December 2014

Real Estate Property Taxes "Tenants Beware"

As a tenant in a commercial property, you undoubtedly, have a provision in your lease regarding real estate taxes. On a triple net lease or even a gross lease (where the Landlord pays the taxes), the taxes increase usually every year due to Proposition 13 whereby the tax increase is 2% per annum. In most cases these increases in taxes are passed on to the tenants unless there is a specific provision in the lease that prohibits it.

As a tenant, you may take it for granted that the taxes may only increase by 2% per year. The real zinger is when the property is sold. Many unsuspecting tenants may not think of the fact that the Landlord may sell the property and thereby a substantial increase in taxes may occur. The Landlord does not usually have to provide the tenant with any advance notice of the sale and one day a new Landlord may appear. If the past Landlord had held on to the property for several years, or even a few years, the real estate taxes could easily double and the tenant is in for a substantial increase in its monthly payments.

In the event that the Landlord elects to obtain a new loan on the property or decides to sell the premises, the Tenant may receive an "estoppel" certificate. This estoppel certificate is a document that needs to be signed by the Tenant and affirms his rights to the Leasehold. Once a tenant receives this certificate, he needs to review its lease.  My recommendation is that the Tenant should talk to his or her attorney and have the attorney review the lease and estoppel certificate. The lawyer will review all of the terms of the lease with the client and should review the tax provisions in the event of a sale. If the tenant has no tax protection provision in the lease, he should try to negotiate some new terms. The Tenant may have some leverage with the Landlord at this time, since the lender or the new buyer will request the tenant's affirmation of the Lease.

The most important words of the lease as it pertains to the real estate tax provisions are "in the event of a sale."  These words usually indicate that either the broker or the lawyer protected the Tenant from a substantial increase in real estate taxes. This protection is usually only available at the time that the lease is negotiated.

 

Purchase or Lease your Commercial Real Estate Building

The subject to lease or purchase a building has been a matter of much discussion for the 40 years that I have been in the commercial real estate business.  My recommendation to clients more often has been to lease rather than to purchase a commercial or industrial building.

The only reason to purchase a building is due to the high cost of moving and expensive improvements that will be installed in the building.  Leasing a building provides much greater flexibility for growth compared to purchasing a building which requires a great deal of capital. Furthermore, owning the building does not provide immediate liquidity when an investor needs to sell the property.

I have been extremely careful in my selection of commercial real estate properties as an investor in the business. That is not to say that I didn’t make mistakes; however, the mistakes were minor, and at the worst I broke even. 

In 2000 I invested in a 60,000-square-foot warehouse in the South Bay area of Los Angeles.  The building was a good building, but it is certainly not a Class A property. I was fortunate to lease the building immediately at a rate of .48 cents per square foot triple net. The tenant was a Fortune 500 company, and I enjoyed 15 years of good cash flow from the property.

The tenant recently notified me that they will be vacating the building in the second quarter of 2015.  I am aware of current rental rates as a commercial real estate expert in the area. As a result, I have just placed the building on the market at .54 cents triple net. This rental rate is consistent with the marketplace, but it only represents a 12.5% increase in the rent in 15 years.

This is typical with rental rates for warehouses generally in the Los Angeles County area unless the building is relatively new or in a high rent location. Therefore, considering modest inflation, commercial real estate rents have actually decreased.  Fortunately my tenant incurred all of the expense of maintaining the building or it would have been even worse. A client I represent leasing her buildings recently said that rental rates have not increased since the 1980's.

Here is the kicker! The building mentioned above has more than tripled in value since the purchase of the property 15 years ago. That is great appreciation in value but only if I intend to sell the building.

I mentioned that it was better to lease than to purchase a commercial real estate building in the beginning of the story.  Let's take the value of the 60,000-square-foot building today which is roughly $7,000,000. If an individual were to purchase this building today, they would probably need a down payment of 30% or $2,100,000 and finance the balance at 5% interest. The payment for a mortgage of $4,900,000 would be $28,644 or about .50 cents per square foot. The current asking price on a lease is .54 cents per square foot. Therefore, the real cost of the building is $2,100,000 since the mortgage payment and the rent are practically the same.

In conclusion, leasing is still the best opportunity provided the lease is negotiated by a skilled broker who protects your best interests.  However if you are a long term user of the property that requires installation of costly capital equipment, you  should strongly consider a purchase.

 

 

“I had a client involved in a real estate matter who needed intensive guidance fast. Lee was able to guide him every step of the way, helping him evaluate properties for potential investment, as well as connecting him with other needed professionals. If Lee doesn’t know the answer when it comes to commercial real estate, he knows someone who does.”  
Jacob Lager, Partner, Zuber Lawler & Del Duca LLP