Mention the word property and most people immediately think of personal real estate such as the home they live in. There is, however, a second category of property out there known as commercial real estate and it has been in the news lately as the economic problems have spread to it as well.

Commercial property is often referred to as business property. You probably visit a structure of this sort at least once a day. It is a type of property that is very unique and important because it is a very accurate gauge of how our economy is doing. This is because it is affected by the number of people that are working, the growth of the economy and the health of the banks. When any of these factors have problems, it shows up in empty stores like we are seeing now.

The first type of commercial property is generally considered the multifamily unit. Put in more simple terms, we are primarily talking about apartments. The definition, however, can also include duplexes and other structures where multiple rentals are occurring. Multifamily properties tend to be fairly sold investments in good times and bad as people always need a place to live.

Retail stores are our second type of commercial properties. They range from small and hug malls to the local stores in your neighborhood. These stores are very indicative of the overall health of the economy. When people are out of work, these stores start failing. One needs only look around at all the empty store spaces in the malls to know things are tough now.

Office buildings are the third form of property. These properties are more stable than we see with retail properties. As such, they are an indicator of whether an economic problem is a minor glitch or something major. Given all the empty and open office spaces these days, you can tell the Great Recession and “recovery” has been a real dozy.

Commercial real estate is often given little thought as an investment focus by most people. This is a mistake. It can be a huge money maker. The key is to understand the types and how to do the investing. If you get that right, you can position yourself to make a ton of money over time. The current recession has been brutal, but it has also created a ton of opportunities given the low prices. This presents you with an opportunity to buy a steal of a deal, so don’t let it go by.

We are again coming to the time of year where budgets are being considered for commercial and retail properties. Most particularly that is the months of February to April in each year. Ideally the building budget should be completed by May in every year if the building is structured on the financial year of operation. If you keep to this time schedule, the accuracy of the budget can be checked and cross referenced with the landlord. Notices required to be sent to tenants can then be handled effectively and on time.

A good property budget in a complex building will take a number of days if not a few weeks to create accuracy and finality. This means you should start early. It is worthwhile noting and considering the other impacts of local legislation and the lease documents themselves when it comes to building outgoings and building budgets. In some circumstances, legislation and or leases dictate that notices must be given to the tenants regards their building outgoings and operating costs contribution in the coming financial period. Take care to find these situations and comply as necessary.

So the commercial property manager and the landlord need to work in harmony as part of the process. At the start of the financial year, the building budget needs to be accurate given the known information at that time.

Having a checklist for the process will always help. Consider the following as a potential checklist in a large complex building:

The tenancy schedule for the building should be checked for accuracy before you start. The only way to do this is to reference back to the leases and occupancy documentation. A poor tenancy schedule can throw you off the track when it comes to the building budget. Look for any critical dates or alerts which will come up in the next financial year for matters which affect the income side of cash flow. That will normally be rent reviews, options, lease expiries, and lease renewals. Look for changes in any lease incentives which could still be active within the tenancy occupancy. That could influence an adjustment in rental payments and any concessions. The history of property performance over the previous 12 months is critical to the establishment of a new budget. Understanding what the property has achieved over the last 12 months will have relevance to the next 12 months. An analysis of arrears and tenant defaults over the last 12 months will be useful in budgeting. The next period of 12 months should have an allowance for bad debts. The property expenditure and operating costs over the last 12 months will also have relevance to the next 12 months. When you analyse these items of expenditure, look for things which were unusual and may have inflated unnecessarily the expenditure within certain categories. Seasonal escalations of outgoings such as energy should be reflected in the relative months of the year. It is not appropriate to average expenditure across 12 months and index it upward by a CPI index. That budget is virtually useless when it comes to tracking monthly results. When looking at the history of the property, look for items of capital expenditure nature which should not have been included in ordinary operating costs. They need to be removed before the new budget is considered. Any items of capital expenditure can be handled separately in a building budget outside of standard building operating costs. Capital expenditure is a cost of the building owner after the net income has been determined. Given the nature and type of property, understand the averages of building outgoings and expenditure as they apply in your location. Importantly, your building has to stay within the averages unless there is a very specific reason to do otherwise. An in depth study of lease documentation is important when you are considering building budgets. The terms and conditions of lease documentation can have elements which impact cash flow. The property manager has to have the ability to read and understand property leases at a high level. When questions arise and any uncertainty exists, the matter can then be referred to the solicitor for the landlord for an interpretation. Given the elements of income and expenditure in a property over a predictable 12 month period, it is important to consider the levels of inflation or escalation in each case. The question really is just how much should the items of expenditure be escalated in the future budgetary period. History will give you some guidance. Care needs to be exercised when it comes to expenditure because some categories will have contracts which dictate escalations of a fixed amount. The same applies to the levels of escalation which should apply to the income from the tenants in the building. In the case of income it is easier to assess growth by consideration of the rent review terms of leases in each separate case. The rent reviews may be based around fixed percentage, fixed amount, or market reviews. They are easy to determine from an income perspective. That is where you need to read the leases and completely understand them before the budget is set.

In summary, the building budgets in a commercial building need to be carefully compared to previous financial periods and then escalations applied given the assumptions of the future. When a building budget is carefully prepared it is great management tool for property managers. Always keep notes of assumptions and findings in any budgets; they are invaluable when you have to review matters during the year.

Once the budget is set, it should be checked and assessed each month as the financial year progresses. If the budget is expected to be outside of actual performance, then adjustments should be done during the year so that the landlord knows how the building is performing.

Commercial Investment Property is usually complex in its function hence requiring a variety of skills to service. Whilst Industrial Property is more ‘basic’ in most ways, the attributes of an ‘office’ and ‘retail’ property are not as easy.

For example the elements of property investment performance that come together in Commercial include:-

Property Analysis Lease Negotiation Valuation Awareness Outgoings Analysis Tenant Negotiations Service Contracts Property budgeting Maintenance Response and planning Legislative Awareness Rating Objections for council and municipal rates Insurance Awareness and Risk Management Vacancy marketing and controls Arrears response and controls Lease interpretation Tenant placement

When all these aspects are considered, it is common to see a number of skilled people working in a Property Management Department of a Real Estate Agency to support the diverse needs of the portfolios.

The fees of a Property Management Service can and should be reflective of the high personal involvement of the broader Property Management Team. As your business grows the list of Commercial Clients and portfolios, so also should the skills and people that support the Clients.

Risk Profile of Your Investors

Investors will usually have a risk profile which must be identified in early onset in the provision of your professional services. Essentially a risk profile will be high-risk or low risk.

A high-risk property will be one that is aggressively rented with strategically high rental figures applying to the tenancies during the duration of the leases. The danger of high-risk profile properties is that the aggressive levels of rental pursued by the Landlord can become difficult for Tenants to support financially during the total duration of the leases. This can and will invariably lead to the collapse of the Tenants business and the creation of an unwanted vacancy. Consider this:

Is your Client willing to accept such risk? Can the Client’s cash flow tolerate the income volatility? Are high vacancy levels acceptable to the Client?

Some Investors prefer to take a position low risk with the establishment of more conservative rentals to produce income stability over the maximum time of the established leases. Obviously it can be said that the potential return in a low risk profile building is less by comparison to the former ‘High Risk’ profile property but the associated low volatility of the Tenant profile provides Investors with a stable long-term result. This means less active threat of unwanted vacancies. Commonly the less active vacancies in such a property, give the Investor a better cash flow.

Expansion and Diversification

Commercial Property will nearly always fall immediately into the type of category of either Office, Industrial, or Retail. Such single property for that Investor will feel the effects of any changes in the market, occupancy changes and the economy.

By example, a downturn in the national economy will quickly effect businesses and hence the Tenants in any property. This can restrict their ability to trade and pay the rent. Industrial Property is the first property type to feel pressures in a shifting economy due to the direct link to small business.

Portfolio expansion and diversification is therefore a useful and important future strategy to lessen the volatility that can occur when you own one property of a singular type. Wise Investors and their Agents encourage expansion and diversification of the portfolio as a means of spreading and reducing risk. This can form part of a true investment service to your Clients, positioning them more favorably on a variety of properties. Diversity for your Clients can mean stability.

Obviously their financial position and available cash will govern their timing and ability to do so. Your guidance in the process is both important and professional.