Most of these activities require significant interpersonal skills as well as skills in financial analysis, sales, research, and problem solving. During a typical day, a commercial broker might

• Prepare an ad or brochure
• Write up an earnest money offer
•  Order a preliminary title report
• Show property
• Answer prospect inquiries on listings
• Inquire about other listings for a client
• Deliver documents
• Make a listing sales pitch
• Obtain information from a governmental agency on a property
• Negotiate the terms of an offer to lease with a lessee and lessor
• Deal with an attorney regarding the title exceptions in a preliminary title report
• Arrange for an environmental report for a property being sold
• Deal with an architect or space planner on the tenant improvements for a lease
• Analyze an investment property for an investor client
• Arrange for credit information from a lessee on a lease
• Make cold calls on prospects
• Write status reports to clients
• Update the list of contacts
• And, hopefully, pick up a commission check from the escrow company.

 A broker’s life is often hectic with phones ringing, offers to write, calls to return, things to get done, deadlines to meet, appointments to attend, and properties to show. 

Brokers earn a living by collecting fees on the sales and leases they complete or by charging set hourly fees for counseling. There are no regular paychecks, which makes for an uneven and uncertain income. Since commercial transactions take time to complete (it’s not unusual for a deal to stretch anywhere from two to six months beginning to end), there can be extended periods of time when there is no money coming in. Consequently, it is important to be able to budget. It is also helpful if you can muster enough cash up front to get you through the first year or so of the business.

Incomes vary from year to year and from broker to broker depending on the market, the level of competition, sheer luck, and so forth. While firm income statistics are difficult to come by, it’s safe to say that overall, good commercial brokers make a good living. An educated guess would be that many commercial brokers earn between $30,000 and $60,000 per year, while quite a few make more than  $100,000 on a regular basis, and a surprising number (mostly long-time, experienced brokers) make between $150,000 and $500,000 annually. And then there are always those few star brokers who make lots of money, sometimes in excess of $1,000,000 per year. It’s not uncommon for an experienced broker, earning $200,000 per year, to make a few unusually large deals and reach the top category for one year.

Do you possess the characteristics to make it in such a field? An honest self-appraisal can help you decide and perhaps avoid future disappointments. The following personal qualities are some of the predictors of success in the business.

• Self-motivated
• Aggressive
• Hardworking
• Honest
• Intelligent
• Influential
• Competent
• Tough

From How to Succeed in Commercial Real Estate by John Bowman.

When we speak of investing in commercial real estate, we are talking about individuals who put capital to work in a commercial property seeking to earn a profit from three potential areas: property appreciation (either a market-driven increase in value or from adding value such as making improvements or solving a vacancy problem); from cash flow from rent collected (after expenses), and from potential tax benefits of ownership.

Generally speaking there are two main categories of commercial property: multi-residential (or multi-family) commercial property and non-residential commercial property. Multi-residential properties include any properties intended to house more than one family—from duplexes, to small apartment buildings, to large apartment complexes and rental communities.

Non-residential commercial property is real estate in every other form (except single-family residential). Office, industrial and retail properties make up the dominant portion of the non-residential market. The remainder of non-residential commercial property includes hospitality, medical buildings, civic buildings, care facilities such as nursing homes, and land zoned for commercial purposes.

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From A Field Guide to Commercial Real Estate Investment by Robert McComb.

Company Size

A large company can offer many advantages to the beginner. Large companies typically offer a stimulating environment of brokers actively doing what you want to learn. They may have a training program, listings that you can start work on immediately, and sometimes will provide a mentor. However, large firms are not without pitfalls. They often are pressure cooker environments where production is more important than understanding the business. All too often, large firms focus on making money rather than representing clients. The beginner often falls through the cracks because everyone is too busy working on projects. Large firms also tend to have more brokers who do not want you to call on their long-term clients or to prospect a certain territory. These factors tend to diminish your ability to flourish as a prospective commercial real estate broker.

 Occasionally, a small company may offer a better training ground.  It may take longer to get up and running as a broker, but you may ultimately become a better one in the end. Many brokers from large firms make money, but never fully understand the business. They are like a plow that goes only an inch or two deep — it may plow a lot of the field, but whenever it hits a rock it has to go around.

Fee Splits

Different companies have different fee split arrangements with brokers that will affect your earnings. Most start off with a 50-50 split and then increase your percentage as you make more money. Ask about the split and compare.

Listings and Projects

Often companies have properties they manage, listings, assignments or long-term clients that you can be assigned to. This is very helpful because it lets you hit the ground running, so to speak.  You immediately start working a listing, talking to clients and getting new prospects.

Management

What is the management like? Will they actually take the time to help you get started?  Are they fair, reasonable and firm? Do they spoon feed all good leads to a select few brokers or do they share them? Because of the competition and dynamics inherent in the brokerage business, a capricious management can destroy good will and a company’s effectiveness.

Broker Experience

What are the company’s other brokers like? Are they reputable, successful, and cooperative?  These are the people you will be working with, and what they know and how they conduct themselves will largely determine how you do business.

Reputation

Does the company have a good reputation? This is very important because the name will precede you into every sales meeting and pitch. It can either help you or hurt you.

Area of Experience

Some brokerages have more experience in some areas than others.  If you want to learn office brokerage it does little good to pick a company that specializes in investments. Generally, the broad areas of specialization are industrial<!–[if supportFields]>xe “industrial”<![endif]–><!–[if supportFields]><![endif]–>, office<!–[if supportFields]>xe “office”<![endif]–><!–[if supportFields]><![endif]–>, retail,<!–[if supportFields]>xe “retail”<![endif]–><!–[if supportFields]><![endif]–> and investments<!–[if supportFields]>xe “investment”<![endif]–><!–[if supportFields]><![endif]–>. Pick the company that is experienced in the area that interests you. Sometimes a company does not have an opening in the specialty area, or farm area, you want. Consequently, some may try to pigeonhole you into another specialty or farm area.  Try and find one that has openings for the specialty area you want.

Training

Some companies offer formal training and others just turn you loose. Others assign you to another broker and, in some, management is actively involved in training. The straight fact is that the best training comes from doing it. There is no substitute for experience.

Salary or Draw

Does the company pay you a salary or draw while you are getting started? Salaries are nice, but should not be the determining factor in deciding where to go. Salary draws put you in the hole and are often hard to pay back, but they are better than nothing if you need help staying afloat until you can make a few sales.

Connections

Some companies have better connections with property owners, the community, and other brokers. The more and better the connections, the better your chance to succeed. Do not overlook a company’s reputation among other brokers. If a company has a poor track record or a history of treating outside brokers unfairly, it will make it harder on you.

Benefits

The obvious questions concerning retirement plans, health insurance, vacation, sick policies, and even parking space should be asked.

Personalities

Brokerages are like families and, as the old adage goes, show me a family and I will show you problems. They have their share of personality conflicts. The commercial real estate business seems to attract many big egos, which are barely restrained in some firms. This can be either negative or positive.  Negative competition can be destructive. Conversely, competition between two good brokers who have integrity and respect for one another can raise the level of success for each.

Staff Support

Is there enough support staff to handle your needs? It can be very frustrating to have to wait two days to get an Earnest Money Agreement or letter typed. Sometimes senior brokers will demand that their business be taken care of first, which puts you at a disadvantage. Sometimes other brokers are just so disorganized everything is a rush, which may delay your work. In some larger companies, there is also support staff for marketing and sometimes assistants. These people prepare brochures<!–[if supportFields]>xe “brochures”<![endif]–><!–[if supportFields]><![endif]–>, collect information, keep track of the market<!–[if supportFields]>xe “market”<![endif]–><!–[if supportFields]><![endif]–>, assemble a listing database<!–[if supportFields]>xe “database”<![endif]–><!–[if supportFields]><![endif]–> and, if qualified, prepare documents and handle calls. They can be very helpful.

National Company vs. Local Company

There is considerable debate over whether a national company or a local company is best. They both have their pros and cons. National companies offer name recognition and often more leads (including national companies), but often leave you feeling like a small insignificant cog in a huge machine. Occasionally, a few long- time brokers in large firms will garner the best prospects; however, you often may be included in the business as a co-broker. They often are pressure cooker and cutthroat environments that try and pit you against your fellow brokers. Many seem to emphasize money over professionalism. 

National companies sometimes offer formal training programs, which are helpful. Some may just attach you to one of the experienced brokers, which can be a blessing or curse, depending on the quality of the broker to whom you are attached. Often, in large companies, there will be many brokers on one listing or deal, which translates to less commission for you. If the commission, for example, was $30,000, the company may take half with the balance split between three brokers. This means you make $5,000 or 16.67% of the total. This would be reduced to $2,500, or 8.3%, if there was a cooperating, outside broker. In smaller companies, there usually are fewer splits. If you were on your own you could have made the entire $30,000, if there were no cooperating broker. 

Local companies often have deep roots in the community, which translates to name recognition and leads. They sometimes, however, have difficulty doing business with national company prospects because those prospects often prefer the name recognition of national real estate firms or their affiliations. Brokers from smaller companies have to overcome the size issue when competing for listings. Small or medium-sized companies often offer a more personal atmosphere and personal attention, but not the volume of business. Size of a company, however, is not necessarily the determining factor for success in commercial real estate. This is because the quality of firms varies so much. There are many struggling large firms, and highly successful, competitive, small to medium-sized ones. Because more business is usually generated by more people working together, your decision should be based more on whether the company has many active brokers rather than size. 

From How to Succeed in Commercial Real Estate by John Bowman.

A great deal of the return on investment comes from leveraged appreciation of the asset value, which is normally based upon the income.  Let me explain what I mean in simple terms, so you can plug in your local market numbers to create some real world examples:  By leverage, we mean that the asset is being purchased with only a portion of the purchase price coming from the buyer and the balance coming from a lender.  The loan will be repaid by the occupants’ rental payments to the new buyer; therefore any increase in value of the entire asset represents a real return on the original amount invested.  In short, the original loan will eventually be paid off by tenants and the investor will profit in the long run.

In very simple numbers it works like this:  Suppose you contract to buy a one million dollar building, with a 25 percent down payment and another 5 percent in loan points, closing, and other costs.  We can readily see that the investor has $300,000 of his or her own capital at work.  If the property appreciates or increases in value at 3 percent per year, the next year the building would be worth one million thirty thousand dollars, or $30,000 more than the investor paid for it.  Since the investor only has $300,000 at work,  the return on investment is the $30,000 gained divided by the $300,000 invested.  In short, the investor has made a 10 percent return on just 3 percent appreciation. 

 Return on Investment (ROI) = (Appreciated Value – Original Value) ÷ Amount Invested

Note: In this example we are only examining the return on investment in terms of appreciation; however, as described below, there are other aspects of investment that contribute to the overall return on investment as well. 

If we add the appreciated return on investment shown above to the cash-on-cash return, which is the spendable income the asset produces after all operating expenses and mortgage payments are subtracted, the total return on investment is even greater.

If, in our simple example, the net spendable income were another $20,000, the return would increase by 6.67 percent.  Remember, we arrived at this by dividing the $20,000 gained by the $300,000 initially invested.  Loans payments may be a combination of principle pay-down and the interest.  Unless the loan is an interest-only loan (in which there is no principle pay down), the true yield is actually even higher.  Because some of the mortgage payment is interest, some of it goes to reduce the debt, which, in turn, increases the investor’s equity position in the property.  Since the mortgage is paid from rent collected, it is a real return on investment that shows up when the investor sells or refinances. However, in interest-only loans, which are common in commercial real estate, there is no principle pay-down.

From A Field Guide to Commercial Real Estate Investment by Robert McComb.

The sooner you get into commercial real estate the better.

Certainly, there are some similarities between residential and commercial real estate, and there may be some residual value in starting in residential first. However, it is also true that many of the things you learn in residential real estate are unlikely to apply at all to commercial real estate, and, in addition, most of the prospects you encounter in residential real estate are not transferable to commercial. So why learn two things? If you want to learn something specific, learn it. Don’t waste your time on something else. The sooner you can start talking to commercial prospects, getting commercial listings, and making commercial deals, the sooner you will learn the business. 

From How to Succeed in Commercial Real Estate by John Bowman.