How to Sell Your Property Without Leaving Money on the Table

The 7 steps of a sale — from picking a broker to picking a buyer — and why the highest offer isn’t always the best

Last week I introduced the concept of selling your property.

This is often the culmination of years of hard work, perseverance, and (hopefully) some luck.

1. You studied the investment fundamentals.

2. You took the time to pick your niche and build your team.

3. You reviewed many properties until you found the one with economics a little better than the rest.

4. You completed the acquisition and set yourself up for successful operations with your team.

5. You successfully executed your business plan and increased the net operating income.

Well done!

Now you are ready to reap the rewards by selling your property.

This week we are going to dive deep into the sale (aka disposition) process and unpack the key steps that will yield the best results including:

• Understanding market and economic conditions.

• Working with a broker.

• Preparing your property for sale.

• The marketing and bidding process.

• Selecting a buyer.

• Navigating the purchase and sale agreement, the due diligence process, and closing.

• What to do with the sale proceeds.

Let’s dig in.

Understanding Market and Economic Conditions

One of the realities of owning real estate (and any other investment) is that there are two main things that affect value: (i) things you can control and (ii) things you cannot control.

Things you can control include the systems, processes, and actions you take to manage your property such as painting the building, selecting a broker, and how you treat your tenants.

Things you can’t control include everything else. Humbling, isn’t it?! Examples of things you can’t control include how the economy is doing, the policies politicians put into place, and whether your tenant can pay rent.

Understand and accept the difference between these two things and take advantage of the economic tailwinds when they are blowing in your direction.

If the economy is strong and buyers are paying high value for real estate like yours, this may motivate you to sell. On the other hand, if market conditions are poor, you may not want to sell until they recover.

A good broker will help you navigate this.

Working With a Broker

A good investment broker will be your main ally in the sale process. “Investment” brokers specialize in selling properties, as opposed to leasing them. However, there are many brokers that do both. The most important thing is to find one that regularly sells properties of your type (aka asset class) in your property’s market.

A good broker will:

• Educate you on the market conditions.

• Give you an estimate of what your property will sell for. This is known as a “broker opinion of value”. Values will mainly be based on cap rates as discussed in Cap Rates: The Simple Math of Real Estate Investing.

• Advise you on how to prepare your property for sale.

• Prepare marketing materials and run the sales and marketing process.

• Help you select a buyer and navigate the closing process.

In exchange for all this critical work, you will pay them a sales commission when (and only when) the property sells. This commission will be between 1% and 6% depending on the value of the property. The smaller the property, the higher the commission. Here are two examples:

• $1,000,000 property value at 6% commission rate = $60,000 commission.

• $3,000,000 property value at 4% commission rate = $120,000 commission.

Commissions vary from market to market. Start by asking the broker what they think is fair and work from there. Once you come to an agreement, you will sign a broker listing agreement. This is just like a broker listing agreement for leasing I discussed previously, but modified for a sale. The broker will have a template to use.

Pro tip: talk with multiple brokers about selling your property before you select one. Getting multiple opinions of the market and value is extremely helpful. And remember, just because you talk with a broker doesn’t mean that you are committing to do anything. It is just a conversation at this point.

Preparing Your Property For Sale

Once you decide to sell and you select a broker, I highly recommend you follow their advice on how to prepare your property for sale. Here’s an example:

My company owned a 100% leased, 30-year-old industrial building in an excellent market. The only problem was that the building looked old. We followed the broker’s recommendation to (i) paint the building and (ii) re-coat and re-stripe the asphalt.

Wow! It looked almost brand new and made such a better first impression on buyers.

The result: our sale price increase far exceeded the money we spent on these two cosmetic upgrades.

The Marketing and Bidding Process

The first step the broker will take is to prepare the marketing materials which include a 1-4 page brochure and a 5-20 page offering memorandum (OM).

The brochure is the teaser that they will email out to their database of brokers and investors, as well as post to sale websites like CoStar and LoopNet. Interested buyers will then express interest and request an OM.

Most brokers will have potential buyers sign a confidentiality agreement before releasing the OM. This allows them to (i) register the potential buyer in their database for follow-up and (ii) legally require the potential buyer to keep non-public information confidential.

In a strong seller’s market where values are high, the broker may not list a sales price. They will run a bidding process with a group of buyers to maximize the price.

In a weaker seller’s market, the broker may list a sales price and react to offers as they come in.

It all depends on (i) the market conditions and (ii) the strategy you and your broker agree upon.

I have experienced successful sales as a seller using both strategies at different times. However, it is MUCH more thrilling as a seller to see a broker run a bidding process that drives up the sales price. Good brokers are masterful at this.

Selecting a Buyer

Selecting a buyer? This is just about picking the one with the highest price, right?

Yes and no.

Remember that an offer (aka a non-binding letter of intent) will include the price and other deal terms such as (i) the due diligence period, (ii) the closing date, (iii) whether there are extension options, and (iv) the deposit amounts.

Additionally, each buyer will have their own reputation based on previous purchases (if any) that the broker will share with you.

Here’s an example of three offers:

Table 1: Buyer Offer Sheet

You are faced with some trade-offs. The strongest price is from a buyer with a bad reputation (for not closing deals), the longest timeline, and the lowest deposit. The long timeline (30 + 30 + 30), the low deposit ($10,000 vs. $30,000), and the bad reputation are red flags. Be careful. You could spend 30-90 days with this buyer and end up with a dead deal.

The lowest price is from the buyer with the best reputation and timeline.

Who should you pick?

There is no right answer. Talk it through with your broker and make the best decision for you.

I have gone both routes in my investing career. My preference? If the price is close, I go with the buyer with the strong reputation. It is rough to spend 30-60 days with a buyer only to have the deal collapse at the last minute.

Pro tip: Watch out for “re-trades”. A re-trade is when a buyer tries to renegotiate the price down, typically because of an issue they find in due diligence. Sometimes this is warranted: the roof needs replacing immediately and you never disclosed this. Sometimes it is not: the buyer later decided their rent assumptions were wrong. Buyers typically develop bad reputations because they try to re-trade on each deal. If re-trades come up, lean on your broker to help you navigate a workable solution.

Navigating the Purchase & Sale Agreement, the Due Diligence Process, and Closing

Once you select a buyer, the process is very similar to the acquisition process I previously wrote about. I suggest you revisit:

• Demystifying Real Estate Purchase Agreements.

• Due Diligence: Your Property Investigation Checklist.

• Closing Day: What to Expect

But…there are two differences worth highlighting:

Due Diligence

As you prepare the due diligence for the buyer, make sure you look for potential red flags from a buyer’s perspective. Do this before or during the marketing process so that you have time to clean up any issues.

For example, I was once selling a property that had 8 years remaining on the roof warranty. As we prepared the due diligence, we couldn’t find the warranty document. We had to request this from the roof installer. They provided a copy, but it took a couple of weeks. No harm, no foul. But this would have been a stressful scramble if the buyer had found the problem in the last days of their due diligence process.

The lesson: review your files in advance of giving them to the buyer to address any gaps or red flags.

Lender Communication

As soon as you are considering selling the property, talk with your lender to confirm that you can sell it and what the loan payoff amount will be.

I was once selling a property and didn’t take this important step. The loan was set up such that if the loan was paid off at any day after the 1st of the month, the borrower (i.e. me) had to pay a full 30 days of interest. We closed on the 3rd, so had to pay for 27 extra days of interest.

Had I checked this in advance, I could have structured the sale to close on the 1st.

Learn from my mistake. Talk with your lender in advance of committing to sale terms and dates.

What To Do With the Sale Proceeds

A successful sale is the culmination of a successful investment. It is the “points on the board” of your hard work. Your profit is secured.

But…you will still need to pay taxes unless you complete a 1031 tax-deferred exchange as discussed in 5 Tax Advantages That Make Real Estate Investing So Powerful. I suggest you re-read the 1031 exchange section of that newsletter before you consider selling your property.

Here are two examples from my investing history:

Sell & 1031 Exchange

We successfully executed the business plan of a retail property. I didn’t need the cash and wanted to use the proceeds to invest in another property. I completed a 1031 exchange into another cash-flowing property.

Sell & Pay Long-Term Capital Gains

We successfully executed the business plan for an industrial property. I wanted to use the cash and was willing to pay the tax now.

Just remember that by completing a 1031 exchange, you are deferring (not eliminating) your tax to be paid in an uncertain date in the future. The economic conditions in the future are unknown. This is a future risk you are taking.

Closing Thoughts

Whether you decide to 1031 exchange or not, selling a property can be an excellent way to turn your hard work into cash.

The most important thing is to work with an investment broker who regularly sells properties similar to your property in your property’s market. They will know what the property is worth and who the likely buyers are.

Responding to a random offer you receive or trying to sell the property without a broker is like gambling: it may work out, but the odds are against you.

Be a professional.

Leverage the power of a good broker.

You got this.

You Improved the Property. Now How Do You Get Paid?

The three ways to turn a value-add into cash — and how to pick the one that fits your goals

We have covered a lot on executing your business plan over the last nine weeks.

• I defined what it means to add value and discussed the many ways to do this.

• I discussed the critical role of contractors and how to navigate construction contracts.

• I then spent five newsletters breaking down leasing from a leasing overview to nailing your rent projections to understanding effective rent to reading leasing contracts to analyzing whether or not to renew a tenant.

Executing your business plan is a process. Early on I presented a formula for success:

Understand Your Goals + Focus + Talk with Experts + Budgeting + Develop a Game Plan = Setting the Property Up for Success

You then need to execute.

Today I will talk through what to do once you have successfully executed your business plan. Your hard work, patience, and perseverance have paid off. Maybe there was even a little luck along the way.

But here's the question most investors face next: how do you actually get your money out?

There are three main ways to do this:

1. Enjoy the cash flow.

2. Sell the property.

3. Cash out refinance.

Each way has its pros and cons. The decision of what to do depends on the goals you are trying to achieve, which may change over time.

Let’s dig in.

Your Real Estate Investment Example

Let’s create an example to use in explaining and evaluating the three ways to monetize your investment. The math will tie to my previous post: Cap Rates: The Simple Math of Real Estate Investing

Here’s the example:

A little over two years ago, you bought a property that was 100% leased to one tenant with two years left on the lease. The net operating income (NOI) at time of purchase was $10,000. [Reminder: NOI = revenue less operating expenses but before interest costs and capital expenditures.]

Your total cost to buy the property was $170,000 — a $165,000 purchase price plus $5,000 in closing costs. After securing a $110,000 loan with a 5.5% interest rate, your equity was $60,000.

• $170,000 - $110,000 = $60,000

The property was old and in need of some cosmetic repairs. As it was fully leased when you bought it, you waited patiently until the lease expired to complete your light rehab.

You spent $30,000 to do a light rehab (paint, carpet) and paid a commission to a broker to find a new tenant. Because the loan amount is fixed, the $30,000 cost increased your equity (aka cash investment): $60,000 original equity + $30,000 light rehab and commissions = $90,000 total equity.

After the light rehab, you were able to increase the NOI to $15,000. 

Here’s a summary table to help you keep track of everything.

Table 1: Financial Impact of a Successful Business Plan Execution

Note that there are two ways to look at your cap rate.

1. Using purchase price (what you pay to buy the property): NOI / Purchase Price — $10,000 / $165,000 = 6.1%

2. Using total costs (your actual return on your cost basis): NOI / Total Costs — $10,000 / $170,000 = 5.9%

Neither is more accurate than the other. Each explains a way to look at your cap rate.

So what do these calculations tell us? Two main things:

#1) Cash Flow Increase

By spending a one-time cost of $30,000 for the light rehab and commissions, you went from $3,950 per year of cash flow to $8,950 per year. $30,000 to get $5,000 more per year? Well worth it.

#2) NOI Increase = Value Increase

You have increased the NOI. NOI is a key metric buyers and lenders use to value a property. To oversimplify a bit, the value of the property has increased. 

Why is this oversimplifying? 

Because cap rates can go up and down depending on overall market sentiment, independent of your individual property. 

For this discussion, let’s assume they stayed fixed.

Monetizing Value

Now let’s get into the fun part. How do you turn your hard work into cash? Said another way, how do you “monetize” the increase in value?

Option 1: Enjoy the Cash Flow

The first way is the most straightforward and passive: do nothing and enjoy the increased cash flow. 

The $8,950 cash flow per year after light rehab on your $90,000 of equity is a 9.9% annual cash-on-cash return. Much of it is shielded from tax by depreciation. See 5 Tax Advantages That Make Real Estate Investing So Powerful. 

If you are a cash flow investor like I am, this may be the best fit for you.

Option 2: Sell the Property

Properties are typically sold based on a capitalization rate (cap rate). In this case you bought the property for a 6.1% cap rate: $10,000 NOI divided by $165,000 purchase price = 6.1%.

Let’s assume you can sell the property for the same 6.1% cap rate. $15,000 post light rehab NOI divided by 6.1% = $245,902.

This gives you a profit before commissions, closing costs, and income tax of $45,902. $245,902 - $200,000 total costs. Not a bad return in two years for your equity investment of $90,000.

If you are focused on increasing your total net worth as much as possible, this could be the path for you. You could consider a 1031 exchange to defer the taxes as I discussed in 5 Tax Advantages That Make Real Estate Investing So Powerful.

Option 3: Cash Out Refinance

Refinancing the property could be a way to have the best of both worlds. 

The increase in NOI will likely allow you to put a bigger loan on the property. Your original loan of $110,000 was about 65% of total costs ($110,000 / $170,000 = 65%). 

Using the same 65% on the new market value we calculated above ($245,902) would give you a new loan of just under $160,000. $245,902 x 65% = $159,836. This new loan amount is almost $50,000 more than your original loan.

Doing this is known as a “cash out refinance”. There is no tax on the $50,000. You could use it to invest in a new property.

But…you will have to pay back $50,000 more in debt when you eventually sell the property. This is additional risk you are taking on.

Important Caveat: Not all lenders will immediately give you a cash out refinance. Every situation is different so talk with multiple lenders.

Remember that your interest costs will go up and your cash flow will go down. If we assume the same 5.5% interest rate, your annual cash flow drops from $8,950 to $6,209.

Table 2: Cash Out Refinance

You also have higher fixed expenses with the new interest costs. This gives you less cushion if you lose the tenant and/or the economy sours.

A cash out refinance is a good option for investors who want the best of both worlds (and are comfortable with higher fixed expenses): ongoing cash flow and additional money to invest in the next deal.

Sale vs Cash Out Refinance

In this example, the cash out refinance proceeds ($49,836) are more than the sales proceeds before closing costs and commissions ($45,902). 

This is not always the case. 

Interest rates and cap rates regularly move around depending on market conditions and market sentiment. If you are on the fence of which option is best for you, educate yourself by talking with brokers on market cap rates and lenders (or debt brokers) on loan options.

Pros and Cons

So let’s put it all together to see what the best fit for you is.

Enjoy the Cash Flow

• Action: none; enjoy the additional cash flow.

• Pros: passive; no further execution risk.

• Cons: minimal current cash compared to a sale or cash out refinance.

• Good for: investors focused on cash flow.

Sell The Property

• Action: sell the property.

• Pros: ability to unlock value and 1031 exchange into a new property to repeat the process of a new strategy on a new property.

• Cons: execution risk on the sale; sale commission costs; tax exposure if no 1031 exchange.

• Good for: investors focused on creating maximum wealth by buying, adding value, and then selling multiple properties over time. Buy > Add Value > Sell > Repeat

Cash Out Refinance

• Action: refinance the property with a larger loan.

• Pros: ability to unlock value without paying taxes and continue to benefit from (a reduced) cash flow; the proceeds from the cash out refinance could be used to buy a new property.

• Cons: execution risk on the refinance; transaction costs of refinance; risk of having more debt and interest expense.

• Good for: investors wanting to balance ongoing cash flow and ability to grow their real estate portfolio by buying new properties.

One additional very important note. This is a single tenant property. If you sell the property, you have eliminated any risk associated with the tenant vacating or defaulting. If you hold the property, whether for cash flow or through a refinance, the risk associated with the tenant stays with you. And a cash out refinance increases the risk because you have more debt you will need to pay back.

What Worked for Me

As with my investing strategy, my monetization strategy has changed over time.

Stage I (Years 1-10+): Buy > Add Value > Sell > Repeat

I was all about maximizing the power of the limited funds I had. The goal was to create value, sell a property, and invest it in a new one. This was an effective method to build wealth. I still have a number of investments that fit this strategy.

Stage II (Years 10+): Enjoy the Cash Flow & Cash Out Refinances

Once I had built wealth, or at least could see a path to that future with my existing investments, I started to be more focused on cash flow. I was able to build up a combination of assets under two strategies:

• Cash Flow: I have one property that I own debt free. The strategy is focused on consistent cash flow.

• Cash Out Refinance: Buy > Add Value > Cash Out Refinance > Repeat. The LP investments I have follow this strategy. I use the cash out refinances to buy more cash-flowing assets. 

These stages have worked well together. I wouldn’t have been able to focus on cash flow investing without the capital I built up through selling properties.

Finding the Monetization Option That Fits You

Let’s think about what might work for you.

Situation A: Limited Capital, Long Time Horizon

This is likely your situation if you are early in your career. You are rich in time, energy, and health, but poor in money. You have a long time horizon for the power of compounding to go to work.

The buy > add value > sell > repeat is a path that could allow you to turn your limited funds into something more meaningful.

Situation B: Some Capital, Shorter Time Horizon

Maybe you are exploring real estate investing for the first time later in life. Your time horizon to retirement, or at least leaving a W-2 job, is shorter. You have worked hard and saved a decent amount of capital to invest.

In this case a combination of enjoying the cash flow and cash out refinances may be a better fit for you.

What is Right for You?

I have seen investors follow each of these paths successfully. It all depends on your available capital, time horizon, and goals. 

Remember the fundamentals from the series on investment fundamentals: pick a nicheand choose your investment strategy.

Take the time to really think:

• What are you trying to achieve?

• What is your investment horizon?

• How much time and money do you have today to work at this?

• How much risk are you willing to take on while still having the ability to sleep well at night?

You can do this.

Renew or Roll the Dice on a New Tenant?

How to weigh a sure renewal against three prospects — and the tenant rights that can make or break the deal

Today is our fifth and final discussion on leasing where we will get into decisions you will need to make when managing your tenants and leases such as whether to:

• Renew an existing tenant or try to find a new tenant.

• Give a tenant a right to renew, expand, contract, or terminate their lease early.

All of this will build off of the four previous newsletters on leasing: 

• Leasing: The Engine That Can Turbo Charge Your Revenue 

• The 4 Tools to Nail Your Rent Projections

• Why the Highest Rent Isn’t Always the Best Deal

• How to Read Leasing Contracts Without Getting Burned

Leasing is dynamic.

It involves negotiating rights and obligations of each party (landlord and tenant). Some can be clearly measured financially. Others are non-financial in nature and harder to quantify.

Today I will break down the following:

• The big four tenant rights: renewal, expansion, contraction, and early termination.

• Defining “Deal Breakers”

• Lease analysis example for decision making.

Let’s dig in.

The Big Four Tenant Rights: Renewal, Expansion, Contraction, and Early Termination

As discussed in How to Read Leasing Contracts Without Getting Burned, leases include rights and obligations for both tenants and landlords. Four of the rights that tenants often want that landlords may be more reluctant to give are:

• Renewal Options

• Expansion Options

• Contraction Options

• Early Termination Options

They are “options” in that the tenant has the option, but not the obligation, to exercise this right. Some of these options will be “unilateral”, meaning only one party (typically the tenant) has the right. Others will be “bilateral”, meaning both the landlord and the tenant each have the independent right to exercise the option.

Let’s define each one and then see how they factor into decision making.

Renewal Options

• Definition: unilateral right of tenant to renew at the expiration of their lease.

• Example: two 3-year options to renew at 100% of market rent.

• Why Tenants Want It: gives them the right, but not the obligation, to continue running their business in that location.

• Why Landlords Don’t Like It: a renewal option encumbers the space and reduces the landlord’s flexibility to lease to other tenants or sell the project to a business that wants to own and occupy the building (aka an owner user).

• Typical Compromise: most landlords will give a renewal option or two at market rent unless they have specific plans for the building at the end of the lease.

• Real World Example: We once leased a retail suite to a national restaurant chain with strong credit. It was a very attractive rent. The only negative was that the tenant would only do the deal if we gave them two 3-year renewal options at a pre-agreed upon fixed rent. This required us to pre-agree upon a rent in the future. We ended up agreeing to this fixed rate renewal option because the rent and tenant credit were so strong. The risk we took on is that the market rent could rise above the rent in the fixed rate renewal option.

Expansion Options

• Definition: unilateral right of tenant to expand into another suite in the building or business park.

• Example: existing tenant in suite A (10,000 square feet) has the ongoing right to expand into suite B (5,000 square feet) at 100% of market rent if the existing tenant in suite B vacates.

• Why Tenants Want It: gives them the right, but not the obligation, to expand at the existing location if the business is growing.

• Why Landlords Don’t Like It: an expansion right encumbers another suite and makes leasing more complicated.

• Typical Compromise: most landlords will strongly resist giving this right.

• Real World Example: Years ago we leased an office suite to a fast growing, venture capital funded technology start up in San Francisco. We gave the tenant multiple expansion rights at market rent in order to win the deal from another landlord because (i) the rent was strong (ii) the tenant improvements were low, and (iii) the space had been vacant for a year.

Contraction Options

• Definition: unilateral right of tenant to reduce their leased square feet.

• Example: existing tenant with a 5-year lease in suite A (10,000 square feet) has the one time right to reduce their leased square feet to 7,500 square feet at the end of year 3. Tenant will pay the cost of demising the suite.

• Why Tenants Want It: gives them the right, but not the obligation, to downsize their business for any reason.

• Why Landlords Don’t Like It: this reduces the stability of the landlord rent roll and income. 

• Typical Compromise: most landlords will strongly resist giving this right.

• Real World Example: We bought an industrial park as part of a portfolio acquisition. The park was 30% leased. The existing tenant had multiple one-year contracts with its customers. As the tenant continued to bring on more customers, they expanded into a total of 70% of the park. In order to get these deals done, we agreed to give the tenant ongoing contraction rights with 3-months notice. It was worth it because (i) there were few other tenant prospects and (ii) the expanding tenant took the spaces immediately and without any tenant improvement costs.

Early Termination Options

• Definition: unilateral (or bilateral) right of either landlord or tenant to terminate the lease early.

• Example: either landlord or tenant may terminate the lease with 6-months notice at any time after the 36th month of the 5-year lease for a one time termination fee of $10,000.

• Why Tenants Want It: gives them the right, but not the obligation, to downsize their business for any reason.

• Why Landlords Don’t Like It: this reduces the stability of the landlord rent roll and income. A landlord may want this right if they plan to redevelop the project in the future.

• Typical Compromise: most landlords and tenants will strongly resist giving this right to the other party.

• Real World Example: Let’s go back to the tech startup example from the expansion option discussion. This same tenant signed a 10-year lease but negotiated a termination option at the end of year 7. We were able to accept this because (i) the termination penalty was equal to an additional year of rent and (ii) the other deal terms were so compelling.

As I said before, options can’t always be quantified financially. It helps to understand which options you can live with and which you can’t, which is where we will go next.

Defining “Deal Breakers”

As you can see by the real world examples, leasing is dynamic and full of trade-offs. Each party (landlord and tenant) will ask for things that the other party may not want to give. 

Sometimes one party will not compromise on an issue no matter how compelling the other deal terms are.

These are “deal breakers”.

Knowing what your deal breakers are in advance will help you better analyze and negotiate leasing opportunities. Here are two examples:

Termination Option with Specialized Tenant Improvements

• Situation: we had a tenant prospect that wanted to lease a suite for 7-years at a good rate but needed expensive tenant improvements to build a customized section in 30% of the space. Not only was the build out expensive, but it was also very unique. No future tenant would want to use it, so it would need to be demolished at the end of the lease. The tenant also wanted an ongoing termination right starting at the end of year 3.

• Why It Was a Deal Breaker: we decided to pass on the prospect due to the combination of (i) the expensive, specialized tenant improvements and (ii) the ongoing termination right.

Expansion Option in a Strong Leasing Market

• Situation: the leasing market was strong with high tenant demand. We had a tenant prospect who wanted to lease 10,000 square feet in a 50,000 square foot industrial park. The lease rate was good and the tenant improvements were low, but the prospect wanted an ongoing expansion option on the other 40,000 square feet for the entirety of their 10-year lease.

• Why It Was a Deal Breaker: we decided to pass on the prospect due to the ongoing expansion option, particularly at a time when the leasing market was so strong. Note that we gave the expansion option in the tech startup example above. The difference was that (i) the tech startup was leasing 40,000 square feet vs. 10,000 square feet in this example and (ii) the leasing market was not as strong in the tech startup example.

Lease Analysis Example for Decision Making

Now that we have a strong foundation of leasing, let’s run through a lease analysis example to show how an owner might decide what to do in various leasing situations.

Imagine a situation in which you have a 5,000 square foot suite that is leased to a tenant that has paid rent on time for the last three years. Their lease is expiring and the tenant wants to renew.

You need to decide whether to renew your current tenant or lease to one of the three prospects your leasing broker has found. The deal terms are summarized in the table below.

Table 1: Lease Comparison Example

So what does this table tell us? Prospect C is the best option. Let’s go through each one in detail to understand why.

Current Tenant vs. Prospect A

• Current Tenant: will renew for three years as-is (no tenant improvements) for an effective rate of $1.450 psf/mo. As the renewal starts the day after the lease expires, the effective rate incl. downtime is also $1.450 psf/mo. This is our baseline.

• Prospect A: will lease the space at a better start rate ($1.50 vs. $1.40) and effective rate ($1.480 vs. $1.450 - even with 2 months of free rent), but their lease will start two months later than the current tenant. This delayed start date reduces the “Effective Rate incl. Downtime” to $1.406 vs $1.450 for the current tenant. 

• Conclusion: unless the owner wants a higher start rate of $1.50 to present better optics for a stronger refinance or sale, the current tenant offers a better effective rate incl. downtime.

Current Tenant vs. Prospect B

• Prospect B: same effective rate as Prospect A, but with $15,000 more in tenant improvement costs and all four of the rights landlords don’t like (renewal, expansion, contraction, and early termination).

• Conclusion: unless the owner really wants the excellent credit, this is a worse deal than Prospect A. Current tenant is still the best deal.

Current Tenant vs. Prospect C

• Prospect C: these are the best economics as compared to current tenant - start rate ($1.70 vs. $1.40), effective rate ($1.677 vs. $1.450), and effective rate incl. downtime ($1.593 vs. $1.450). They have excellent credit and don’t need any tenant improvements. The only downside is that they want renewal options and an expansion option.

• Conclusion: the improved economics would likely be compelling enough for the owner to go with Prospect C over the current tenant, even with the renewal and expansion options. The only way the expansion option might be a deal breaker is if (i) the leasing market is extremely strong or (ii) the landlord has other plans for that suite.

Closing Thoughts

Not all leasing decisions will be obvious. They will be filled with trade-offs relative to financial and non-financial terms. Here’s the process I recommend to help you make decisions on which tenant to go with:

1. Start with the pure math on the financial terms to see the best deal.

2. Then layer in the tenant credit.

3. Finally, factor in the options the tenant is asking for. Are any of these deal breakers for you?

Then take the time to think about what is important to you. 

• Financially, do you care more about (i) cash flow or (ii) maximizing net operating income so that you can sell or refinance?

• How important is tenant credit to you?

• Are you willing to take on the risk and uncertainty associated with the tenant options? If you are selling or refinancing in the near term, make sure you talk with a sale broker and/or debt broker to understand how these options will be viewed by buyers and/or lenders.

Trade-offs will always exist. Take the time to think about them and understand what is most important to you.

Think.

Analyze.

Negotiate.

Repeat.

Be patient and focused to negotiate the deal that works for you.

How to Read Leasing Contracts Without Getting Burned

Breaking down the big three — listing agreement, letter of intent, and lease — and the one skill that makes them readable

We are making good progress in our discussion on leasing. Let’s anchor in on where we are.

What we have discussed thus far:

• Leasing: The Engine That Can Turbo Charge Your Revenue

• The 4 Tools to Nail Your Rent Projections

• Why the Highest Rent Isn’t Always the Best Deal

What is still to come:

• Understanding broker listing agreements, letters of intent, and leases.

• Analysis examples of new leases, renewals, expansions, contractions, and early terminations.

As you can see, there is a lot to cover. Leasing is exciting, dynamic, and complex.

But you don’t need to be intimidated.

As you spend more and more time on it, you will see that it is anchored in a handful of fundamental negotiation criteria: start date, lease duration, rent, leasing costs, and the rights both the landlord and tenant have during the lease term.

These are all concepts that end up in a lease. Understanding how to read and negotiate a lease will pay dividends for you over time.

Today I will focus on breaking down the three key contracts that go into leasing, culminating in a lease agreement:

1. Broker listing agreement.

2. Letter of intent.

3. Lease agreement.

These are the “big three” when it comes to leasing.

Let’s dig in.

What Is a Contract?

Let’s start by reminding ourselves what a contract is: a contract is a written agreement between two or more parties through which they commit to certain terms. We have covered contracts in three previous newsletters:

• Selling/buying a property - Demystifying Real Estate Purchase Agreements

• Hiring vendors to maintain your property - Vendor Service Contracts: What You Need To Know

• Hiring contractors to upgrade your property - Navigating Construction Contracts

In the future we will cover two additional contracts: loan agreements and partnership/joint venture agreements.

Contracts can be short or long. They have a start and (usually) an end date and are signed by all parties involved. They are often written by lawyers.

And they have something called “defined terms”.

Defined Terms

To read and understand a contract correctly, you need to understand the concept of a “defined term”. Here are the basics:

• It is any word or set of words that is capitalized, but not because it is the first word in a sentence. Examples: “Expansion Right”, “Effective Date”.

• It means something special that may or may not be similar to what you think it means. That meaning will either be described in the paragraph in which the defined term is first introduced or in an exhibit that lists all the defined terms in the contract.

• It usually is referred to in other parts of the document.

Here’s an example - “Expansion Right”: a tenant could have a right to expand into the adjacent suite under certain terms and conditions (a specific time window, rent, and tenant improvement package). The lease will define this expansion right and then refer to it in other parts of the document. For example, it might read: “If the Tenant is in default at any time, the Expansion Right shall become null and void.”

The use of defined terms reduces the need to repeat the same concept and words over and over again. They can be both helpful and confusing.

If you take one thing from this entire newsletter today, this is it:

As a reader, the key is to look out for these capitalized words and then look up their meaning. This way you will read and understand a contract correctly. Never assume a defined term means anything other than what is written in the definition.

Let’s move to the first of the three main leasing contracts.

Broker Listing Agreement

The broker listing agreement is a 2-6 page contract between a landlord and a broker. The landlord hires the broker to market and lease the property. There would be a similar agreement if an owner were to hire a broker to SELL the property.

At its most basic level, the listing agreement says that the broker will use commercially reasonable efforts to present qualified tenants to lease the space. The landlord will decide whether to lease to this tenant. If a lease is signed, the landlord will pay the broker.

Here are the key components that make up the listing agreement:

• Listing Period (i.e. the length of the contract): Start and end date; typically, 6-12 months.

• Commission Amount (note that structures and amounts vary between markets and product types). Here is an example: the broker will be paid if a lease is signed as follows:

  • 6% of total rent for months 1 - 60 | 3% for months 61 – 120; nothing after 10 years. Note: it is typical for the broker to earn less for the latter years.

  • 100% to listing broker if no outside broker involved | 50/50 to listing and outside broker if outside broker is involved.

• Payment Timing: Example - 50% paid at lease execution | 50% paid when tenant takes possession of premises.

• Re-Leasing: Listing broker may be required to re-lease space if tenant vacates/defaults within 1 year.

• Marketing Budget: Owner may provide a specific marketing budget.

• Exclusions: Renewals and expansions may be excluded from earning a commission; property sales are typically excluded.

I discuss this in further detail and have downloadable abstract templates for all three contracts in the Downloads section of my website: creprofessor.com/downloads.

I have a number of battle scars from poorly drafted listing agreements. Here are some things to watch out for:

1. If you are a new or smaller commercial real estate investor, the broker will prepare the listing agreement based on their company’s standard form. It often contains more than you want to agree to. Don’t be shy about pushing back on certain terms.

2. Make the duration of the agreement no longer than 6 months. You want the broker to feel the pressure that they don’t have unlimited time. You can always extend the agreement.

3. Exclude payments for renewals. I have seen situations where we renewed an existing tenant, not realizing that the listing agreement required the broker to be paid even though they weren’t involved in the negotiations.

4. Exclude a commission for a sale. I once had a situation where we decided to sell the property and found that the listing agreement, which had been prepared by the broker, included a clause that they would be paid 2% on any sale. We had to get out of this agreement before we could hire a separate broker that specialized in property sales to sell the property.

The key is to read and summarize the agreement to make sure you understand what you are agreeing to. As with all commercial real estate contracts, you can always (try to) negotiate out what you don’t want to agree to.

Let’s move to the next contract.

Letter of Intent

A letter of intent (“LOI”) is a 1-6+ page document that outlines the key terms under which a landlord and prospective tenant would use as the basis for a lease.

We went deep into negotiating LOI terms last week, so I’ll just highlight some key points here.

The LOI becomes the foundation for the terms that will be included in the binding lease agreement. In the majority of cases, most of the terms, other than confidentiality, governing law, and possibly exclusivity, are non-binding. This means either party can walk away from negotiations for any or no reason at any time.

Deal terms such as rent, start date, and tenant improvements are negotiated using the LOI. We discussed this process last week in Why the Highest Rent Isn’t Always the Best Deal.

Here are the key terms in an LOI:

• Start and end date.

• Rent, annual increases, and free rent.

• Security deposit and any personal guarantors.

• Condition of the space and any tenant improvements.

• Options and rights such as renewals, terminations, expansions, contractions, and right to purchase.

• Any brokers involved and any commissions that are different from the listing agreement.

Most of the time a broker will prepare and negotiate the LOI on your behalf based on their advice and your decisions.

Always remember, you are the property owner and the one who makes decisions. Brokers (and any other lawyer, consultant, or advisor) are there to give you opinions, but the owner is the one who makes the decision. Never forget this.

Once the LOI is agreed to, a lease is negotiated. However, not all leases need to start with an LOI. I have done deals where we verbally agree to the key terms and go straight to a lease.

But before we get to the lease agreement section, let me share one story that illustrates the downside of an LOI being non-binding.

I was negotiating a large lease with an excellent credit tenant. We had a signed, non-binding LOI and the lease was fully negotiated and ready for signature. We were just waiting on the tenant’s proof of insurance before we signed the lease.

The next thing we knew, the tenant told us they were backing out of the deal. Something unrelated to our space had changed on their end. Because we hadn’t signed the lease, they had the right to back out.

Key takeaways: (i) an LOI is non-binding and (ii) a lease is not valid until it is signed by both parties.

Lease Agreement

Lease agreements are typically 5-15+ pages with a series of exhibits. They can be simple and not negotiated at all using the American Industrial Real Estate Association's standardized lease form or they can be complicated and highly negotiated over weeks and months, costing $10,000+ in legal fees.

It all depends on (i) how reasonable each party wants to be, (ii) whether the tenant is under pressure to move in due to their business needs, and (iii) whether either party has a biased lease template form that they want to use (i.e. overly landlord or tenant friendly).

There is not enough space to go into all the terms of a lease, so I will limit this discussion to the main sections:

1. General: parties involved, square feet, building, permitted uses, parking.

2. Key Dates: start, end, early possession, timeline for completion of tenant improvements.

3. Rent & Other Financial Obligations: rent, increases, free rent, reimbursement structure (NNN vs modified gross vs gross), security deposit, late charges.

4. Delivery Conditions & Tenant Improvements: condition of the space, who completes and pays for the tenant improvements.

5. Tenant Options/Rights: renewal, termination, expansion, purchase, sublease.

6. Landlord Options/Rights: relocation, termination.

7. Alteration Rights & Maintenance Obligations: who maintains what and whether the tenant has rights to modify the premises with or without landlord’s approval.

8. Defaults, Damage, Condemnation: what constitutes a default and what happens if the building is damaged or condemned.

9. Other Tenant Obligations: estoppels, financial statements, subordination and non-disturbance agreement.

10. Exhibits: such as rules and regulations, rent payment instructions, insurance obligations, tenant improvement details.

You can visit creprofessor.com/downloads to dig in deeper into what goes into a lease and download my summary template.

Leases can be 30+ pages long with exhibits, but make sure you read them in their entirety. One property acquisition almost fell apart due to a clause deep in the lease that gave the existing tenant the right to purchase the property.

The seller had missed the clause and had to do a last-minute scramble days before closing to get the tenant to waive the right.

The deal eventually closed, but not without some significant effort and stress.

Making Sense of It All

As I said before, don’t be intimidated by contracts. You can understand them if you follow these key steps:

1. Think about the purpose of the agreement and what each party is trying to achieve.

2. Listen to the advice of brokers, lawyers, and experts, but remember that you make the decisions. If the advice seems unreasonable, ask questions and/or don’t follow the advice.

3. Be reasonable. Getting through a contract usually involves compromise. Talk with the decision maker on the other side to understand their perspective.

4. Create YOUR best environment to read the contract. For me this means printing out a hard copy and reading it first thing in the morning without distractions. I highlight the important parts, strike out the parts I won’t agree to, and note the areas for further discussion. Find what works best for you.

5. If you don’t understand something, don’t sign the contract. It is better to be embarrassed by asking a question that might make you feel stupid than to agree to something that you don’t understand and could bite you in the future. Try saying: “I am not clear on what situation would come up where this language in the contract would come into play. Can you give me an example?”

Take your time.

Ask questions.

Keep learning.

You got this!

Why the Highest Rent Isn't Always the Best Deal

How to market your space, understand a letter of intent, and see what an offer is really worth

Last week I introduced the 4 tools you can use to accurately project your rents: competitive set, lease comps, understanding your local market, and working with brokers.

Today we are going to take the next step to understand how to (a) bring prospective tenants to your property so you can (b) pick the tenants that will be the best fit for your property.

“Fit” is a broad word. 

It covers things like rent, concessions, start date, length of lease, tenant credit, tenant improvements, and broker commissions.

Different owners will have different priorities, making “fit” unique to each owner.

Regardless of your priorities, you want to maximize your options. As with anything, having multiple options usually yields better decisions and outcomes.

For example, if you are ready to lease a car, it helps to get quotes from multiple car dealers. Having multiple quotes and options allows you to compare price, timing, and other criteria. 

It is often the process of comparing bids that allows you to see what is most important to you.

Getting multiple bids when you are buying something is straightforward. Make the calls or visit the sellers.

Comparing multiple tenants to lease your space is a bit harder. You can’t control when someone needs space, but you can control your marketing outreach to make sure all the tenants that are looking for space to lease consider YOUR space.

This is what we are going to get into today.

• How to market your property.

• Negotiating the best deal for your property. 

Residential and commercial are fundamentally different in these processes, so we will discuss them separately.

Let’s dig in.

Residential: How to Market Your Property

As a reminder, residential refers to both 1-4 unit residential and multifamily (aka apartments). The tenants (aka residents) are individuals, not businesses.

The residential marketing process involves three components:

1. Value add initiatives to show the units and the amenities in the best light.

2. Maximizing the exposure of your property to bring in prospective tenants.

3. Having an effective sales process once a prospective tenant comes in to see the property.

We discussed value add initiatives in The Many Ways You Can Add Value to Your Real Estate Investment.

Maximizing exposure includes all the ways you can get the attention of potential tenants from signage to banners to search engine marketing to social media. These are tried and true marketing techniques across many industries beyond real estate.

The unique aspect of residential real estate is the sales process led by a member of the property management team. The sales person literally walks the prospective tenant through the property, highlighting key features of the property and the location. 

For 1-4 unit residential the focus will be on the individual unit and the benefits of the location.

100+ unit apartments are much more involved. There will be a specific tour path the sales person takes all prospective tenants on.

I personally experienced this as a prospective tenant when I went to my first large apartment complex. Here’s how it went.

1. Leasing Center: it started with a bright and lively leasing center. 

2. Pool: we then walked by the pool, where I saw people sunbathing. 

3. Gym: next it was the renovated gym. In my head I was thinking that I could cancel my gym membership and use this instead. 

4. Unit: we moved on to the unit where the sales person highlighted the renovated kitchen and view. 

5. Dog Park: we ended by walking past the dog park area where I saw dogs running free in a fenced area. 

All the while the sales person was listening to my reactions and adjusting the sales pitch, including saying that she already had another person interested in the unit I liked best.

I signed the lease that day. A sales job well done.

The larger and more professionally managed the apartment complex, the more likely they will follow a similar process.

Residential: Negotiating the Best Deal For Your Property

In Leasing: The Engine That Can Turbo Charge Your Revenue, I oversimplified the leasing process by saying that adding value to residential (as compared to commercial) is about making the improvements and watching your hard work pay off as the rents increase.

The marketing section above debunks some of this simplification, but the distinction between residential and commercial still holds.

Fair housing law affects how larger operators manage the leasing of their apartment complexes. This law prohibits discrimination on the basis of protected classes. Larger operators adopt uniform pricing as a risk-management practice. One price for everyone is a clean way to prove you didn’t treat applicants differently.

For buildings leasing under the uniform pricing model, the prospective tenant either agrees to the rent and signs the form lease or doesn’t. It is a “go, no go” decision without any negotiations. The only flexibility the prospective tenant may have is choosing the length of the lease.

The 1-4 unit residential segment is more actively negotiated, but not as extensively as commercial. The negotiations will typically be limited to the rent and length of the lease.

Commercial real estate leasing is all about negotiations. This is where we will go next.

Commercial: How to Market Your Property

Whether industrial, retail, or office, tenants for commercial properties are businesses. Some of the same marketing fundamentals apply, but the primary method for commercial is direct outreach to individual businesses and their broker representatives.

This is where leasing brokers come in.

There are two main types of brokers when it comes to leasing: landlord rep and tenant rep. “Rep” is short for representative. Some brokers do both, but many specialize.

A landlord rep broker specializes in representing building owners in marketing and leasing their property.

A tenant rep broker specializes in representing businesses (i.e. tenants) in finding space for them to lease and negotiating the best deal for them.

Both landlord rep and tenant rep brokers are compensated by earning a commission if a lease is signed. This commission is paid by the owner. We will cover commissions in a future newsletter.

The leasing process is as follows:

1. Owner hires a landlord rep broker on an exclusive basis using a broker listing agreement detailing the length of the agreement and how much the broker will be paid. We will cover the details of the listing agreement next week.

2. The landlord rep broker markets the property to brokers and businesses in the area using a leasing brochure. See below for links to some examples.

   1. Retail - link from LoopNet.com.

   2. Industrial - link from broker website.

   3. Office - link from owner website.

3. A prospective tenant will tour a space with or without a tenant rep broker.

4. If the tenant likes the space, negotiations will begin.

Negotiations are where we will move to next.

Commercial: Negotiating the Best Deal For Your Property

Negotiations play a HUGE role in commercial leasing. 

The owner and landlord rep broker set an “asking rate” that is usually shown on the leasing brochure. The tenant rep broker then uses this as a starting point to try to negotiate the best deal for their client (the business that is interested in leasing the space). 

At this stage the parties are negotiating a non-binding Letter of Intent (LOI) that outlines the primary lease terms that will be incorporated into a lease. We will cover the details of the LOI next week.

See below for a table that shows how the negotiations for an industrial building might play out, using the example from last week’s newsletter.

Table 1: Lease Negotiation Example

Let’s break down what is going on in the table above.

• Asking Rate vs. Underwriting Target = $1.50 vs. $1.40: the asking rate is higher than the underwriting target to leave some room for negotiations.

• Initial Offer from Tenant’s Broker: the broker started aggressively: $1.30 start rate (vs. the asking rate of $1.50) plus 5 months of free rent and $3 psf of TI’s. The effective rate is $1.159 vs. the underwriting target of $1.411. There is still a lot of work to be done.

• Over the subsequent three LOIs, all parties came to an agreement on the terms shown in “Offer #4”. Let’s compare the amounts agreed to in Offer #4 vs. the Underwriting Target.

  • Start Rate: $1.40 vs. $1.40 = good outcome.

  • Effective Rate: $1.415 vs. $1.411 = good outcome. The owner was able to agree to 1 month of free rent but get an additional month of paid rent to help increase the effective rate (36 months of paid rent + 1 month free rent = 37 month lease).

  • Tenant Improvements: $0.50 vs. $0.50 = good outcome.

As I said in the beginning with any negotiation, you need to understand the criteria that are most important to you such as:

• Maximum starting rent.

• When the rent starts: start date plus months of free rent.

• Length of lease.

• Amount of tenant improvements (TI’s) you are willing to give.

Different owners will have different criteria preferences and these preferences will change over time. Examples:

• An owner who plans to hold the property forever may be willing to take a lower starting rent in exchange for a sooner rent start date, no free rent, and no TI’s.

• An owner planning to sell (or refinance) the property in the near term may want the complete opposite: maximize the starting rent but be willing to push out the start date and give more free rent and TI’s. This is because they want to maximize the net operating income to sell at a cap rate that maximizes the sales price.

Negotiations are about knowing which criteria are most important to you and the prospective tenant and then finding a deal that both parties can live with.

When it comes to comparing multiple prospective tenants, this can mean running parallel negotiations.

See below for a table that shows the initial offers (#1) from two prospective tenants.

Table 2: Lease Offer Comparison for Two Separate Tenant Prospects

Let’s break down what is going on in the table above.

• Starting Lease Rate: both offers are below your $1.40 target. Tenant A’s offer is better at $1.30 vs. $1.20 for Tenant B, but…

• Effective Rate: Tenant A’s offer is worse at $1.159 vs. $1.242 for Tenant B.

• Credit: Although Tenant B has a better effective rate, they have weaker credit.

• Other Criteria: Tenant B’s offer is more attractive in other areas vs. Tenant A:

  • Annual Rent Increases: 3.5% vs. 3.0%.

  • Free Rent: none vs. 5 months.

  • Tenant Improvements: none vs. $3.00 psf ($15,000 in TI’s).

• Start Date: I have introduced a new factor showing when the lease will start. You have an underwriting target of September 2026. Tenant A is proposing March 2027. Tenant B is proposing August 2026. That is a 7 month difference. 7 months at $1.40 psf/mo x 5,000 square feet = $49,000 of rent. This is huge, especially for an owner focused on cash flow.

Tenant B is a better deal despite the lower starting rate. You need to get comfortable with the weaker credit, but this is an analysis exercise.

So how do you approach this?

1. Understand the criteria that are most important to you.

2. Recognize that these are just the first round of offers. Remember Table 1. Things will evolve during the negotiations.

3. Accept that you often need to simultaneously negotiate with multiple tenant prospects at once to see where you end up.

4. Remember that you can say “no.” You won’t come to acceptable terms with all tenant prospects.

Negotiations can go on for weeks and even months. Or they can happen in a matter of days. Here are three real world examples of industrial leases I have experienced.

Example 1: Typical

Negotiations for the industrial building happened over two offers and then moved to the lease negotiations.

Example 2: Extremely Fast

We knew the tenant needed a building immediately and that they were considering multiple options. We skipped the letter of intent and sent them a lease ready for signature with terms that we felt were reasonable. They signed the lease immediately without any negotiations. Very unusual, but true.

Example 3: Extremely Slow

The negotiations with this Fortune 50 company over the LOI took over six months and then the lease negotiations took another year. Painfully slow, but we didn’t have any other tenant prospects.

Closing Thoughts

This discussion highlighted the similarities and differences between residential and commercial. They follow different formulas.

Residential

Effective Marketing + Strong Sales Process = Strong Leasing Performance

Commercial

Hire a Broker + Direct Marketing + Active Negotiations = Strong Leasing Performance

In both cases, you as the owner need to make sure you understand the criteria (ex. maximum rent vs. steady cash flow vs. spending more money) that are most important to you so that you can take action and make decisions that yield the best results for you and your investors.

Take the time to think about what you want, measure the results of your team’s actions, and make adjustments as needed.

You got this.

The 4 Tools to Nail Your Rent Projections

Competitive sets, lease comps, local market review, and broker intel - how the pros figure out what a property will rent for

Last week I gave you an overview of the leasing process and the differences between commercial and residential leasing. 

Today we are going to deep dive into how to understand a market and where your property fits into it. This will help you accurately project (aka underwrite) your rent.

Real estate investing is about buying investment properties. This is fundamentally different from buying a home you will live in.

An investment property needs to perform by bringing in rent.

From the tenant’s perspective, rent is an expense. Tenants (i.e. businesses and individuals) want to minimize expenses. Therefore, they want to minimize rent.

Owners want maximum rent. Tenants want minimum rent.

This is where we see the tension of supply and demand.

When you are buying a property, you need to project what the property will rent for. Unfortunately, this is when you know the least about the property and you have a due diligence deadline. You run the risk of making a costly underwriting error if you estimate market rents too high.

But don’t worry. There are ways to mitigate this risk.

Today I will navigate you through the tools and techniques to understand the market in which your property is located. This mitigates risk. They include:

• Your competitive set.

• Lease comparables (aka lease comps).

• Understanding the local market.

• Working with brokers.

• Macro factors that change market conditions.

• How to make sense of it all.

Let’s dig in.

Tool #1: Your Competitive Set

Unless you are developing a property in the middle of nowhere (do not do this!), you should be able to use similar properties in the same market to better understand the leasing prospects for your property.

Similar properties in your property’s geographic market are known as your “competitive set”. 

They won’t be exactly the same, but they will be similar. You will take into account things like location, building age, condition, square feet or number of units, multifamily amenities, occupancy, owner, and any other factors you think are relevant.

Creating your competitive set allows you to define your competition. These are the properties you will be competing with for tenants. As with any competitors, each will have strengths and weaknesses.

One property may be in a better location than yours, but have some functional challenges. Another might have worse curb appeal than yours, but have access to cheap electric or some other unique feature. Create your competitive set by: 

1. Putting the buildings and their characteristics in an excel table with a picture of each asset.

2. Adding notes on the pros and cons of each property.

3. Adding a row for the asking rent for each property. This is how much the property is “asking” tenants to pay.

4. Creating a map of each building showing their location relative to your property. 

Here is an example of a competitive set for an industrial property.

Table 1: Competitive Set Example for Industrial Property

Now let’s add in lease comps.

Tool #2: Lease Comparables (aka Lease Comps)

The competitive set helps you understand the market, but it is limited in that it only includes asking rents.

You want to look at deals that have actually been signed in the market.

This is where lease comps come in.

Lease comps are a table of data that includes details on leases that have been signed in your market in the past 12-24 months. You want recent comps because markets change over time and older comps become stale. Here is an example of a set of lease comps:

Table 2: Lease Comps Example for Industrial Property

Effective rent refers to the average rent taking into account annual increases and free rent over the full lease term. We will cover this in a future newsletter.

Lease comps are history, not speculation. They are made up of leases that have been signed at properties that are similar to yours. 

In the table above, I compared my starting rent projections of $1.40 per square foot (psf) per month to the comp average of $1.38. We are a bit high. 

Then I removed the first comp with ABC Plumbing because it was a short-term deal in a challenging space. This brings the average up to $1.43 compared to my assumption of $1.40, which makes me feel more comfortable.

The effective rent also checks out at $1.44 (after removing ABC Plumbing) vs. my assumption of $1.41.

It can be sobering to look at the lease comps relative to what you are projecting for rents for your property. Be realistic. If the lease comps don’t support your projections, this is a red flag. 

In this case you better have some secret sauce to convince you, your investors, and your lender why you will be able to hit your rent projections.

I have made the mistake of not taking into account free rent and tenant improvements when looking at lease comps. I relied on a high lease comp to support my rent projections only to find out after I owned the property that the rent was so high because the owner had given 6+ months of free rent and a huge tenant improvement package to get the starting rent unusually high. This is why it is so important to track both free rent and tenant improvements as separate columns.

Don’t make this mistake yourself.

Sometimes you will see a lease comp that looks much higher or lower than the rest. Ask for details on this and consider removing it from your set of lease comps.

Let’s move on from lease comps to understanding your market.

Note on table 2: columns marked with an asterisk (*) refer to data used in commercial, not residential. For residential, the competitive set and the lease comp data are often combined into a single table that includes the asking rent but no lease comps.

Tool #3: Understand The Local Market

Each market has its own unique characteristics. These affect how a market will perform. Characteristics will include:

• Population size.

• Health of the local economy.

• Major employers.

• Universities and the quality of education.

• Tax policy and whether the local municipality is pro or anti-development.

• Access to freeways and airports.

• Housing affordability.

• Quality of life factors such as entertainment, outdoors, weather, and schools for children.

• Any other unique factors of that market.

All of this translates into determining whether people want to live there. Can they find a job that allows them to afford housing, send their kids to a good school, and have a good quality of life?

The key is to understand the market you are investing in and how your property fits into it. Take the time to read research materials and talk with market experts.

Let’s move on to the role of brokers.

Tool #4: Working With Brokers

You may be reading this and wondering how you are going to get all this data to understand the market, develop your competitive set, and build out your lease comps.

There are professional databases out there such as LoopNet & CoStar for commercial and Zillow & Redfin for residential. These can be excellent sources of information but (a) they can cost money for premium subscriptions and (b) there is no substitute for talking with people who work a geographic market every day. 

Local market brokers will be your market experts.

The key word in this statement is LOCAL. You want to work with brokers (and property managers for residential) that focus on the market your property is in. Finding a broker who has “done a deal” in that market is different from a broker who focuses on your market.

Always pick the broker with market focus. They live and breathe the market. They are the experts.

They will understand the market drivers, the characteristics of the other owners, and most importantly, what the tenants in that market value most.

They are used to helping investors new to the market understand it. Look at properties for sale that fit your target market and asset class. Find a broker who is selling one or two properties. Then reach out to them to say that you plan to invest in this market and would like to meet them to help get a better understanding of the key market drivers. 

Make it clear that you are ready to invest soon, so they know you are not wasting their time.

They will put together competitive sets and lease comps from their database. The good ones will give you an overview of the market by (a) giving you a Google Earth tour of the market in their office and (b) driving you around the market to see the properties that make up the competitive set and lease comps.

Pro tip: don’t just take one broker’s opinion of the market. Try to talk with 2-3 brokers to triangulate the information. Lease comps are facts, but there is subjectivity as to which lease comps to select and how the competitive buildings compare to your building. Be respectful of brokers’ time, but don’t feel you need to be exclusive to just one.

That wraps up the four key tools, but there is one more thing to watch: macro factors.

Macro Factors That Change Market Conditions

So far we have been property specific while also understanding market factors.

But there can also be major changes in market conditions that can completely adjust how all properties in the market perform by fundamentally changing the supply and demand dynamics for a period of time.

Here are some examples:

• Major new development(s): rents have been going up so developers decide it is time to build. A few years later, the market is flooded with new supply giving leverage to tenants and reducing rents. This is what has happened to the multifamily / apartment market over the past few years (2023-2025).

• Global pandemic: the COVID-19 pandemic of 2020 and the resulting government actions completely changed the dynamics for multiple asset classes:

  • Apartments: increased demand due to stay at home orders.

  • Office: reduced demand due to increased amount of remote work.

  • Industrial: increased demand due to online shopping and consolidation of supply chains to be more local.

  • Retail: reduced demand due to stay at home orders.

• Macro-economic slow down: when the economy slows, demand across all asset classes tends to decrease as both people and businesses cut expenses. The reverse happens when the economy is growing.

• War and geopolitical uncertainty: fear tends to make people uncertain and spend less.

Some of these examples affect all markets and asset classes. Some are more local and asset specific. All tend to be uncontrollable from an individual property owner’s perspective. All you can do is decide how to interpret the information and take (or not take) action.

So how do you bring it all together?

How To Make Sense of It All

Competitive sets, lease comps, broker guidance, market factors…it is a lot to take in.

Here’s my guidance on how to make sense of it all.

1. Analyze the market before you make your first offer. Pick your niche. Take the time to understand the market before you have a due diligence deadline.

2. Kick the tires. Get out in the market. Walk and/or tour your competitive set.

3. If you will be adding value to your property, have two versions of your rent projections: (a) before your value add initiatives and (b) after. Compare your lease comps against each. You may even decide to create a second competitive set to compare your “post renovation” property to.

4. Talk with multiple, local brokers. Don’t just rely on one person’s opinion.

5. This is not a “one and done” exercise. Revisit the data and talk with brokers regularly. The market will continue to change, as should your projections and asking rates.

6. Markets go through cycles. Sometimes they favor the owners/landlords. Sometimes they favor the tenants.

At some point during your property ownership, most of you will be blindsided by some macro event that will turn your world upside down (examples: 2025 tariffs, 2020 global pandemic, 2008 great financial crisis, 2001 internet bust).

Welcome to living in an uncertain world. This is life.

When it happens, breathe. 

Take it slowly. 

Think. Don’t react too quickly.

The tools and techniques described here will help you navigate the market in good times as well as when the world feels like it has turned upside down overnight.

Competitive Set + Lease Comps + Broker Reconnaissance + Local Market Conditions = Accurate Rent Projections

The process is there to help and guide you. 

You got this!

Leasing: The Engine That Can Turbo Charge Your Revenue

Why your leasing strategy is so important to increasing the value of your real estate investment

Welcome to another edition of Real Estate Investing Explained. 

We are well underway on our current series: Executing Your Business Plan. So far we have covered:

• The Many Ways You Can Add Value to Your Real Estate Investment

• Understanding the Critical Role of Contractors

• Navigating Construction Contracts

Today we transition to leasing.

The most common way to add value is to physically upgrade the look and functionality of your investment and then execute your leasing strategy to increase revenue, which will drive up the value of your property.

Physical Upgrade + Leasing = Value Increase

Physical transformation first. 

Leasing strategy second.

It doesn’t always work this way, but it is the most typical. 

Sometimes the market rents increase (or decrease) regardless of what you do to the property.

Sometimes you will get lucky and find a property where the rents are below market and can be increased without doing anything. The previous owner may have not paid attention to market rents or had a different strategy.

Over the next set of newsletters we will get into all things leasing including:

1. Leasing strategies.

2. Analyzing lease comparables.

3. The leasing process and the role of brokers.

4. Negotiating a letter of intent (LOI) and a lease.

Leasing is not something that will fit into a single newsletter. It is much more complex.

But don’t worry! I will guide you through it.

Today we will cover:

1. Differences between commercial and residential leasing.

2. What to expect in the leasing process.

3. Defining your leasing strategy.

Leasing is one of the most interesting and dynamic aspects of the business. It is where all your hard work manifests into value.

Let’s dig in.

Differences Between Commercial and Residential Leasing

When it comes to leasing, there are some key differences between commercial and residential.

As a reminder, commercial refers to industrial, retail, and office. Residential refers to apartments and 1-4 unit residential.

Let’s start with the similarities.

• Everyone wants tenants to lease their space. This is where revenue comes from.

• These tenants should be able to pay the rent, not beat up the space, and be a “good neighbor” to the other tenants.

• All tenants have a lease that details the rent, term (aka lease duration), and other “rules” of occupancy.

• Proactive owners actively market their space and may be willing to offer incentives such as free rent.

That being said, they are fundamentally different in key ways.

• Negotiating Rent: residential is covered by federal fair housing law to protect against discrimination. Every tenant needs to be offered the same terms. Therefore, rent is never negotiable. Commercial rents are actively negotiated in conjunction with free rent and tenant improvements. Commercial leasing is all about negotiations.

• Tenant Improvements (TI’s): think of TI’s as a custom remodel of the suite for a specific tenant. This doesn’t happen in residential but is very common in commercial.

• Leasing Broker Involvement: leasing brokers play an active role in most commercial leases. They are on the front line of the negotiations. Leasing for residential is typically done by someone on the property manager’s team. 

To oversimplify, adding value to residential is about making the improvements and watching your hard work pay off as the rents increase.

Commercial is a two stage approach of making the improvements and then actively marketing and negotiating to get the right tenants in at the best combination of rents, TI’s, and tenant credit.

It is an oversimplification to highlight the differences.

As you read the rest of the discussion on leasing, keep these differences in mind to recognize which are going to be applicable to you as you pick your asset class (commercial or residential). 

Let’s continue to the leasing process.

What to Expect in the Leasing Process

Despite the differences between commercial and residential, leasing does follow a fairly standard process. Here are the steps:

1. Understand the market and how your property fits into it.

2. Define your leasing strategy.

3. Assemble your leasing team: leasing broker and/or property manager.

4. Market and screen potential tenants.

5. Negotiations: letters of intent and leases.

6. Delivering the space for occupancy.

A simple process, but not always an easy one to execute. Much of this will depend on your leasing strategy, which is where we will focus on next.

Defining Your Leasing Strategy

Your leasing strategy should be part of your overall strategy beyond just leasing. We discussed this in The Risk-Return Spectrum: Choosing Your Real Estate Investment Strategy. There are three main strategies:

1. Core/Turnkey: low risk, low return. You buy a property that is well leased and maintained. There is minimal work to do.

2. Light Rehab: medium risk, medium return. There is some work to do, but it is mainly cosmetic (paint, carpet, clean up). 

3. Value Add: high risk, high return. There is a lot of work to do. The property might even be vacant. You will be repositioning it and taking on a lot of risk for superior returns. 

If you are buying core deals, you are unlikely to take an active role in leasing because there won’t be much to do. It is either a commercial property leased long term or a residential property with high ongoing occupancy and rents due to the location and construction quality.

Light Rehab and Value Add deals will require a more hands on approach. You will need to think about questions such as:

• How aggressive do you want to be in your rent?

• How important is maximum rent vs. occupancy?

• How long can you last with low or no occupancy relative to your other expenses?

• What is your budget for customizing the suite for the right tenant?

• How important is the tenant’s credit and financial strength?

• What is the condition of the economy and where are you in the real estate market cycle? 

These are important questions that you need to really think about.

Talk with your partner and team. Ask for the advice from people you trust. Talk with your leasing broker.

The answers to these question should not be set in stone. They should be revisited regularly, particularly when circumstances change.

In your first year of ownership you may be full of confidence and enthusiasm. If things don’t go well, you could find yourself wishing you had done the lease you passed on 12 months ago.

Welcome to the dynamic world of real estate investing! 

Time and changing circumstances change your perspective, adding to or reducing your confidence and tolerance for risk.

This is normal and to be expected.

But we are just scratching the surface of leasing.

This newsletter was just the teaser.

Next week we will dive deeper into the details with a discussion on how to analyze the market and the critical importance of understanding lease comparables (aka lease comps).

This is where things get interesting and the experienced operators start to distinguish themselves.

As always, I will share my knowledge and experience so that you can turbo charge your learning curve.

Stay tuned for next week. 

This is going to be fun!

Navigating Construction Contracts

Pricing structures, change orders, and mechanic liens

Last week we discussed the critical role of contractors. I also reiterated the process of adding value to your real estate investment by taking the time to: 

1. Understand your goals.

2. Focus (aka think).

3. Talk with experts.

4. Get a budget. 

5. Develop a game plan.

I wrote about the importance of talking with experts and budgeting.

This week is about navigating the process of executing a binding document with a contractor to do the work. 

It builds on the contract fundamentals I discussed in Vendor Service Contracts: What You Need To Know. Today we will expand our scope from a service contract to the specifics of construction contracts.

With the exception of the initial purchase of your investment property, construction will be where you spend the most amount of money at a single point in time. Understanding the components that make up contracts and where the risks are is critical.

Today we will cover:

1. Contract fundamentals.

2. Specific components of construction contracts.

3. The four types of pricing structures.

4. Being clear on the scope of work & navigating change orders.

5. Understanding mechanic liens and retainers.

6. Best practices.

As always, we will walk through the jargon of commercial real estate to understand the fundamentals and empower you with knowledge.

Let’s dig in.

Contract Fundamentals

The newsletter on vendor service contracts is a useful reference for some of the core components that will go into a construction contract. These components include:

• Owners - both property owner (i.e. you or your entity) and vendor / contractors.

• Scope of work.

• Whether there is a warranty.

• Cost and payment timing.

• Duration, frequency, and termination.

• Insurance.

Construction contracts build off of these components.

Specific Components of Construction Contracts

All the components above will exist in a construction contract with some caveats:

• Cost: there are four alternative types of pricing structures to define the cost.

• Scope of Work: this is critical to define clearly and include in the contract. 

• Payment Timing: how payments are managed is more nuanced. This process includes risks and leverage. 

Let’s break down these additional components in the following sections.

The Four Types of Pricing Structures

The construction industry has evolved to have four fundamental pricing structures that each have pros and cons. Different circumstances lend themselves to individual pricing structures. The pricing structures are: 

1. Time and materials.

2. Lump sum (aka stipulated sum).

3. Cost plus.

4. Guaranteed maximum (aka GMAX).

Let’s break down each one.

Time and Materials

• Best For: small jobs with a single contractor (no subcontractors).

• Pricing structure: based on number of hours at an hourly rate plus the cost of materials.

• Example: electrician at $120 per hour for 6 hours = $720 in time plus $480 in materials = $1,200.

• Pros: minimal paperwork to get contractor started. Sometimes you don’t even use a contract. The contractor just bills you for the work. Fast and efficient.

• Cons: pricing uncertainty until the job is done.

Lump Sum (aka Stipulated Sum)

• Best For: jobs where the scope of work can be clearly defined in advance and the cost is more than $5,000 or so.

• Pricing structure: fixed fee for a defined scope of work. The contractor has taken the time to understand the scope of work and given you a fixed fee to complete this work. Sometimes they give you a breakdown of the costs by line item including their general conditions and profit (see role of contractors). Other times they just give you a single amount with no backup. Either way, they are saying they will do the work for that price.

• Example: general contractor will clean up the interior of the suite / unit including paint, carpet, lighting, plumbing fixtures, and electrical improvements for a fixed price.

• Pros: clarity in the scope and costs.

• Cons: takes more time as the contractor needs to bid the work. This takes even more time for you as the owner when you are getting and comparing bids from multiple contractors.

Cost Plus

• Best For: custom remodels where price is less important OR the scope cannot be clearly defined up front.

• Pricing structure: whatever the general contractor pays their subcontractors PLUS agreed upon general conditions and a percent profit.

• Example: a unit renovation where the owner or their designer is actively involved in each step, figuring out the materials and scope of work in real time as the job is being completed.

• Pros: owner sees the cost impact of each decision but does not unfairly put the price increase risk on the contractor. This would be unfair because the scope has not been clearly defined. The contractor can’t accurately bid the work without a clear scope.

• Cons: price uncertainty until the job is complete.

Guaranteed Maximum (aka GMAX)

• Best For: very large jobs. 

• Pricing structure: similar to lump sum with transparent subcontractor costs BUT costs are tracked on an ongoing basis. At the end of the job any cost savings against the original contract are shared between owner and contractor at a pre-agreed upon split.

• Example: major renovation (or even new construction) where the pricing is in the millions.

• Pros: owner has a cap on their costs with the ability to see some cost savings.

• Cons: only appropriate for very large jobs. You are unlikely to use this as a new or smaller real estate investor.

As I said earlier, the characteristics of the work will lend themselves to a specific pricing structure. You will likely use time and materials or lump sum 90%+ of the time. 

Many contractors have their own contract forms or use the AIA templates. This is fine. Just read the contract before you sign it to understand what you are agreeing to.

Regardless of which pricing and cost structure you choose to proceed with, you will still have the risk of change orders. This is where we will focus next.

Being Clear on the Scope of Work & Navigating Change Orders

What is a change order? Have you heard of one? Does it make you squirm?

A change order is your contractor asking for more money to complete the work than already agreed to in the contract. [Note: this is not applicable for a cost plus structure. A cost plus contract is set up so everything is a change order because you are figuring out the scope as you go.]

A change order is a 1-3+ page addendum to your construction contract that adjusts the scope and cost. It must be signed by both the owner and contractor.

Change orders occur when (a) the owner changes the scope of work or (b) the contractor finds an “unforeseen condition”. Let’s give an example of each.

Example 1: Owner Changes the Scope of Work

At the start of the job the scope has been defined, the contract has been signed, and the work has started. You (the owner) see the work as it is being installed and you are having second thoughts. Maybe you don’t like the paint color or the broker gives you new information on something at a competitive building that is being well received by tenants.

You decide you want to make a change.

The contractor may be able to make the change without disrupting the timeline, but they will charge you for it. 

This is fair and appropriate. A change order will be created.

Now let’s discuss the second example.

Example 2: Contractor Finds an Unforeseen Condition

The contractor is proceeding with the work and comes upon something unexpected. Maybe the wood framing is rotted out when they remove the drywall or there is a sink hole discovered under the flooring. 

The contractor would have had no way of knowing this without tearing up the unit in advance. These are legitimate change orders. These are risks you take on as a real estate investor.

That being said, not all contractor initiated change orders are that clear. Sometimes you will have contractors issue a change order for something they should have known in advance or because the work is taking longer than they thought.

These are not always legitimate and you should push back on them. Discuss them with the contractor and work together to come up with a fair solution.

The best defense against all change orders is to be clear on the scope of work. If you want the job to be on time and on budget, define the scope of work in advance and stick to it.

Let’s move on to paying your contractor. This is where you have some leverage if you have a disagreement.

Understanding Mechanic Liens and Retainers

Contractors need to get paid for the work they do. In order to protect themselves from owners not paying them, there is the lien process. 

A lien is a document filed against your property with the county when there is a payment dispute. This tells anyone looking at the title documents of your property that you have a dispute, which will affect your ability to sell or finance your property. 

Bad news. 

Avoid this.

Here’s the sequence of steps.

1. Your contractor sends you a preliminary notice saying that they are performing work on your property for a specific dollar amount. Some larger material suppliers will even follow this same process. 

2. You pay them for the work. Keep evidence of your payments. You could even consider asking for a lien release for larger jobs. Once complete, move on.

3. If you don’t pay them for the work, the contractor could decide to file a lien which will be recorded against your property. 

As long as you pay the contractor, all will be fine. For larger jobs there is the risk that the contractor doesn’t pay one of their subcontractors and the subcontractor files a lien. This is unusual, but does happen. Just keep careful record of your payments.

The flip side of this process is that not paying your contractor can be an effective tool for the owner. Just be careful and reasonable with this.

Large jobs with multiple payments made over time have a built in mechanism for this: the retainer.

A retainer is an amount that is not paid to the contractor. Example: 10% of each bill. It really only comes into play when the job is long enough in duration that there are monthly payments. You are unlikely to see this much if at all, but the concept is useful to discuss.

As soon as you pay your contractor for 100% of the work, you lose any leverage you had. 

Why is this relevant?

Let’s say the job is 95% complete. Everything is done except for the final light fixture installations. The contractor tells you the work is basically done and the light fixtures will be installed in 2 weeks when they arrive. They ask for full payment.

Don’t pay them yet. 

Pay them an amount equal to the percent of work complete. 

You want to hold back some money until the work is 100% complete so you can keep some leverage. Contractors are busy. Once you pay them 100%, their natural inclination is to focus on the next job.

But…a contractor’s profit is often tied to the last dollars of payment. Be fair, but don’t give up this leverage to make sure the job is completed in a timely manner.

Now it is time to wrap all of this up in some best practices.

Best Practices

Construction is risky, whether it is a renovation of an existing property or building a new one. It often involves multiple trades and work on parts of the building you can’t see until you open up walls, floors, or ceilings.

This is the risk of being a real estate investor.

Here are some best practices to reduce your risk.

1. Define scope clearly in advance of bid(s). The only thing more important than having a clearly defined scope of work included in the contract is picking a contractor you trust.

2. Pay attention to payments. Track the cost and invoices in excel. Check that the amount you are being asked to pay (a) ties to the amount in the contract and (b) reflects the scope of work that is complete. Visit the property to verify this or have the contractor send you pictures.

3. Having pictures and notes sent from the contractor to you each week is an excellent protocol, especially when you are not able to get out to the property regularly.

4. Be clear on start date and duration. You want this in the contract. I once agreed to the scope and cost of a roof repair in the summer, signed the contract in September, but the contractor didn’t start the work until November at the start of the rainy season. It was a nightmare! Put the target start date and duration in the contract.

5. Manage the punch list. A punch list is a list of items that need to be fixed once the work is substantially complete. It could include paint touch up, missing electric outlet covers, or other small items that the contractor needs to fix at the end of the job. Walk the job with the contractor when the job is complete to agree upon the punch list items. Don’t pay them 100% until the punch list is complete.

6. Warranty documentation. If there is a warranty, make sure you get the documentation of this warranty from the contractor.

7. Watch out for liens. Keep records of your payments and the invoices. Consider asking your contractor for a lien waiver for larger jobs.

8. Make sure you get the contractor’s proof of insurance.

9. Work with a contractor you trust. This is the most important thing you can do. Things happen. Work with someone you trust so you can fairly navigate issues as they come up.

As always, keep learning. Increase your knowledge. Ask good questions and treat others fairly.

You got this.

Understanding the Critical Role of Contractors

How to know enough to not feel like an imposter

Last week I shared the many ways you can add value to your real estate investment: asset class by asset class.

Today I will discuss the critical role contractors play in helping you understand costs, refine your business plan, and execute your value add initiatives.

Contractors are the key player in bridging the gap between what you think you might want to do and what you can afford to do.

Have a vision of an amazing new porch on your 6-unit apartment or a new facade on your industrial building? It is all just a concept until you have a realistic sense of costs. 

Contractors give you these costs.

Today we will get into the details. You don’t even need to know what a “contractor” is. I will explain it all including:

1. General contractors vs contractors vs subcontractors.

2. The role of a general contractor and how they make money.

3. How to find a contractor and the key questions to ask them.

4. How to go from an idea to a price estimate to a real bid.

5. Signing a contract and navigating change orders.

6. Best practices.

By the end of this newsletter you will know enough to work with a contractor without feeling like an imposter.

Let’s dig in.

General Contractors vs. Contractors vs. Subcontractors

These terms are used casually and often incorrectly. Let’s get them straight.

General Contractor (GC)

A general contractor is in the business of managing construction work across multiple disciplines. Disciplines refer to things like painting, asphalt, electrical, plumbing, etc.

The key word is “general”. They are generalists as opposed to specialists.

They typically don’t have a huge team that does all of the work across disciplines. It is more likely that they subcontract out some or all of the work to others.

Subcontractors

A subcontractor is someone who specializes in a specific discipline such as painting, electrical, or asphalt. 

Sometimes they are hired by a general contractor. Sometimes they are hired directly by an owner. 

They are specialists in one or more discipline. They are the ones who will actually do the work.

Contractors

The word “contractor” is used as a general term to refer to someone an owner is hiring to do construction work. For example: “We need to find a contractor who will help us with our value add plan.”

It could either refer to a general contractor or a subcontractor.

If you (as owner) hire a “subcontractor” to paint your building, you would likely refer to them as a contractor. They only really become a subcontractor when hired by a general contractor.

Now let’s discuss how a general contractor makes money.

The Role of a General Contractor and How They Make Money

Let’s use an extreme, but not that unusual example, to explain how a general contractor (aka GC) makes money. In this case the GC doesn’t do any of the work. They have a very small team and hire subcontractors to do all of the construction work.

They will typically add one or two line items to the cost reflecting money that is going to them as opposed to the subcontractors.

• General Conditions or Overhead and Supervision: this reflects some allocation of their team that will oversee the work on a day-to-day basis.

• Profit or Fee: this is the profit they will make on the job.

Combined these two line items will reflect a 15% to 20% increase over what the GC is paying the subcontractors. Example: if you have a $30,000 job, expect to pay an additional $4,500 to $6,000 if you hire a GC. [Pro tip: if you have a much bigger job - example $500,000 - you will likely be able to negotiate a lower percentage.]

So what to you get for this additional cost? Two key things:

1. Subcontractor Relationships: GCs work with lots of subcontractors. They know the good ones and the bad ones. They can put pressure on one when needed as they may be giving them work in the future. As an owner with one property, you don’t have the same leverage.

2. Project Management: the GC will manage the day-to-day project. This includes obtaining and evaluating bids, creating subcontracts, and managing the work. The painter doesn’t show up? The GC will deal with it. Timing and coordination issues? The GC will deal with it.

Many owners think the GC earns their fee. Others want to manage the subcontractors themselves. 

My perspective: when there are multiple disciplines (aka trades) required such a painting, asphalt, electrical, drywall, and plumbing, I prefer the GC route. When it is only one discipline (ex. painting), I am more likely to go direct to a painter.

Your property, your choice.

Whichever route you take, there are some key questions to ask a potential contractor.

How To Find a Contractor and The Key Questions To Ask Them

Let’s say you have your first property and some value add ideas as discussed in last week’s newsletter: The Many Ways You Can Add Value to Your Real Estate Investment. 

Ask your broker and/or property manager which contractors they have worked with and who they would recommend. Then pick one or two to talk with to ask them the following key questions.

1. How long have you been in business? You want at least five years. Longer is generally better as it shows they run a fair and profitable business.

2. Are you licensed and insured? It is risky working with a contractor who is not. You could also consider asking for references to speak with.

3. Is this type of work typical for you? “This type of work” refers to your specific scope of work for your property. You want a contractor who is comfortable with both the scope and size (aka cost) of your job. Don't work with a contractor who only does $500,000+ jobs if you have a $30,000 job.

4. Do you have in-house design capabilities? Maybe you want to do an exterior renovation that includes painting, wood, and metal work. Many contractors have in-house design teams that can come up with a plan so you don’t have to hire a separate architect or designer.

5. What components of my scope will require a permit and what is the permitting process? Not all work (ex. painting) requires a permit. Some permitting is fast. Some is slow. Some triggers other upgrades. You want to understand this.

6. How soon could you get started and what would be your estimated timeline for the work? You don’t want to spend a bunch of time with a group only to learn that they can’t get started for 6 months.

7. What is your level of interest in working together? You want someone who wants to work with you.

You can see by this list that there is more to selecting a contractor than only costs.

But costs are important so let’s transition to pricing.

How To Go From an Idea To a Price Estimate To a Real Bid

As I described in the last newsletter, there are multiple steps in going from ideas to pricing, most notably understanding what you can afford. The steps are:

1. Understand your goals.

2. Focus (aka think).

3. Talk with experts.

4. Budgeting. This is where we will focus now.

5. Develop a game plan.

There are two main stages of budgeting and understanding how much something will cost.

Stage 1: Price Estimate or Rough Order of Magnitude (aka ROM)

This is when you are in the early stage. You need some general sense of how much it will cost to paint vs. redo the parking vs. renovate a kitchen. 

A contractor will help you do this, but they will be spec’ing their time to do so without a guarantee of getting the work. 

Be mindful of this dynamic and don’t abuse it. Only work with one contractor at this stage.

Stage 2: Contract Pricing

Once you have defined your scope, then you move to getting real bids that you could go to contract on with a contractor. 

Some like to get final pricing only from the same contractor that gave you the ROM pricing. Others like to get multiple bids.

Getting multiple bids is more work and guarantees you will have to tell 1-2 contractors they are not getting the work even though they put time and energy into the process.

But there is nothing like getting multiple bids. You always learn something and may find you get better pricing.

You don’t always have to pick the lowest price, but you do get a comfort level that you are not overpaying.

Signing a Contract & Navigating Change Orders

Once you have pricing you are comfortable with, you will move to signing a contract. There are multiple types of contract and ways contractors like to do them.

We will go through all the details of this next week.

Best Practices

So how do you make sense of all this? 

Here are what I believe are the best practices.

1. Interview the contractor. Don’t skip this part. You will learn a lot in the process.

2. Value their time. Don’t view getting a bid as “free”. It may not cost you anything at the time, but you don’t have unlimited “credit” to exercise contractors for bids forever without at some point paying them to do some work (i.e. giving them a job). 

3. GCs are a good fit when you have multiple disciplines. If only one, consider going directly to a subcontractor.

4. Don’t pick the cheapest option automatically. There is a saying in the contracting business: Cheap, Quality, Fast. You can only pick two. You may find the cheapest, but you may pay the price with low quality. Look at the total package.

5. The best contractors are found with experience and repeat business. If you are new, ask others for referrals. If you have a good experience with a contractor, keep using them. Build a win-win relationship over time.

It can be hard navigating your first job, but like anything you will get better with practice and repetition. 

Good luck!

The Many Ways You Can Add Value to Your Real Estate Investment

Options for industrial, retail, office, multifamily, and 1-4 unit residential

Last week we kicked off the series on executing your business plan and I discussed the general ways you can add value to your investment: cosmetic and functional improvements that lead to better leasing (and revenue) performance.

Today we are going to get into specifics by asset class.

As discussed in Asset Classes Explained, there are five main asset classes:

• Industrial

• Office

• Retail

• Multifamily aka Apartments

• 1-4 Unit Residential

There are different ways to add value to each of them. The themes are similar, but the details are different.

In today’s discussion, we will focus on improving the physical building(s) in both cosmetic and functional ways. We will go asset class by asset class.

By the end of this reading you will have a clear menu of options to choose from for yourinvestment. You won’t be an expert, but you will know enough to be dangerous.

Let’s dig in.

Industrial

Industrial is the most straightforward asset class. It is basically a warehouse building made out of concrete with a small amount of office inside. Industrial is used for manufacturing, storing, and/or distributing product. Anything you buy online goes through an industrial building, typically referred to as a warehouse.

So if it is a simple concrete box, there is nothing to do right? 

Wrong!

There are plenty of ways to add value:

• Paint & Asphalt: It is hard to find a better bang for your buck to change the look and feel of a warehouse than painting the building and doing a new slurry coating (aka painting) the asphalt. It does nothing functionally, but it drastically improves the first impression of tenants.

• Signage: Adding signs above each suite can give a better sense of identity. You could also add a monument sign on the street with slots for tenants’ names.

• Facade Enhancements: There are ways to make a building look more modern and create better suite identity by adding additional material elements to the exterior. For example: wood panels or metal awnings in sections of the building.

• Adding Parking or Re-striping Existing Parking: Industrial users often need space to store their trailers and other materials or for more parking for their employees. Sometimes you can expand or reconfigure your existing site to meet these needs.

• Warehouse Improvements: Industrial tenants want functionality. Your space will lease faster and at higher rents with increased functionality. Talk with local leasing brokers to understand the local tenant needs. Then consider improvements to lighting, smoothing the concrete floor, air circulation, power, and truck doors.

• Office Improvements: Although the office portion of a warehouse building may be a small percentage of the total square footage, it is important to make it clean and functional. Nothing fancy, but nothing too beat up. Your local leasing broker will guide you.

Let’s move on to retail.

Retail

Retail is much more complicated than industrial. It generally includes multiple buildings laid out across a site with ample parking. Example: a neighborhood shopping center anchored by a grocery store with 20 additional small suites such as restaurants, hair salons, workout studios, and various other stores. Customers are coming and going throughout the day, so traffic (and pedestrian) flow is very important.

With all these moving parts, there are many ways to add value.

• Paint & Asphalt: Same concept as industrial.

• Signage: Same concept as industrial, but WAY more important for retail. There should be a universal signage program that works for all tenants. It should look like a cohesive center. This often includes a large monument sign (10’+ tall) on the main road with major tenants listed.

• Facade Enhancements: Retail buildings often incorporate lots of interesting architectural elements using different materials and elevations. See figure 1 below for an example.

• Adding Parking or Re-striping Existing Parking: Same concept as industrial, but even more important. Few things deter retail customers from coming to your center more than not being able to find parking. Get the most parking you can.

• Suite Improvements: Most retail tenants want their suite to be a clean, functional box to work with. Retail suites tend to be fairly consistent in size and shape, so national tenants are used to working with these sizes. They will then customize their improvements inside that consistent shape. Go into a few Subway sandwich shops or postal annex stores and you will see what I mean.

• Amenities: Retail is about place making. The longer customers stay at your center, the more likely they are to buy from your tenants, and the more rent you can charge. The best retail operators figure out ways to make their centers inviting by adding things like outside seating, fountains, water features, fire pits, and other attractive amenities. They create places people want to hang out in.

Figure 1: Example of a Retail Facade

Let’s move on to office.

Office

When I refer to office, I am referring to buildings where people generally work on computers. I spent 20+ years of my career working inside office buildings. They can be a single building or an office park.

Here are some ways to add value.

• Paint & Asphalt: Same concept as industrial, but not always an option. Many times an office building is made of a stone material and the parking is in a concrete structure. In these cases, there is little to be done.

• Signage: Monument and building signage can be very valuable to tenants. Sometimes you can charge extra for these.

• Adding Parking or Re-striping Existing Parking: Parking can be very important for office tenants. Sometimes you can even charge more for covered parking (in a structure or under a carport).

• Suite Improvements: Office suites, particularly larger ones, are usually customized to the individual tenant needs. It is expensive and wasteful. Imagine if you remodeled an apartment every time a new tenant moved in. Welcome to the wonderful world of office! If you have a vacant suite, work with your leasing broker on a plan to create a clean, functional layout that will work for most tenants. 

• Amenities: Same concept as retail. Office tenants need to attract employees. Good amenities are appreciated by employees. They include workout facilities, coffee shops, attractive seating for lunch, and anything else that feels inviting.

Let’s move on to multifamily.

Multifamily

Reminder that multifamily is a fancy way of referring to apartment buildings. This could be a single 12 unit apartment building or a 10+ building community with 200+ units or a downtown tower with 300+ units. The higher the number of units, the more likely there are interesting opportunities to add value.

• Paint & Asphalt: Same concept as industrial, but apartment buildings are often made out of wood. Sometimes the wood siding needs to be replaced.

• Facade Enhancements: Same concept as retail. The more interesting and inviting you can make your apartment community look, the more likely you are to attract tenants.

• Adding Parking or Re-striping Existing Parking: Same concept as office, including the potential to charge for covered parking.

• Unit Improvements: Here’s where things get different than the other asset classes. Apartment tenants don’t have the ability to customize their space. They “get what they get”. The best multifamily operators do two things to their units that give them pricing power and reduce maintenance costs: (a) they put in the amenities that tenants want the most such as in unit washer & dryers, newer appliances, new cabinet doors, and new countertops and (b) they put durable materials in place that last longer such as luxury vinyl plank (LVP) flooring. These improvements command more rent, lease faster, and cost less to maintain when a tenant moves out.

• Amenities: Just like retail and office, multifamily is often about place making. This is where people literally call home. The best operators add amenities residents want most such as secure dog parks, workout facilities, nice pools with seating, BBQ areas, and business centers.

Now let’s see how 1-4 unit residential compares to multifamily

1-4 Unit Residential

Let’s remind ourselves why this is a separate asset class. It is driven by the way it can be financed. Lender’s will consider giving you a loan for your property based on your personal credit. For all the other asset classes, they evaluate and underwrite the propertyperformance. This personal credit evaluation can mean it is an easier entry point for investors.

All the same concepts of multifamily value add apply to 1-4 unit residential, but the smaller size will likely limit the number of amenities you can add.

Now that we have covered all the asset classes, let’s touch upon some additional items that apply to all asset classes.

All Asset Classes

Sometimes you will be faced with the decision of whether to repair or replace a building system. Repairing will be significantly cheaper but replacing will last longer. If a building system is too old or has been left without proper maintenance, replacement may be your only option. This can be true with parking lot asphalt, wood siding, and HVAC units.

There are also two potential value add options that are applicable across all asset classes.

• Convert the Use: Your property may be worth more if you convert the allowable use to a different asset class. Example: industrial to multifamily. It is not fast or easy, but can add a ton of value. You could then sell the land/building or redevelop it yourself.

• Parcelization: This is the process of dividing an existing piece of land (aka lot or parcel) into two or more legal lots so they can be sold individually. You may have a property with a lot of excess land. Divide it into a separate parcel to sell or redevelop it.

How to Bring it All Together

We have covered a lot. Asset class by asset class. Many ways to add value.

So how do you make sense of it all?

Here’s the formula: 

Understand Your Goals + Focus + Talk with Experts + Budgeting + Develop a Game Plan = Setting the Property Up for Success

1. Understand Your Goals: start here. Re-read Stop Chasing Every Deal: Why Successful Investors Pick a Niche. If you don’t know your goals, you will be lost at how to address each decision.

2. Focus (aka Think!): now is the time to focus on the list of options within your asset class. Which are most appealing to you? Drive the neighborhood your property is in and look at what your competitors are doing. Take pictures and keep notes.

3. Talk with Experts: this is the most important step where theory meets reality. Share your ideas and brainstorm with the local team (brokers and/or property managers) that will lease your building. They are the market and leasing experts. Ask them what they think of your property. Ask them to rank the list of options I gave you in order of priority and impact. Ask them what else they recommend doing. Check back on You Don’t Have to Do Everything Yourself: Building Your Real Estate Team to understand how to build the right team around you.

4. Budgeting: once you have narrowed and ranked your list of initiatives, it is time to start getting a rough sense of cost. You need a budget to work with. This is where contractors come in, which is next week’s topic.

5. Develop a Game Plan: Finally, look at all the information together and come up with a game plan. Don’t hesitate to circle back with the leasing team to re-visit the list now that you have a better sense of costs.

You may need to stagger your plan over multiple years due to construction lead times, seasonality, budget constraints, or timing of your leases. 

Be patient and realistic.

As with many things in life, it can feel overwhelming. By breaking it down into manageable parts, you can make progress.

You can do this!

Step by step.

One piece at a time.

Stay calm and carry on.

New Series Kickoff: Executing Your Business Plan

From business plan creation through completion

We are making great progress in our journey of understanding how to personally invest in real estate. We have covered four main subject areas so far:

1. Introduction to Real Estate Investing

2. Investment Fundamentals

3. The Acquisition Process

4. Owning and Managing Real Estate

See the end of this newsletter for the link to all 20+ newsletters so far.

Today we are kicking off a new series: Executing Your Business Plan. 

Whereas owning and managing real estate anchors you in the tasks with which every investor will be faced, executing your business plan leads you down a proactive approach to adding value to your investment and making you more money!

This is one of my favorite aspects of owning investment properties. The ability to take action to improve performance and make you more money.

Some like to say that most of the money is made in the buy (aka the acquisition). 

I agree to a certain extent. 

You can never change your original cost basis or location. These two factors play a huge role in how the property will perform.

But…they are not everything.

Your ability to identify and execute a business plan will play a material role in how well your property will perform over the months and years of your ownership.

In this series we will cover:

• Ways to add value to your property.

• How to create a property business plan.

• Construction.

• Leasing.

• Investor and lender constraints and opportunities.

Today we will start with an overview of ways to add value to your property.

Let’s dig in.

Definition: Adding Value

The terms “adding value” and “value add” are thrown around a lot in real estate investing. They are very similar terms that mean different things.

Adding value is the act of doing something to increase the value of your property. Usually you have to spend some money to create the value, but this is not always the case. Let’s list some examples of adding value:

• Cosmetic improvements

  • Exterior: this could be as simple as painting your property or cleaning up the landscaping. Anything that makes the property look better.

  • Interior: same concept for the inside of the property. Think paint and carpet.

• Functional improvements: 

  • Interior: we are staying inside the building, but we are improving the way the tenant can functionally use the property. Examples could include: improved lighting, an additional room, or new HVAC.

  • Exterior: same concept on the outside. Examples could include: expanded driveway or a new tenant signage program.

• Leasing: sometimes the biggest value creation will be through leasing. This could be through renewing and/or restructuring the leases with existing and/or leasing to new tenants. As we discussed in Cap Rates: The Simple Math of Real Estate Investing, much of real estate value is determined by the NOI. The biggest driver to NOI is usually the rent the tenants are paying. 

Improving the interior and/or exterior of a property usually go hand in hand with increasing the rents and driving up the property value.

These are examples of “adding value”. Let’s compare this to “value add”.

Definition: Value Add

Value add is most commonly used as an investment category signifying the amount of risk associated with a real estate investment. We discussed this in The Risk-Return Spectrum: Choosing Your Real Estate Investment Strategy. A quick summary:

Low Risk/Low Return ←――――――――――――→ High Risk/High Return

Core/Turnkey → Light Rehab → Value Add → Development

1. Core/Turnkey: low risk, low return. You buy a property that is well leased and maintained. There is minimal work to do.

2. Light Rehab: medium risk, medium return. There is some work to do, but it is mainly cosmetic (paint, carpet, clean up). If you do the work, you can increase the rent and value of the property.

3. Value Add: high risk, high return. There is a lot of work to do. The property might even be vacant. You will be repositioning it and taking on a lot of risk for superior returns. You will either find a tenant once the work is complete or sell it (fix and flip).

4. Development: highest risk, highest return. You build something from scratch.

So when someone says this is a “value add” deal, they are usually referring to the risk involved.

Comparison: Adding Value vs Value Add

Even in the lowest risk deals, there are often ways to add value. 

However, not all deals with the ability to add value are considered “value add” relative to risk/return.

Again, similar terms with different meaning. Here are examples of how each might be used:

• Value Add: “We have a big appetite for risk at our company. We focus exclusively on value add industrial deals.”

• Adding Value: “The deal has a ton of upside because there are so many ways to add value in the first few years.”

We will focus on adding value in this series.

A Menu of Options: Choose Your Own Adventure

Those of you born in the 1970s or 1980s may remember a book series called “Choose Your Own Adventure”. In it, the reader started in chapter 1 and was faced with a choice at the end of the chapter. Choose one option, go to page 22. Choose a different option, go to page 45. This continued throughout the book.

Creating and executing your property business plan requires a similar approach.

You start by assessing the opportunity and options available to you. From there, you start executing the plan and adjust as you go.

You have to adjust because (i) you continue to learn more about the property and the impacts of your plan as you go and (ii) the world and circumstances are always changing.

A Variety of Approaches

I introduced the analogy of three types of cars to give examples of types of real estate in Daily Issues You Will Face While Owning Real Estate. They were:

1. A top of the line Mercedes

2. A reliable but basic Honda

3. A car that constantly breaks down

Understanding the type of property you have at acquisition and the type of property you want it to become will guide your business plan.

For example, you may buy a property that is beat up (#3) but have a plan to turn it into a clean, functional property (#2) by executing your business plan.

Or you buy a property similar to a Honda (#2) but plan to not put a dime into it during your hold period knowing that it may get beat up over time (trending towards #3) but you will be able to maximize the near term cash flow.

Your money. Your property. Your choice.

What’s Next

Next week I will expand on the menu of options by sharing specific details of the ways to add value to each of our five main asset classes: 1-4 unit residential, multifamily, industrial, retail, and office.

This will give you a comprehensive “menu” of what can be done to add value.

You will then be able to combine this menu with the characteristics of your specific property and goals to come up with your own business plan.

Get ready to get your creative juices flowing. 

This is the fun part!

Vendor Service Contracts: What You Need To Know

A simple contract you will use over and over again

Welcome to another newsletter of Real Estate Investing Explained. 

Today’s topic will mark the end of the series on Operating & Managing Real Estate. In this series we covered the foundation of operations including:

• Series Kickoff and Glossary of Terms

• Getting Organized for Success

• Developing Your Leadership Skills

• Daily Issues You Will Face While Owning Real Estate

• Getting Meaning from Monthly Reports

• The Property Manager: On the Front Line of Your Property

• Real Estate Insurance: The Transfer of Risk

• Property Tax: The Expense That Never Goes Away

Next week we will be moving on to the series on Executing Your Business Plan where we will cover leasing, construction, and ways to add value.

But before we get there we need to cover service contracts. These are legal documents that are used to engage another company to do work at your property. It could be one-time or on a recurring basis. 

Examples include landscaping, pest control, cleaning, HVAC service, and many other services.

If you own a home, you might be used to bringing in vendors and technicians to fix something. You are unlikely to sign a contract. You simply pay them when the work is done.

With real estate investment properties, particularly commercial, a better practice is to use a service contract to document the details in advance including:

• Who is the owner.

• Scope of work. How the work will be performed and to what quality.

• Whether there is a warranty.

• Costs and payment timing.

• Duration, frequency and termination.

• Insurance required.

• Many other “legal” sections if prepared by a larger real estate company such as confidentiality, indemnities, dispute resolution, notices, limitations of liability, non-discrimination, OFAC compliance, and some others. Don’t worry about these sections for this discussion. You can understand them later if you develop a larger portfolio.

Yes, it is more cumbersome. But a little bit of paperwork up front will save you misunderstandings and problems in the future.

Today I will explain each of these and why they matter.

Let’s dig in.

Who is the Owner

Do you own the property as an individual or through a separate legal entity such as an LLC? There are pros and cons to each.

• Individual: 

  • Pros: easier to get a loan for a 1-4 unit residential property. Lower annual tax cost.

  • Cons: more risk of personal liability.

• Legal Entity Such as a LLC:

  • Pros: additional layer of legal protection.

  • Cons: annual LLC tax and separate tax return.

Whatever you choose, you need to make sure the service contract lists the “Owner” correctly. If you own a property through an LLC (ex. 123 Main Street Owner, LLC), don’t list and sign the contract under your name individually. Sign it under the LLC. In this case, the LLC is the owner.

Scope of Work, How the Work Will Be Performed and To What Quality

This describes what the vendor is going to do. It might be monthly landscaping or repairing a broken HVAC unit. 

A simple approach can be to ask the vendor for a proposal and then include the proposal as an exhibit to the service contract. The exhibit serves as the details of the scope of work. This way, everyone is clear and in agreement.

You could also consider adding language saying something like: “work shall be performed in a professional manner to industry standard quality”. It is not perfect, but it does set some basic expectations beyond what is written in the proposal.

Whether There is a Warranty

Not all work will include a warranty, but some should. 

Anything new, such as an HVAC unit, should include a warranty. You want at least one year.

The contract is where you agree what the warranty will be, what it will cover, and how long it will last. The vendor may also give you a separate warranty document once the work is complete.

Costs and Payment Timing

A clearly documented scope of work and list of costs will reduce the chances of there being disputes after the work is complete. They go hand in hand.

If the scope is not clear, the vendor may hit you with “change orders”. Change orders are a fancy way of saying that the vendor is going to charge you more than the amount in the contract for various reasons including (i) increased scope of work or (ii) unforeseen or unanticipated conditions.

Unscrupulous people may even try to hit you with a change order because they feel they aren’t charging enough or this is part of their strategy (low bid to get the work then multiple change orders).

Avoid the risk of change orders by being clear on the scope, the costs, and the timing under which you, as owner, will pay them. 

And don’t necessarily take the lowest bid if it is materially below the others. This can be an indicator of a vendor who doesn’t understand the scope.

Let’s move on.

Duration, Frequency, & Termination

This describes how long the agreement lasts and the frequency of the work. This varies depending on the type of work. Examples:

• Landscape Maintenance: this could be a one year contract where the frequency of service is bi-weekly or weekly.

• HVAC Repair: this could be a one-time service that needs to be done in 30 days, after which the contract is done.

For recurring services such as landscape maintenance, the practical approach is to have a one year contract that can be renewed at an agreed upon rate (example 3% increase) with 30 days notice.

There should also be language that either party can terminate with 30 days notice if one party is not following the agreed upon terms of the contract.

Let’s transition to insurance.

Insurance

We talked about insurance in Real Estate Insurance: The Transfer of Risk. 

Any time someone is coming to work on your property, there is the risk that (a) they could hurt themselves or someone else or (b) they could damage your property.

You want to require each vendor to have some basic types of insurance such as worker’s compensation to protect their employees and commercial general liability to protect you and your property. There are many other types of insurance that could be requested, but these are the two major ones.

Now that we have covered the components of a service contract, let’s discuss where to find one and how to use it on a day to day basis.

[Note: I am not discussing the “legal” sections referenced in the introduction as giving legal advice is not part of my scope.]

How to Get a Service Agreement Template

Now that you understand the basics of what is in a service contract, what do you do with the information? How do you get a contract?

As discussed in The Property Manager: On the Front Line of Your Property, I believe there is real benefit to hiring a property manager. 

A good property manager will have a standard service contract that they use. The great ones will be able to talk you through their form and explain it to you.

Don’t feel you need to reinvent the wheel. Review their template. If it looks good, use it or make the edits you need to make it work for you.

My Perspective

I believe in using service contracts, but I like them to be short and easy to understand. 

I am also mindful that asking a vendor to sign a form they are not familiar with slows down the process. Sometimes the vendor will even have to talk with a lawyer to confirm they are ok with this. This can really slow down the process when you are trying to get work done.

I try to be reasonable. 

If the vendor has their own form, I am willing to read it based on the information described above. If it is clear, then I am willing to sign it. Other times I might hand-write edits to the document to make something more clear or to make a small change.

I try not to get caught up in going back and forth on language in a document. I want to focus the majority of our efforts on getting work down at the property, not negotiating documents.

Some might say this is taking on more risk than I need to. Fair enough.

But remember that real estate investing is not risk-free. There are always things that could go wrong. If that scares you, real estate investing may not be for you.

Don’t be reckless. 

Be practical and reasonable.

I try to do business with vendors (and people in general) I trust. If an issue comes up outside of the contract, we work it out as two reasonable people.

Property Tax: The Expense That Never Goes Away

The ongoing expense that varies from state to state

Last week we discussed insurance in detail. Today we are getting into property taxes.

My original plan was to do them as a combined newsletter, but when I started writing about insurance I realized just how many layers of information there are.

Why was I planning to cover them in a single newsletter? Because they share multiple similarities:

• The amount of each expense is largely outside of your control.

• They are generally permanent. You could get rid of almost every other expense, but property taxes and insurance will always be with your property.

• They are specialized subjects that benefit from the owner having a certain amount of knowledge and expertise.

But…property taxes are simpler to explain than insurance. Phew!

Today we will discuss:

• Why property taxes exist and what they fund.

• How they are determined.

• Ways to reduce your property taxes.

• Owner best practices.

That’s it. Much more simple than insurance.

Let’s dig in.

Why Property Taxes Exist and What They Fund

Property taxes are revenue for the county the property is located in. 

Read that word carefully: county. Not the state.

They are the way each county (in each state in the U.S.) funds basic services such as public schools, police, and libraries. A portion of the revenue is sometimes distributed to each city within that county. [Yes, this is a U.S. centric newsletter.]

You may have seen a proposition or other measure on your local election ballot that talks about adding an additional fee to homeowners to fund XYZ. If passed, this would add to every homeowner’s property tax expense. Here’s an example of a property tax bill with propositions and measures that passed the voting ballot and were added to each homeowner’s property tax bill: 

Table 1: Example of Propositions on a Property Tax Bill (California). Each one increased the “rate”. More on this later.

To add another layer of complexity, property taxes are determined at the state level but administered, collected, and used at the county level.

Your main takeaway should be that property taxes fund your local government and services. They are never going away. All 50 states have some type of property taxes.

But wait - some of you may be thinking that certain states don’t have property taxes. This is not correct. Some states don’t have income taxes or sales tax, but every state has property taxes.

Let’s transition to how they are determined.

How Property Taxes Are Determined

As I said above, every state has property taxes. But unfortunately every state calculates them in a different way.

Here are the similarities across all states:

• County Assessor: the team at each county that determines, administers, and collects property taxes.

• Assessed Value: the value of the property and land as determined by the county assessor.

• Rate: a percentage that is applied to the assessed value to determine the property tax.

Here are the differences:

• Assessment Methodology: how the assessed value is determined (generally, but not always, via fair market value appraisal).

• Assessment Frequency: how often the assessed value is determined (every 1-4 years).

• Payment Timing: frequency and timing of payment throughout year (1-4 times per year).

• Payment Period: whether the payment is in advance or in arrears.

• Appeal Options: whether and how the property taxes can be appealed with the goal of reducing them.

So we have a basic framework (the similarities), but a unique way of implementing it within each state (the differences).

Here are some examples:

California

• Assessment Methodology: the value is determined by the most recent purchase price and then grown at 2% per year. That’s it. Super simple. That is why you hear of people that have owned their property for 30+ years and have a low property tax basis (and expense), while the person next door who recently bought their property has a much higher property tax basis (and expense).

• Assessment Frequency: July 1 every year add the 2% increase and adjust for propositions and measures.

• Rate: a little over 1%. Example: $1,000,000 x 1.132% = $11,320.00 per year.

• Payment Timing: twice per year in December and April.

• Payment Period: December covers the second half of the year (7/1 to 12/31). April covers the first half of the year (1/1 to 6/30).

• Appeal Options: through property tax consultants, who do not need to be licensed.

Texas

• Assessment Methodology: fair market value appraisal.

• Assessment Frequency: beginning of each year.

• Rate: changes each year.

• Payment Timing: January of the year after assessment.

• Payment Period: 100% in arrears.

• Appeal Options: typically through a lawyer.

These are just two examples. Each of the 50 states in the U.S. has a different approach.

Ways to Reduce Your Property Taxes

There are ways to appeal and reduce your property taxes. Why would you want to do this? To reduce your operating expense. And you may feel the assessed value is unreasonable.

If you own properties in multiple states with different rules, it may be helpful to use a property tax consultant such as Ryan.

The typical structure will be that they work on 100% contingency. They only get paid if your property taxes are reduced. Example: they might keep 10% - 30% of the reduction as their fee.

My personal opinion is that property tax consultants serve an important role in the industry as this is a specialized area of expertise that varies from state to state. These consultants can help save you money and estimate your future property taxes for properties you are purchasing.

My approach has been:

• Personal Home: I appealed this one myself because (i) I understood the California process and (ii) I live in a 100+ home community where the homes are very similar, making it easy to supply sales comparables. I had bought my home a couple years before the Great Financial Crisis of 2008. By successfully appealing my property taxes, I saved quite a bit of money each year.

• Industrial Portfolio: when I worked for a company with 100+ properties across many states, we used property tax consultants. It was too complex and labor intensive to justify using one of our internal team members.

Educate yourself by talking with a property tax consultant. If you own a small property (less than $5M), find a smaller local property tax consultant who may give you more focus than a larger, national firm.

Owner Best Practices

Here are my recommended best practices when working on property taxes for your investment property.

Due Diligence & Underwriting - Assessment Methodology

Remember, these vary from state to state. Don’t assume the seller’s property taxes will be your property taxes growing at inflation each year. 

Do the research and/or talk to a property tax consultant before you commit non-refundable money towards the purchase of the property. You need to understand how they will change during your ownership. 

Propositions & Measures - Expiration Dates

These often have an expiration date. This is especially important when you see a very large additional charge on a property tax bill. 

My former company once bought a property where the additional charges were as much as the base property tax bill. This was related to a fee that would expire two years after our acquisition. Knowing the near term expiration changed the way we thought about the deal.

Closing Statement - Payment Timing

The timing of the payment will determine how the property tax expense is prorated in the closing statement on closing day. This could be a big charge or credit. 

For example, if property taxes are paid in advance, you (as buyer) could find yourself owing the seller for their prepayment and have to pay this amount through the closing statement. 

What would this mean? You could be short on cash on the day of closing. Understand this in advance to avoid surprises.

Appeals

Be proactive. It doesn’t cost you anything to have a conversation with a property tax consultant. If there is a way to save money on your property taxes, you should consider this. 

Pro tip: there is usually a deadline by which you must file the appeal. Do the research so you don’t miss it.

Remember, property taxes vary from state to state. Take the time to understand how things work in the state you are buying the property.

As always, have a learning mindset. Be patient. Talk to experts. Take the time to understand it.

Real Estate Insurance: The Transfer of Risk

A breakdown of the different ways you can (and should) insure against risk

Today we are going to dive into the world of real estate insurance. 

I have spent a LOT of time on this subject in the 20+ years I worked full time for real estate companies. 

Insurance is a fascinating financial product that shares similarities to:

• Private equity, venture capital, and stock investing.

• Investment banking.

• Sports betting and assembling a professional sports team.

In each case someone is making a calculated and well researched investment (or bet) in hopes that they will make money.

Insurance is a financial instrument where insurance companies earn smaller guaranteed payments (premiums) while putting big dollars at risk (claims). Their goal is to make more money on the premiums than they pay out in claims over years and decades.

I will break down the basics of real estate insurance in a way you can understand and use. As a real estate investor, you will need (and likely be required to carry) insurance to protect you, your investors, your lender, and your property.

Today we will cover:

1. What insurance actually is

2. Types of real estate insurance

3. Premiums, limits, deductibles, policy term, & exclusions

4. Insurance policies

5. Insurance certificates

6. Lender insurance requirements

7. Working with an insurance broker

8. How to handle an insurance claims

9. Why you should strive to be a good customer to the insurance carriers

Let’s dig in.

What Insurance Actually Is

At its most basic level, insurance is a financial transaction: small amounts of guaranteed money for major risk protection.

For example, you own a property that would cost $200,000 to re-build if it were destroyed. You don’t have $200,000 sitting around, so you would be in a bind if the property were destroyed.

Enter the insurance company aka carrier (ex. State Farm, Liberty, Allstate, etc).

They offer to insure the property for $1,000 per year.

• You pay the $1,000 at the beginning of the one year policy.

• The insurance carrier will pay the cost to rebuild the property IF it is destroyed. Either way, they keep the money you paid them.

This same concept applies to many other types of insurance: auto, life, health.

The person buying insurance pays a small fixed amount. The insurance carrier keeps the money and only pays if there is a claim (damage, a medical procedure, etc.).

Now let’s get specific to real estate insurance.

Types of Real Estate Insurance

I am going to focus on insurance you would have as a personal real estate investor. 

[Note: if you own a real estate company (or any other company) with employees, there are many other types of “corporate” insurance you would want such as worker’s compensation, crime, etc. Talk with your insurance broker to learn more.]

There are two types of insurance you will want as a real estate investor: property and liability.

Property Insurance - Insuring Physical Objects

Property insurance covers physical objects from damage, theft, and destruction. Effectively, anything that could harm the object. In the case of real estate, “objects” are:

1. The building and anything attached to it such as HVAC and lighting.

2. Any supplies stored in the building such as light bulbs and carpeting.

3. 12-24 months of rental income you could lose while the building is being repaired if the tenants are unable to occupy the building and pay rent.

Think of property insurance as insuring against damage. How could the property be damaged? Fire, theft, hail, storm, wind, earthquake. It could be anything. 

Liability insurance is totally different.

Liability Insurance - Insuring You From Being Sued

Liability insurance covers you if you are sued. 

Let’s say your tenant or one of their customers/employees trips just in front of the entrance to the tenant’s suite. They break their arm and have medical bills. They could sue you.

If you are sued, the liability insurance coverage kicks in to defend the lawsuit and pay for damages (if any).

In summary, property insurance protects the building and rents. Liability insurance protects you if you are sued.

Pro tip: For additional liability protection beyond your standard policy, consider an umbrella policy that provides extra coverage (typically $1-5M) for a relatively low premium.

Additional Pro Tip: If you are developing a property from the ground up, property insurance will be known as “Builder’s Risk” and liability insurance will be known as “Owner’s Interest”.

So far, so good. 

Now let’s dive a level deeper.

Premiums, Limits, Deductibles, Policy Term, & Exclusions

There are five key factors that come into play with insurance:

• Premiums: how much you have to pay for insurance each year.

• Limits: the maximum amount the insurance carrier will pay if there is a claim.

• Deductibles: a small amount you pay if there is a claim (in addition to the premiums).

• Policy Term: the length of the policy (ex. 12 months).

• Exclusions: what is NOT covered.

Let’s briefly discuss each one.

Premiums

Premiums are the fees you as the person buying insurance pay. It is the insurance carrier’s revenue.

Limits

Limits are the maximum amount the insurance carrier will pay if there is a claim. Two examples:

• $200,000 property claim and the policy limit is $150,000.

  • The carrier will pay $150,000 (policy limit < claim). 

• $100,000 property claim and the policy limit is $150,000.

  • The carrier will pay $100,000 (policy limit > claim).

Pay attention to your limits to make sure they give you adequate coverage.

Deductibles

If you have ever paid attention to a health insurance claim, you are probably familiar with a deductible. It is the additional amount you have to pay (in addition to your premium) in the event there is a claim. In the $200,000 example above, the deductible might be $1,000. You would pay this as part of the claim, but you only pay it in the event that there is a claim. The concept is that you will have to cover minor costs and the insurance carrier only steps in for more “major” claims.

Policy Term

This is the length of the policy. Most policies for real estate are 12 months.

Exclusions

Certain events will not be covered under your typical property or liability policy. If you want this coverage, you will need to buy a separate (and often more expensive) policy for this specific risk. Sometimes they are included in your property policy with higher deductibles. Examples of exclusions include: (i) earthquake risk in California, Oregon, and Washington, (ii) hurricane risk in the Gulf of Mexico region, (iii) hail risk in Colorado and Texas, and (iv) environmental pollution. 

Note that “wear and tear” is almost never covered by insurance. The 20 year old HVAC unit that stops working will not be a covered claim.

Pro Tip: Look out for “vacancy exclusions”. Vacant buildings are at higher risk for theft and vandalism. Most policies exclude coverage for vandalism and theft for buildings (not suites) that have been vacant for 90+ days. Make sure you read your policy to understand this risk and consider better lighting and/or security for vacant buildings.

Let’s transition to the actual policy.

Insurance Policies

An insurance policy is the document provided by the insurance carrier. It is a legal document that outlines all the terms of the policy. 

In an ideal world you would receive a draft of the document 30 days before the start of your policy period. In the real world, these normally come 10-60 days after the policy starts.

A good insurance broker will help you negotiate the best deal points of the policy and compare the options from multiple insurance carriers.

Think of the insurance policy as adding all the specific details of the items we have discussed so far (premiums, limits, deductibles, etc.). 

The policies are long and written as legal documents. For the industrial property I own, the policy is 50+ pages. A practical approach for those of you who cringe at the idea of reading one is to focus on the following:

• Is your name and/or legal entity correct?

• Is the property address correct?

• Are the dates in the policy term correct?

• Review the premium, limits, deductibles, policy term, & exclusions.

• Review the vacancy exclusion language.

• Make sure you know who to contact if you have a claim.

Most of the time you won’t have a claim. But when you do, you don’t want to be caught discovering that you didn’t have the coverage you thought you did.

Is there an easier way to understand your policy? 

Yes. 

Enter insurance certificates.

Insurance Certificates

Whereas a policy includes all the legal language of your policy, an insurance certificate is a one page document that summarizes your policy. 

It will list the type of coverage (property, liability), limits, deductibles, policy term, and sometimes exclusions.

It is also where the insurance carrier will add “additional insured” parties as required by other documents you sign such as a property management agreement or loan agreement. 

An “additional insured” has limited coverage under your policy in the event of a claim without having to pay anything for this coverage.

This is especially true for lenders.

Lender Insurance Requirements

If you have a loan on your property, you will have a set of loan documents as discussed in Debt: An Amazing Tool with Strings Attached.

The loan documents will list various lender insurance requirements that must be met for the lender to give you the loan.

These could include:

• The types of coverage: property, liability, earthquake, etc.

• The amount of coverage: example - property insurance equal to the full replacement cost of the building.

• The maximum deductible allowed: example - $1,000 or $5,000.

Make sure you price out insurance coverage that meets the lender requirements BEFORE you sign the loan agreement.

An insurance broker can be very helpful in this process

Working With an Insurance Broker

You want to work with an insurance broker that specializes in real estate insurance.

They will help you compare insurance options to find the best combination of price and coverage. They know what is “market” and they will help you find the right fit for you.

Ask people you know who have invested in similar properties for a referral. A good insurance broker will make a world of difference.

They will also help you work your way through a claim.

How to Handle Insurance Claims

Insurance claims are a whole separate animal. They can be simple or long and tedious. 

I won’t go into much detail, but here are what I believe are the best practices having navigated claims ranging in size from $25,000 to $10,000,000+.

• Communicate early. If you think there MAY be a claim, let your insurance broker and carrier know immediately. There is no penalty or risk of an increased premium next year if there doesn’t end of being a claim.

• Ask questions. You will likely be assigned a “claims adjuster” by the insurance carrier. Ask for clarification of the process and timeline.

• Be persistent. Claims adjusters often have an unmanageable workload. Don’t be a jerk, but be persistent.

It is a process. Not a fun one, but one that can be navigated. It will help if you are already a good customer.

A note on asset classes and claims. Different asset classes tend to have different types of claims and frequency of those claims.

• Multifamily and 1-4 Unit Residential: highest claim volume from “slip and falls” and kitchen fires.

• Retail and Office: “slip and falls” are most common claims.

• Industrial: theft of copper and other “recyclable” materials are most common claims.

Go in eyes wide open as you consider your asset class and strive to be a good customer.

Why You Should Strive to Be a Good Customer to the Insurance Carriers

What does it mean to be a good customer to the insurance carrier? It means:

• You pay your premiums on time. This is their revenue.

• You maintain your property well and have good standard operating procedures. This leads to lower risks of claims.

• You are loyal. You don’t switch carriers every year. 

An insurance company will look at you (their customer) in terms of how you have performed over the life of the relationship. Remember that their goal is to make more money on the premiums than they pay out in claims over years and decades.

You are more likely to have lower premiums each year (and a better claim outcome) if you have been a customer for five years without a claim than if you are three months into your first policy year with the company. 

Don’t necessarily change carriers every year to save a few bucks. Think of it as a long term partnership.

Pro tip: as you build up a portfolio of properties, look into putting them into a single “portfolio” insurance policy. This could save you money and make things simpler to operate.

Closing Thoughts

Don’t be intimidated by insurance. Understand that it plays an important role in the world of real estate investing. 

View it with curiosity and always be learning.

The Property Manager: On the Front Line of Your Property

Why the relationship with your property manager is so important

As we did last week, let’s anchor in on where we are in the process of learning how to be a real estate investor.

• You own your first property.

• You have a business plan and are in the early stages of executing it.

• You have hired a local property manager.

• You are eyes wide open that unexpected issues will come up.

• You understand how to review the monthly reports.

Today we are going to discuss how to work effectively with your property manager.

Your property manager is on the front line of your property. They are the main point of contact with tenants and vendors. 

Your tenants’ experience of the property will be based on four things: 

1. Where the property is physically located.

2. How much rent they have to pay.

3. The physical condition of the property.

4. How the property manager responds to their requests and challenges.

You can’t change the location and you want to maximize the rent. The physical condition is generally fixed other than the ability to maintain it and possibly improve it.

It is the performance of the property manager that is the most malleable. It is one of the few things that you as the property owner have the ability to influence.

Today we will discuss:

• The role of the property manager.

• Why being a property manager is so challenging.

• When to hire a property manager and how to find a good one.

• The importance of setting clear expectations relative to your operational philosophy and goals.

• How much discretion to give the property manager.

• What to do when things aren’t working out.

Let’s dig in.

The Role of a Property Manager

A property manager is the person or team that manages the property for you on a day to day basis. They will likely be an employee of the company you hire to manage your property.

In addition to the monthly reporting package generated by their team, they have two main focus areas:

1. Tenants

2. Vendors

Tenants

Property managers respond to tenant requests and give tenants direction. They use the lease (and instructions from the owner, if any) to determine how they respond to issues. Here are some examples of issues that will come up with tenants.

• The tenant is paying rent late.

• The HVAC unit in the tenant’s suite stopped working and needs maintenance.

• The tenant is leaving trash in the common area.

The property manager has to interpret how to handle the issue, get approval from the owner, communicate the resolution to the tenant, and make sure the tenant cooperates.

This is very easy to say, but hard to do.

Vendors

Property managers also hire vendors to maintain, repair, and upgrade your property. Some of this is done proactively. Some of this is done reactively. You as the owner set the direction of the maintenance standards, but it is the property manager who has to execute this. Here are some examples of issues.

• Exterior maintenance relative to cleanliness and the landscaping.

• Preventative maintenance (if any) of the building systems.

Want to operate your property like a slum lord? It falls on the property manager to execute this and face the consequences of the unhappy tenants.

Why Being a Property Manager is So Challenging

Let me state this clearly:

The role of a property manager is one of the hardest in the real estate industry.

Why?

There are multiple reasons:

• Lack of Time Control: a property manager is faced with a variety of issues each day, many of which are unplanned and time sensitive. Things break. Emergencies happen. Property managers have a very hard time keeping control over their schedule and time.

• Workload: property management is a low margin business. Owners of property management firms tend to overload their property managers with a heavy workload.

• Context Shifting: a property manager is a jack of all trades. From communicating with a tenant, to analyzing a lease, to reviewing and commenting on a financial report, to preparing a vendor contract, to interpreting a technical building issue - a property manager has to do it all, often in a single day.

• 80/20: 80% of what happens at a property goes well and unnoticed. It is the 20% of issues that go wrong (most of the time outside of the property manager’s control), that get noticed and complained about to the property manager. It can be a thankless job.

Let me say it again.

The role of a property manager is one of the hardest in the real estate industry.

The good ones do all of this with amazing customer service and keep everyone happy.

I have SO much respect for property managers. 

When to Hire a Property Manager and How to Find a Good One

Some of you may be considering managing the property yourself. That is fine, but proceed with caution. 

I did this for a year on my property. It is like taking on a part-time job. Once I received an emergency call while on vacation with my family, I realized I would much rather pay someone else to do the work.

Hiring a property manager is particularly important if any of the following criteria apply to you:

• You don’t live near the property.

• You have a full time job.

• You have a low tolerance for customer service issues.

• You put a high value your time and mental peace.

The good news is that there are great property managers out there. Here’s how to find one.

• Ask for referrals. Search the internet. Ask AI. Note: referrals are the best.

• Interview 2-3 firms. Yes this will take time, but it will give you a good comparison.

• Check references. What are their existing clients saying.

• Request an example monthly report.

• Discuss your operating philosophy and goals.

You don’t always want to go with the cheapest option. Find the one that has the right balance of costs and service - and who is on board with your philosophy and goals.

A note of fees: property managers typically charge a fee based on percentage of rent collected from the tenants each month. This varies by market and property type. Here’s a rough range to give you an idea:

• 1-4 Unit Residential: 8-10%

• Large Multifamily, Retail, Office, and Industrial: 3-5%

They may also charge fees for construction management, leasing, and other “one time” services.

Once you select the right property manager for you, make sure you set clear expectations.

The Importance of Setting Clear Expectations Relative to YOUR Operational Philosophy and Goals

In a previous newsletter - Daily Issues You Will Face While Owning Real Estate - I discussed the importance of being clear on your own operating philosophy using three types of cars as an analogy: 

Do you want to operate the property like a top of the line Mercedes, a reliable but basic Honda, or a car that constantly breaks down?

If you don’t understand your own philosophy and goals, your unfortunate property manager will either (a) constantly be guessing at how to handle issues and coming to you regularly for direction or (b) taking action on issues that may or may not be what you want.

Take the time to be clear on your philosophy and goals.

Once you do this, you can set the framework of a good working relationship with your property manager that will benefit your property. Here are the specific steps I recommend:

1. Send an email to the property manager explaining your philosophy and goals.

2. Meet with the property manager onsite to walk the property and discuss your philosophy and goals. Make sure you take the time to get to know your property manager and understand their daily workload outside of your property. 

3. Agree upon expectations for how the property will be operated day to day. 

4. Agree upon how often you will have a call or meeting and what will be covered. This will be much more efficient than ad hoc communication.

5. Agree upon what communication should fall outside of the call/meeting schedule. What should qualify as an emergency? Do you prefer texts, calls, or emails?

6. Agree to check in after 90 days to discuss what is working and not working.

Setting the foundation up front will help establish a clear working relationship that will benefit each of you and the property.

Here are some examples of how you can operate a property to give you an idea of how to develop your own operating philosophy.

Tenant Compliance

• “Letter of the Lease”: strictly interpret the lease. Don’t give the property manager any wiggle room. If the tenant is unhappy, too bad. They signed the lease. If they paid a day after the grace period, immediately move to eviction.

• “Best of Alternatives”: use the lease as a foundation, but be practical. You may be strict on the rent, but be more flexible on maintenance issues. Maybe the lease says that the tenant has to maintain the HVAC, but you tell the property manager that you are willing to pay for maintenance issues for tenants who are consistently paying rent on time.

I like option 2, but it does run the risk of getting out of hand if not closely monitored.

Property Maintenance

• “Reliable but Basic Honda”: keep the property functioning well, but don’t try to fix and improve every possible issue.

• “Top of the Line Mercedes”: keep everything looking and functioning perfectly. Cost is irrelevant.

• “Car That Constantly Breaks Down”: do the bare minimum.

I operate my property as a “reliable but basic Honda” and use the “best of alternatives” approach to tenant issues.

Once you have set clear expectations with the property manager, you will want to decide how much discretion they should have.

How Much Discretion to Give Your Property Manager

When I talk about discretion, I am mainly referring to financial discretion. Spending money.

Your property manager will be making decisions daily that don’t cost any money. This is what you want. There is no point in paying someone to manage your property if they have to come to you for approval on every issue.

When it comes to financial issues, I recommend setting a dollar threshold under which the property manager has the discretion to resolve issues without coming to you for approval.

For example, you could set a threshold of $250. This could be per issue with a monthly cap or per month. This allows the property manager to resolve small issues without having to come to you each time for approval. It will save each of you time and will benefit tenant relations as issues can be solved real time.

Try a dollar threshold for a few months. If it works well and you develop an increasing level of trust with your property manager, consider increasing the threshold. If it is not working, consider reducing or eliminating the threshold.

Remember that you can change things over time. 

Start with an approach, set a time period under which to try and evaluate it, and then make modifications if needed.

What To Do When Things Aren’t Working Out

All that being said, you can do everything to set yourself, the property manager, and the property up for success, but still have problems.

There will be times when things aren’t working out. 

Welcome to being a real estate owner.

Here are some red flags to watch for relative to the performance of your property manager.

• Poor Property Condition: the property is not being maintained to your agreed upon standards. You see this repeatedly in your property visits.

• Non-Responsiveness: your property manager does not respond to your emails or calls. You may also hear from your tenants saying they are contacting you because the property manager is not responding to them.

• Poor Treatment of Tenants or Vendors: in short, your property manager acts like a jerk.

• Deadlines Consistently Missed: your property manager is responsive, but never hits agreed upon deadlines.

Sometimes these issues can be resolved with a conversation with your property manager (or your property manager’s boss). Sometimes they can’t.

When they can’t, it is time to make a change. Don’t settle for poor performance. You will lose tenants and spend more money maintaining your property in the long run.

Interview 2-3 new property management companies to find a better fit for you.

Closing Thoughts

Finding the right property manager is critical to your success as a real estate investor. 

In the property I own directly with a partner, I experienced three of the four red flag issues above with the first property manager. I ended up firing them and finding a new one. 

Everything has been SO much better since then. It was worth the time and the additional monthly expense.

Take the time to find the right team for you and your property.

Your time. Your money. Your choice.

Getting Meaning from Monthly Reports

Understanding income statements, rent rolls, A/R, and balance sheets

Let’s anchor in on where we are in the process of learning how to be a real estate investor.

• You own your first property.

• You have a business plan and are in the early stages of executing it.

• You have hired a local property management and accounting firm.

• You are eyes wide open that unexpected issues will come up.

Having a clear business plan relative to leasing and construction is probably the most important step you must take. We will get into the details of this in a future newsletter.

Today we are going to discuss how to interpret and get meaning from the monthly reporting package you will receive from your property management and accounting team.

I will define and discuss the individual reports that go into the reporting package:

1. Summary page

2. Rent Roll

3. Accounts Receivable (aka A/R)

4. Cash Flow and Income Statement with a Comparison to Budget

5. Balance Sheet

6. Construction Activity & Leasing Report

You do NOT need to have any accounting knowledge to understand these. All you need is patience, common sense, and a little guidance from Professor Bateman.

Let’s dig in.

Reporting Package Overview

Let’s start with the very basics.

What is a “reporting package” and where does it come from?

• What: a reporting package is a collection of reports that help you understand how your property is performing.

• When: it will likely be delivered to you within the first 10 days for the month and include activity for the previous month. Example: by May 10th you receive the report for April.

• Format: it will be a pdf sent to you by the property manager.

The property manager’s accounting team will have prepared it according to the company’s accounting practices combined with the structure you (the client) have agreed upon. [Note: if you don’t have a property manager, you might have prepared it yourself or hired an accountant to do it.]

You don’t need to be an accountant to understand the reports, but it does help to have some foundational knowledge. Here are some basics.

Whenever there is financial activity at a property, the accountant records it in the general ledger. This could include:

• Rent charged to or paid by the tenant.

• A maintenance invoice received by or paid to a vendor.

• Distributions made to investors.

• And any other financial activity.

Think of the general ledger as a big excel file with (i) a date, (ii) a category ID, (iii) the amount, and (iv) comments.

Most reports are just a roll up of this activity, summarized in a specific way using the dates, category IDs, and amounts.

That’s about it. Yes, it is an oversimplification of the reporting process but it gives you an overview of how it works.

To be clear, it is way more complicated if you are doing the work, but as a reader of reports this should anchor you on the basics.

Now let’s discuss the individual reports within the reporting package. Your specific report may be different in order and content. Use the list below as an example only.

#1 - Summary Page

The summary page is just as it sounds: a summary. It will include highlights such as:

• Property square feet and percent leased.

• List of new or vacating tenants.

• Amount of rent not paid (aka delinquent).

• List of construction or maintenance projects.

• Current cash, recent distributions, NOI and any other “snapshot” financial data.

There may be comments on some or all of these or it could just be a statement of the facts.

All of it will likely be in one page. It will help you understand the overall property performance before you read the individual reports.

#2 - Rent Roll

The rent roll is a summary of the leases and suites for your property.

Each accounting firm will create a slightly different version of a rent roll. Rent roll templates can also differ by asset class.

See below for an example of a rent roll for a three unit residential property.

Example: Rent Roll of 1-4 Unit Residential Property

It gives you a way to see your tenants in a summarized report. If there was a vacant suite, it would be listed as vacant as shown in the example below.

Example: Rent Roll of 1-4 Unit Residential Property - Including Vacant Suite

Important Note: never rely exclusively on your rent roll when making a decision about a specific tenant. In this case, you want to refer to the signed lease as there could have been a mistake made when the rent roll was prepared.

That being said, rent rolls are very useful to reference day to day.

Let’s move on to the A/R report.

#3 - Accounts Receivable (A/R)

Whereas a rent roll lists what each tenant is contractually required to pay each month, the A/R report will be your guide to what the tenant actually paid.

In the example above, Tenant 1 in suite A is supposed to pay $1,000 per month. If they did not pay that month, the A/R report would show this outstanding balance (aka delinquency).

Example: A/R Report

The comments would have been added by the property manager who would have (hopefully) contacted the tenant to find out what was going on.

It is then your decision as the property owner to decide whether to allow the tenant some time to catch up on the rent or move to eviction.

Let’s move on to the overall property performance reports.

#4 - Cash Flow & Income Statement

Rent rolls and A/R reports are specific to revenue. The cash flow and income statement capture the revenue and expense activity that combine into the net operating income (NOI) and net income.

As an individual investor, I like to think of the cash flow and income statement as a single report.

But those of you who are accountants or in the real estate industry probably recognize that this is not always the case. Here’s how they differ:

An income statement is a summary of activity through NOI and inclusive of debt service, capital improvements (capex), leasing costs (tenant improvements and commissions) that totals in net income. It does not necessarily correlate to (a) the cash activity that occurred at the property that month nor (b) include a starting and ending cash balance.

This is because there are many, many accounting rules that indicate how reports should be prepared. They are anchored on logic that makes sense, but do not always result in helpful information for an individual investor.

Here’s what a cash flow and income statement might look like.

Example: Cash Flow & Income Statement

It looks like an income statement through “Net Income” but then adds comments on the starting and ending cash to give you an ending cash balance.

Cash is king. You always want to know how much cash you have.

A further variation on the income statement would be to include a “comparison to budget”. This would look like the example above with three extra columns:

1. The budgeted amounts for that month. The monthly budget would have been finalized at the end of the previous year - in this example, the end of 2025.

2. A comparison of the actual amounts to the budgeted amounts.

3. Comments on any significant variances to budget.

Now that you have a sense of a cash flow and income statement, let’s move on to the balance sheet.

#5 - Balance Sheet

A balance sheet is a snapshot of assets, liabilities, and equity.

• Assets are things at the property that have value.

• Liabilities are things the property owes to others.

• Equity is the difference between the two.

It looks like this.

Example: Balance Sheet

The balance sheet is literal. It must “balance”.

• Assets = Liabilities + Equity

• Equity = Assets - Liabilities

Balance sheets are helpful to track your liabilities, but I don’t find them particularly useful in my day to day operations of a property.

#6 - Construction Activity & Leasing Report

These last two reports will vary in both who they come from and what they look like.

A construction activity report will likely come from the property manager. It will provide some level of detail on planned, in process, and completed construction activity. It will show things like (i) costs - both budgeted and actual, (ii) timeline - both budgeted and actual, (iii) a narrative on how the work is going.

This will likely be your most important report if you are in the middle of a renovation.

A leasing report will either come from your property manager (all residential properties) or your broker (all commercial properties). It will show leasing activity and lease comparables (aka lease comps).

Lease comps are completed leases at similar properties. They help give you a benchmark of what similar properties are leasing for in the same market. They help you determine what you should charge for rent for your property. We will get into this in a future newsletter.

So what is the takeaway on all these reports?

My Recommendations

Here’s how I use the reports.

For the deals in which I am a limited partner (LP) investor, I read the summary of the report with a focus on what is most important to me. If cash flow (aka investor distributions) is most important, I focus on that.

I recognize that as an LP (a) I have no control over day to day activity nor decision making and (b) I have invested as an LP so I don’t have to do any work. With this in mind, I don’t bother reading much beyond the summary page(s).

If you are an individual LP investor, you will “get what you get” relative to reports from the general partner (GP). Here are three examples of reports I get as an LP investor with three different GPs.

• Monthly report an income statement and balance sheet, but with minimal narrative.

• Quarterly report with detailed narrative and an income statement.

• Annual letter with a narrative only. One page. No numbers.

This does not correlate to the property performance. It is just a choice that each GP has made as to how they want to communicate with their investors. As an LP, I have no ability to change this.

When I am investing by myself or with a partner, I take the opposite approach to reviewing the reporting package.

Not only do I read everything in the report, but I also have my own excel file of (i) monthly cash flow and income statement, (ii) rent roll, and (iii) capex report.

My excel based cash flow and income statement includes both historical and projected amounts per month with a running cash balance so I can project capital spending and investor distributions.

It is more work for me to enter the information from the reporting package pdf into excel each month, but it is well worth the effort as this makes sure I really understand the property financial performance.

A side benefit is that as long as the property manager gives me the information I need to enter into my excel file, I don’t care what format they deliver the reports to me in. They can use their standard templates.

Recognize that if you ask a property manager for customized reports that differ from their standard templates, it may be more work for them. This could mean more costs to you.

Make sure you agree on the content, timing, and frequency of the reporting package before you hire your property manager or accountant. I suggest starting by requesting an example reporting package and seeing if it has the content you need.

Red Flags to Watch For

As you review the reports, here are a list of things to be on the lookout for.

• Increasing A/R: this indicates tenants are consistently paying late or not at all. Work with your property manager to come up with an action plan.

• Actual Expenses Are Significantly (>10%) Over Budget: either your budget was too low or there are issues going on at the property. Discuss with your property manager.

• Minimal Cash Balances: always leave a cash cushion for the unexpected.

• Vacant Suites Staying Vacant for 3+ Months: work with your property manager or leasing broker. You may need to lower the asking rate or change brokerage teams.

• Construction Delays and/or Cost Overruns: watch this closely and actively manage the team managing the jobs.

Pay attention and don’t be shy about calling your property manager to discuss in detail. Use your common sense and ask questions. Don’t be a jerk, but don’t be too passive.

Your Property, Your Choice

You can decide how you approach each investment.

It is your investment, your money, your time.

And you can always change your approach to report review over time. That is what I did.

How I approach it today is different than I did five years ago and will likely change five years from now.

That is learning and evolution. As my needs change, I adapt my approach to better meet my needs.

Don’t be intimidated by the jargon of real estate reports: income statements, rent rolls, and balance sheets.

Ask your property manager or accountant to explain them to you in simple terms. Take notes. Be a student.

After reading a month or two of reports, you will find they are key to extracting meaningful insight into how your investment is performing.

Daily Issues You Will Face While Owning Real Estate

From A/R to maintenance issues to finding tenants

Over the past three weeks we have covered real estate terms, getting organized, and developing your leadership skills.

Now we are going to get into the day to day issues you will face as a real estate investor. 

Just as we did in the discussion on due diligence, we are going to use an income statement as our guide. 

• Revenue

• Operating Expenses

• Capital Improvements

• Leasing Costs

• Interest Costs (i.e. debt)

• Other Issues Affecting Value

Almost everything you will be faced with could have an impact on the income statement. All other issues will have an impact on sale value and debt options.

I won’t overwhelm you with trying to give every detail of each issue. Think of this as a high level overview. We will dive into the specifics in the rest of the newsletters in this series on operating real estate.

Let’s dig in.

What is an “Issue”?

For this discussion, let’s define an issue as something that comes up that you have the power to take action on. That is not to say that there is a solution for everything, but most of the time there is something you can do.

But let’s make something very clear: 

There are many things that will be outside of your control that will affect the performance of your property. Examples of these over the past 10 years include:

• A global pandemic

• Inflation that impacts both costs and interest rates

• War

• Political policies and changes in laws

That being said, there are many things within your control. You want to know what those are and what your options are. That is where this newsletter comes in.

Let’s start with revenue.

Revenue

As a reminder, revenue is made up of rent from tenants (and other income like parking) but is offset by vacancy and credit loss (i.e. tenants not paying rent).

Issue #1 - Tenants Not Paying Rent

You have leases in place but the tenants are not paying rent or are paying late.

• Your Options: (i) do nothing; maybe you can live with the tenant paying late as long as they pay by the end of the month, (ii) same as previous but also charge a late fee, (iii) talk with the tenant to understand if this is a temporary issue; if so, work out a payment plan, or (iv) evict the tenant.

• Future Discussion Newsletter: property management.

Issue #2 - Existing Tenants Causing Problems

Maybe they are loud or leaving trash in the common areas. They are doing something that disrupts others and/or damages the property.

• Your Options: (i) do nothing; be a passive landlord, (ii) all bark, no bite - threaten to do something but never do it, or (iii) give the tenant a deadline to resolve the issue and then move to eviction if they don’t.

• Future Discussion Newsletter: property management.

Issue #3 - No Tenant

To state the obvious, if you don’t have a tenant in one of your units you will not get rent. Said another way, this is vacancy at your property. It is like an airplane that takes off without a passenger in a seat. You will never get that rent back.

• Your Options: (i) find a tenant by working with a motivated broker that knows the local market and/or (ii) expand an existing tenant.

• Future Discussion Newsletter: leasing.

Issue #4 - Lease Rate

How aggressive do you want to be in setting your lease rates? Are you willing to give an existing tenant a lower lease rate than you would a new tenant?

• Your Options: understand the market conditions and decide on an operational philosophy. Maybe you care more about steady cash flow than driving the rent as high as possible with periods of vacancy.

• Future Discussion Newsletter: leasing.

Issue #5 - How a New Tenant Will Use the Space (Commercial Properties Only)

You may have a tenant ready to lease your space at a great lease rate, but you are concerned about how they will use the space. You could be worried they will be disruptive to other tenants and/or be hard on your property. 

• Your Options: talk with your broker and people your trust. Check with your insurance broker to see if it will affect your insurance rates. Consider a shorter term lease and put strong usage language in the lease.

• Future Discussion Newsletter: leasing.

That should be enough to chew on for revenue. Let’s move on to operating expenses.

Operating Expenses

Operating expenses are made up of utilities, repairs and maintenance (“R&M”), insurance, property taxes, and property management fees (“PM Fee”). Some assets will have a more detailed list, but these are the major items.

Issue #6 - R&M: Costs vs. Quality

You will have a number of vendors performing services such as landscaping, pest control, HVAC maintenance, etc. You will need to analyze the trade-offs between frequency, quality, and price.

• Your Options: develop your own operating philosophy. What kind of landlord do you want to be? Do you want to operate the property like a top of the line Mercedes, a reliable but basic Honda, or a car that constantly breaks down?

• Future Discussion Newsletter: property management.

Issue #7 - Property Manager

This is a similar concept. What are you looking for in your property manager? How proactive do you want them to be? Are you willing to pay more for a property manager with a manageable workload, or do you want the cheapest that has an unrealistic number of other properties?

• Your Options: same concept as R&M costs. 

• Future Discussion Newsletter: property management.

Issue #8 - Insurance

Insurance can get expensive. You will be faced with the choice of having broad coverage or minimal coverage. If you have a loan on the property, the lender will play an active role in determining your coverage requirements. Broad coverage is more expensive than minimal coverage and unfortunately there is no “right” answer to the amount of coverage to have. Additionally, you may have to file an insurance claim at some point.

• Your Options: (i) understand your tolerance for risk and (ii) dive in deep and early when you have an insurance claim by actively engaging with your insurance broker and/or claims adjuster.

• Future Discussion Newsletter: insurance and property taxes.

Let’s move on to the “below the NOI” line items. Reminder: NOI = Revenue minus Operating Expenses.

Capital Improvements (aka Capex)

Issue #9 - Repair or Replace

Things are going to break and deteriorate. That is the reality of owning a property. It might be the HVAC unit, a dishwasher, or a section of the roof. As the landlord, you may need to address this under the terms of the lease.

• Your Options: (i) read the lease to determine who is responsible for the issue - landlord or tenant, (ii) review the age of the system - example: if the HVAC unit is 20+ years old, a replacement may make more sense than a repair, (iii) price out both the repair and the replacement, and (iv) get opinions from multiple vendors.

• Future Discussion Newsletter: construction.

Issue #10 - Replacement Quality

This is the same concept as R&M vendors and property managers. How high a quality system and work do you want for your property. Are you OK with the cheapest lighting, HVAC, and quality of work that won’t last as long but is less expensive? Or are you willing to pay more for high quality systems and work that will last longer term?

• Your Options: (i) develop your own operating philosophy, (ii) be eyes wide open on the trade-offs and the reality of your cash position, and (iii) get multiple bids for the work and talk with the contractors about their work before you sign a contract.

• Future Discussion Newsletter: construction.

Leasing Costs: Tenant Improvements (“TI’s”) and Broker Commissions

Issue #11 - Your TI Budget

How much are you willing to spend for the right tenant? What is the reality of your cash situation? Although TI’s are mainly applicable to commercial properties, the same concept applies to residential relative to how much you want to improve the unit for a prospective tenant.

• Your Options: (i) develop your own operating philosophy, (ii) be careful of tenants that want specialized TI’s that are unlikely to be re-used by a future tenant, or (iii) try to push the cost of the TI’s onto the tenant in exchange for free rent and/or a lower lease rate.

• Future Discussion Newsletter: leasing.

Issue #12 - Leasing Commissions (Commercial Properties)

Brokers play a very active role in leasing commercial properties. Commissions can get expensive and need to be paid at the time the lease is signed (i.e. upfront). This can squeeze you on cash at a time your revenue is down because you have a vacant suite.

• Your Options: (i) build up cash prior to a potential vacancy and (ii) understand the time commitment and risks of not using a broker.

• Future Discussion Newsletter: leasing.

Let’s move on to debt.

Interest Costs, Debt, and Other Lender Issues

Issue #13 - Rising Interest Costs

You may be tempted by the low interest rate that come with a floating rate, adjustable loan. But if interests rates go up, your monthly interest costs could double. Yikes!

• Your Options: there may not be any options if your interest costs go up. This could wipe out your cash flow and/or put you in a situation where you can’t make debt service. Be very careful of floating rate debt. This adds a significant amount of uncontrollable risk.

• Future Discussion Newsletter: investor and lender issues.

Issue #14 - Lender Approvals

As discussed in Debt: An Amazing Tool with Strings Attached, your lender may have approval rights on a number of issues and not allow you to do what you believe is best for the property.

• Your Options: (i) read and understand the loan documents so you know your rights, (ii) develop a positive working relationship with your lender from day one and be reasonable; this will pay dividends in the future, and (iii) make the case for why you want to do what you want to do.

• Future Discussion Newsletter: investor and lender issues.

And finally, let’s quickly address “other issues”.

Other Issues Affecting Value

There are some issues that may not affect your cash flow during ownership, but will be problems when you go to sell or refinance the property. These could include:

• Environmental issues

• Zoning changes

• Challenging neighbors

• Challenging tenants

Your Options: (i) conduct annual property reviews to identify issues early, (ii) maintain good relationships with city officials and neighbors, (iii) address problems immediately rather than letting them compound, and (iv) document everything in case issues arise during sale.

The key is to be eyes wide open on the risk to your future sale and/or refinance and then try to resolve the issues as best as you can before you are in the time crunch of a sale or refinance.

That’s the list of 15 or so issues. Are these all the possible issues you will face?

No, but they give you a sense of the type of issues you will face.

What are our key takeaways?

Key Takeaways

Here’s what you need to keep in mind:

1. Develop your own operating philosophy. Combine this with your niche, and you will have a clear foundation on which you evaluate your decisions. Without a philosophy, you will find yourself over analyzing each decision and not having any consistent approach.

2. Issues that you need to figure out will come up. Methodically break them down into parts. Do the research. Talk to experts. And then make a decision.

3. Not all issues are equal. Cash flow problems (non-paying tenants, rising interest costs) demand immediate attention. Quality decisions (Mercedes vs Honda) can be determined over time.

4. There will be unexpected costs. Keep a cash cushion. Don’t distribute every last dollar.

Life is full of challenges. Think of all the ones you have overcome in your life just to be able to be sitting here reading this newsletter.

Operating real estate is a lot more complicated than owning stock. 

It can be time consuming and stressful. There is no sugarcoating it.

If you don’t want this in your life but you still want to be a real estate investor, there is alway the option to invest as an LP and have the GP do all the work (for a fee).

But for those of you willing to do the work, it can be financially lucrative and intellectually rewarding. 

You can do it.

Developing Your Leadership Skills

The power of reading non-fiction and creating a reading journal

Reading non-fiction has made me a better leader.

No question. No debate.

I have learned so much through the reading process, not just about other subjects, but also about myself.

Last week we talked about getting organized. Soon we will be moving on to all the things that will come with operating your property: (i) proactively executing your business plan, (ii) reacting to issues, and (iii) leading others to accomplish your goals.

You need to develop your own tools to do these well. Not just the specifics of real estate, but also the fundamental leadership skills needed for these functions in anydomain.

That is why this week we will talk about reading as a foundational practice to understand yourself and develop your leadership skills.

We will cover three topics:

1. The list of some of my favorite books that talk about key skills to develop.

2. How to remember what you read by creating your own reading journal.

3. The most important skills all leaders need.

Let’s dig in.

Why Non-Fiction

Fiction is tons of fun, but non-fiction helps me grow.

It makes me a better leader, investor, employee, and professor.

It makes me a better person.

It expands my perspective and helps me think.

Non-fiction books are also an insane bargain. For less than $20 (or free at the library) you get a comprehensive presentation of someone's deep research into a subject.

That person put 100's of hours into creating it.

An editor read many drafts to perfect the organization and main points.

All of this is then there for anyone to buy for less than $20. What a deal!

So here’s a list of books I recommend to make you a better leader, not only of your properties, but also of your life and everything else you do.

Recommended Reading List

Understanding Yourself: if you don’t understand yourself, you will limit your growth.

• Emotional Intelligence 2.0 by Travis Bradberry and Jean Greaves: probably one of the most foundational discussions of not only how to understand emotional intelligence (aka EQ), but also how to develop it. Emotional intelligence is critical to working with others.

• Mindset by Carol Dweck: one of the most influential psychology books of the last decade. Do you have a fixed or growth mindset? Read this book to understand the importance of a growth mindset and how to develop one. It may change your entire perspective on life.

• Grit by Angela Duckworth: understand the need for consistency of effort over the long run to achieve your goals.

• Quit by Annie Duke: Duke is both a university professor and former world poker champion. She discusses our bias against quitting and shows you the formula for when you should quit.

• Clear Thinking by Shane Parrish: a guidebook on how to make better decisions.

Your Career & Leadership: read to help guide your career and become a leader.

• Legacy by James Kerr: short lessons on leadership based on the legendary New Zealand national rugby team. I think I have read this four times.

• The Wisdom of Andrew Carnegie as told by Napoleon Hill: this was the precursor to Think and Grow Rich. It is an interview with Andrew Carnegie full of his principles for a successful life. These lessons from 1908 still hold true today.

• The Infinite Game by Simon Sinek: a discussion on a more grounded form of leadership that yields better results.

• Atomic Habits by James Clear: the incredibly popular book on the importance of habits and how to develop them. Over 25 million copies sold. Read it. Live it.

Money and Investing: these will help you think about investing at a more foundational level than just real estate.

• What to Make of a Life by Jim Collins: helps you understand the power of what happens when you find the things you are naturally good at.

• The Psychology of Money and The Art of Spending Money both by Morgan Housel: these books help you understand the major role that psychology plays in influencing all of our decisions about money.

• The Simple Path to Wealth by J.L. Collins: this guy is the master of helping you understand the stock market and its importance as a passive vehicle for wealth creation. He also explains what IRAs, 401Ks, and 529 plans are.

• The Algebra of Wealth by Scott Galloway: wealth = focus + (stoicism x time x diversification).

• The Five Types of Wealth by Sahid Bloom: helps you think beyond wealth as being limited only to money.

Living a Good Life: making money is a way earn your freedom, but it is a pointless exercise if you don’t live a good life.

• Transitions by William Bridges: explains the three steps we go through when making transitions in life.

• 30 Lessons for Living by Karl Pillner: based on interviews with people in their 70s, 80s, and 90s. A great way to learn from those that have “been there, done that” in the journey of life.

• The Daily Stoic by Ryan Holiday: I read this every morning. One page per day. I can’t speak highly enough about stoicism. It is the 2000+ year old philosophy that is anchored on the concept of distinguishing between what you can and cannot control. Don’t waste your time getting emotional on what you cannot control. All of Holiday’s seven+ books on stoicism are outstanding.

That’s my curated list of 15+ favorites from the 50+ non-fiction books I have read in the last five years.

Now what?

Let’s say you choose to read some or all of these books. Pick one that looks interesting. Create a dedicated 20-60 minute uninterrupted block to start reading. Keep going if it interests you. Move on to another book if it doesn’t.

Remember, I didn’t magically read all of these at once. I found one that was interesting (Atomic Habits) and kept following my curiosity.

The list I am sharing here is a manifestation of the power of compounding in action.

I have found that 10-12 books per year is my pace. I tend to go through spurts, reading three books in six weeks and then not reading anything for a month or two. Find your own rhythm but make reading a priority.

Ideally, you want to retain the key learnings from each of these books to be able to refer back to them when you feel the need. This is what we will talk about next.

Remember What You Read: Create Your Own Reading Journal

I used to mainly listen to non-fiction books via audio. I enjoyed listening while on a hike or during a car ride. It was super convenient.

The downside to this convenience was that I often forgot the lessons of the book months later.

Then I heard about the concept of a commonplace library: the idea of writing down the key points or quotes of a book in a centralized place (ex. notecards by subject or a reading journal).

This required me to restructure the way I read.

I moved to a kindle so I could highlight as I go. Highlighting is key to be able to go back and reference the important parts of the book.

I bought a Moleskin journal that is dedicated to summaries of the books I read. One to two pages of notes per book. Here are the specific steps:

1. Read the book in any format that allows you to highlight specific passages.

2. Once you finish the book, set it aside for a week or so.

3. Come back to the book with fresh eyes to go through the highlighted sections. Summarize the key concepts in your dedicated journal. I don’t bother with quotes or putting in everything I highlighted. I just want to capture the key concepts. I like being limited to 1-2 pages of notes.

I now have a journal full of knowledge that I can refer back to. It is one of my favorite possessions. These pictures will give you a better sense of it.

Note: if you absolutely have to listen on audio, consider carrying around a notebook to take notes as you go.

Image 1: My Moleskin Journal Dedicated to Reading Summaries

Image 2: The Table of Contents

Image 3: An Example of a Book Summary

Anytime I am making a big decision or think of something that I have read and want to re-visit, I turn to my reading journal.

So what have I learned about leadership through reading and becoming a leader at work?

Important Leadership Skills

1. Be Clear on What You Want: get priorities correct so as to spend time on the correct things.

2. Measure Success: figure out how to measure whether you are achieving your goals. Measure what matters. Results will follow

3. Be Driven & Humble: this is the magic combination. Recognize you can always learn from others. You don’t want to be the smartest person in the room.

4. Give credit to others. Take the blame for mistakes.

5. Embody the leadership skills you admire. People will watch what you do more than what you say.

6. Build and Rely on Your Team: don’t do everything yourself. Assemble a team of people that are good at specific areas. Trust them and give them room to do things their own way. Don’t micromanage them.

7. Respect Differences: other people’s ways may be different from your own. It is results that count, not the methods.

8. Be Prepared: for meetings and discussions. This means doing the reading and research in advance and expecting the same from others.

9. Create Focus Time: progress happens in dedicated blocks of time, not in endless meeting and emails. Set aside regular blocks of 90-120 minutes to actually think and do work.

10. Take a Walk: my best ideas come from my hikes and bikes in nature. Get out of the office to think. Walking 1:1 meetings can be great too.

11. Be Curious: ask lots of questions. Always be learning.

12. Create Relationships: the team you work with are not robots. They are people with feelings. Build up your “relationship bank” with others so that you can “draw” from it when you need to have challenging conversations. You need to establish trust before you can work through conflict.

13. Don’t Be a Jerk: this should be obvious, but some people still behave poorly. Everyone is dealing with something challenging outside (or sometimes inside) the office. Be kind. Be helpful. Give people the benefit of the doubt.

14. Leaders make decisions with or without perfect information.

Reading and Leadership

Readers are leaders.

For me, much of growth and leadership is integrating information from different areas and applying them to the situation at hand.

Reading is foundational to this.

Read. Read. And then read some more.

It will make you a better investor, leader, and person.

Getting Organized for Success

Building a foundation of property information so you can focus on adding value

You are on the path to becoming a real estate investor.

You will identity your niche, study a market, find a property, and go through the acquisition process to closing. At that point you will be a real estate investor.

Then what?

How do you set yourself up for success?

The key is to build a foundation of information based on everything your learned during the acquisition and due diligence process. Half a day of organizing information could save you 100’s of hours of searching for what you need during your ownership of the property. 

More importantly, it will help you stay on track with your business plan and make better decisions.

I have found there are four ways to organize and access your property information. I like to use all four, but everyone’s brain works differently. Develop the method that works best for you.

1. Digital folder of documents.

2. Photo library.

3. Master excel and site plan files.

4. Physical notebook of most important / current information.

I will walk you through all four so that you can (a) see an example of each approach and (b) adapt them to what works for you.

Let’s dig in.

Why Take the Time to Organize the Property Information?

As discussed in Due Diligence: Your Property Investigation Checklist, you will spend significant time creating a detailed understanding of the property. You will review the Offering Memorandum (OM), develop your own financial analysis and business plan, review various reports, and get to know the market. 

In short, you became an expert on the property at that moment of time.

Don’t let this knowledge waste away!!

Take the time to organize and summarize it in a way you can easily reference when you need it.

I highly recommend you do this within the first week of owning the property. The acquisition information will be fresh in your mind. Block out 4-6 hours on your calendar. Go somewhere without distractions. Organize everything at once.

If you already own a property without a system, it is not too late. Start now. 

Let’s get into the details of the system by starting with the documents.

Creating Your Digital Folder of Documents

Almost everything you review and receive will be digital. You may print some of the information, but it will have likely been created in digital format.

Your task is to organize it into a logical folder system that you can reference (and add to) in the multiple years you will own the property.

Here’s a property folder structure that works for me:

• 01-Business Plan: 

  • Documents: business plan, underwriting model (financial analysis/projection).

• 02-Acquisition

  • Documents: OM, due diligence reports, closing documents, title policy.

• 03-Legal Ownership

  • Documents: LLC or other legal ownership entity, grant deed.

• 04-Loan

  • Documents: loan documents as discussed in Debt: An Amazing Tool with Strings Attached. 

• 05-Equity (if you have outside investors or a partner)

  • Documents: partnership/JV agreement, investor communication.

• 06-Plans & Pics

  • Documents: site plans, floor plans, ALTA survey, pictures.

• 07-Leases

  • Documents: leases, form lease agreement (i.e. your standard lease template), lease proposals.

• 08-Marketing

  • Documents: broker listing agreement, marketing materials, marketing reports.

• 09-CapEx & R&M

  • Documents: folder for each job with proposal, contract, invoices, costs, etc.

• 10-Income Statements

  • Documents: Financial reports organized by date for ease of reference.

• 11-Property Management

  • Documents: Property management agreement, tenant correspondence.

• 12-Insurance

  • Documents: insurance policy and certificates, folder for each claim (if any), insurance broker related documents.

• 13-Property Tax

  • Documents: property tax bills organized by date, property tax appeal info (if any).

• 14-Appraisals & Sale Comps

  • Documents: all appraisals organized by date, any relevant sale comparables.

• 15-Zoning City

  • Documents: zoning report / information, parking counts, city correspondence.

You can do this in dropbox, iCloud, your c-drive…it really doesn’t matter what format you use. However, I strongly encourage you to use something that (a) is backed up to the cloud and (b) can be accessed from multiple devices including your phone. Example tools:

• Cloud storage: Dropbox, Google Drive, iCloud, OneDrive.

• Note-taking: Evernote, Notion, OneNote (for digital notebook alternative).

• Spreadsheet: Excel, Google Sheets.

• Photo organization: Google Photos, iCloud Photos.

Important note: Your property documents likely contain sensitive information (financial details, tenant data, legal agreements). Ensure your cloud storage has strong password protection and two-factor authentication.

You will be referencing and adding to documents all the time. This structure gives you a place for everything. As you buy more properties, mirror the folder structure so it is easy to navigate from property to property.

Let’s move on to pictures.

Photo Library

Photos are critical to help you make decisions from afar. Even if you live in the same city as the property, it is helpful to be able to get a visual of what you are focusing on - anywhere, anytime.

Enter your phone.

Here are the steps I recommend.

1. Take pictures from every corner of the property, both exterior and interior. 

2. Put the pictures in a dedicated photo folder on your phone.

3. If you want to go to the next level, organize and label these photos in a powerpoint or other digital file. Example: you might label one as “view from northwest corner”.

These photos will be so helpful to you as you operate the property day to day. Not only will it reinforce your property knowledge as you build the photo library, but it will also save you many avoidable trips to the property. You can use your time to focus on making good decisions.

Let’s move on to the two critical documents you should create.

Document #1: Master Excel File

Even if you are not a “numbers” person, I encourage you to create a master excel file. I like to name mine “[Property Name]-Key Info-[year].xlsx”. At the end of each year I create a new one and archive the old one.

Here’s what is in the excel file. Each bullet represents a separate sheet.

• Notebook Cover: we will get into this later.

• Cash Flow: a monthly cash flow that includes the property performance and a running cash balance so I know what distributions I can make. Here’s my update protocol:

  • Monthly: update current month information based on report prepared by the property manager.

  • Quarterly: when making investor distributions.

  • As Needed: when forecasting future capex and leasing assumptions.

• Rent Roll: list of units / suites at a property with information on square footage, tenants, rent, lease start, lease end, and many other pieces of information. I update the rent roll when a lease is signed or modified.

• Vendors: list of contact information for vendors I use for the property. Put the ones you use most regularly in your contacts on your phone.

• Property Tax: list of property tax billing details by year.

This is the file I go into the most for my property. 

Let’s move on to the second critical document.

Document #2: Site Plan

Having an aerial view of the property will be very helpful. This can be as simple as a snapshot from Google Maps (aerial view) with labels of key information. Here’s a screenshot of one I made in powerpoint. 

Image: Example Site Plan with Notes

I am not looking for perfection on this. I am looking for something that I can reference easily.

Now let’s move on to what I believe is the most critical piece: your property notebook.

Your Property Notebook

A notebook you say? Why can’t it all be digital?

You can go digital only, but I don’t recommend it.

Having spent 25+ years organizing property and other information, I believe having a single purpose notebook sets you up for success.

A “single purpose notebook” is just as it sounds. One notebook. One purpose.

In this case the “purpose” is your property. Once you own a portfolio of properties, you will probably want to expand and restructure it to include the whole portfolio but for now let’s stick with one property.

You can do this with a three-ring binder, but I really like the Circa system by Levenger. It is like a spiral bound notebook that you can have blank sheets of paper for note taking but also add print outs of digital files. The key is to have multiple divider tabs for the areas of the business you focus on regularly.

Here’s the structure I use for a property:

• Cover Page: this is the “Notebook Cover” sheet from the master excel file. It is my working page of the most important information about the property. It includes:

  • Financial Snapshot: an abbreviated cash flow that includes eight lines - revenue, operating expenses, NOI, capex, leasing costs, debt service, net income, investor distributions. I have one column for previous year and one for current year.

  • Capex: list of the major building systems with anticipated (or most recent) replacement year and comments. These could include roof, exterior painting, asphalt, and any other part of the building I am focused on.

  • Loan Info: loan amount, interest rate, loan expiration date, and any operational items the lender needs to approve (see Debt: An Amazing Tool with Strings Attached for a refresher).

  • Key Initiatives: this is the most important. What am I planning to do to add value the property? It should include what, when, and the anticipated cost.

  • Action Items: this is a blank area I handwrite in as needed. I like a pencil so I can add and erase as I get things done. Example: call broker about leasing status or get bids to replace the roof.

  • Waiting: same concept as “action items” but to keep track of what someone else said they would do for my property. Example: broker - update on tenant prospect or PM - update on electrical repair.

• Tab #1: Notes: blank pages I can take note on while talking to someone or working through an issue.

• Tab #2: Projects: key documents related to value add or other projects I am working on. For example, it might include a rendering and cost estimate of an exterior renovation.

• Tab #3: Leasing: any leasing and marketing activity. It might include the leasing brochure, market reports, and notes on potential tenants.

• Tab #4: PM: this is a separate section for the key vendor list and any ongoing issues I am working with the property management team on.

• Tab #5: Building: this is where I put the site plan and other important building information in.

Tabs 2-5 change over time depending on what I am working on. When I was replacing the roof and skylights, I had a dedicated tab for this. Once complete, I repurpose the tab.

The most important aspects of the notebook system are:

1. I have a portable system I can take with me to the property, office, home, anywhere.

2. I have one place that I take notes and reference key property information.

3. It is dynamic. The structure changes with my changing focus areas.

4. It is a visual reminder that I need to stay focused on the property. 

So what do you do with these techniques?

Making Them Your Own

The key to any organizational system is to make it your own. 

Do you like to have a folder for every item? Then make a detailed folder system.

Are you a minimalist? Then have a minimal number of folders.

Are you an iPad only person? Then create a system that leverages your iPad.

It doesn’t matter how you do it. What matters is that you use a system.

Don’t wing it by trying to remember everything.

This system works for me. In a year I will have probably modified it a bit.

Find a system that works for you and make it happen. You will be making property decisions all the time. You want the information at your fingertips.

This is why having a system is so important.

New Series Kickoff: Owning & Managing Real Estate

Starting with your complete glossary of real estate terms, from AM to WALT

We have covered a lot so far. I like to think of it as three main subject areas:

1. Introduction to Real Estate Investing

2. Investment Fundamentals

3. The Acquisition Process

Today kicks off the next series of topics: 

Owning and Managing Real Estate

We will be covering the following over the coming weeks:

• Understanding the terms (aka the jargon and acronyms)

• Getting organized for success

• Developing your leadership skills

• Day to day activities

• Reading reports

• Property management and accounting

  • Contracts 101: what’s in a vendor service agreement

• Insurance and property taxes

• Leasing

  • Contracts 101: what’s in a broker listing agreement

  • Contracts 101: what’s in a lease agreement

• Construction

  • Contracts 101: what’s in a construction agreement

• Investor and lender issues

• Ways to add value to your property

• Executing your business plan

• What to do next

My core background is in real estate operations. It is a dynamic and exciting aspect of the business, filled with both opportunities and challenges. 

I will be your step-by-step guide.

This week we will focus on understanding the terms specific to real estate. 

Think of this as your real estate glossary. 

So grab your favorite beverage. 

Sit back and relax.

Let’s dig in.

Why Are There Commercial Real Estate Specific Terms?

Those of you that have worked in various industries, or even followed a particular sport, know that each domain develops their own acronyms and jargon. This is because:

• It is often more efficient to use an acronym.

• Each domain has its own unique specifics.

Commercial real estate is no exception. 

If you work for a company, you will even find that each company has their own additional layer of terms.

Don't worry. You will figure it out. 

The key is to pay attention, be patient, and ask questions. Asking questions is not a sign of ignorance. It is a sign of being a learner. This is a good thing.

The list that follows is broken into sections. You can also find it on my downloads page. Keep it handy for future reference.

Teams & Departments

This is a list of the team that is most involved in property operations.

• AM (Asset Manager or Asset Management): the team or team member that oversees and drives theproperty business plan. Think of them as the chief operating officer for a property or collection of properties. Example usage: 'I need to run this by the AM before we commit to the capital expense.'"

• PM (Property Manager or Property Management): the team or team member that oversees the day to day operations including tenant and vendor interaction. They are in the “front line”, whereas the AM team is a step removed. Example usage: 'The PM will take lead on communicating that to the tenants.'"

• CM (Construction Manager or Construction Management): the team or team member that oversees the construction. The PM team often does some construction, but the CM team handles the bigger and/or more complicated jobs. Example usage: 'The CM should handle the roof replacement as it is a more complicated job.'"

• PA (Property Accountant or Property Accounting): the team or team member that oversees the accounting and reporting. 

• Leasing: the team or team member that oversees the leasing of the property, often working with leasing brokers. 

• Broker: the team or team member that provides 3rd party services for a commission. There are brokers that specialize in leasing, property sales, and even insurance. 

• Landlord aka Lessor: the property owner (i.e. you).

• Tenant or Lessee: the tenant.

Acquisitions

These are the terms that will come up during an acquisition of a property.

• OM (Offering Memorandum): a detailed summary of the property and forecasted financial performance prepared by the broker selling the property. Potential buyers use this to create an initial understanding of the property and its value.

• Investment Memorandum: a detailed summary of the property and forecasted financial performance prepared by the buyer of the property (i.e. you). Think of this as the OM with your updated financial projections and business plan.

• Base Case Underwriting Model: the multi-year financial projection prepared by the buyer of the property (i.e. you). 

• PSA (Purchase & Sale Agreement): we covered this in Demystifying Real Estate Purchase Agreements. It is the legal document between a property buyer and seller.

• DD (Due Diligence): we covered this in Due Diligence: Your Property Investigation Checklist. This is the investigation done by the buyer of a property before they go non-refundable with their deposit.

• Go Hard or Non-Refundable: we covered this in Due Diligence: Your Property Investigation Checklist. This is when buyer completes the due diligence, waives contingencies, and “goes hard” with their deposit.

• PCA (Property Condition Assessment): we covered this in Due Diligence: Your Property Investigation Checklist. A 3rd party summary of the physical conditionof the property. It is sometimes referred to as the “engineering report”.

• Phase I or ESA (Environmental Site Assessment): we covered this in Due Diligence: Your Property Investigation Checklist. A 3rd party summary of the environmentalcondition of the property.

• Survey or ALTA Survey: we covered this in Due Diligence: Your Property Investigation Checklist. A 3rd party summary of the title conditions of the property.

Reporting

The reports will be your guide to how the property is performing. 

• Rent Roll: the list of units / suites at a property with information on square footage, tenants, rent, lease start, lease end, and many other pieces of information. Each company has their own version of the rent roll.

• % Leased:leased square feet divided by total square feet. Example: “the property is 95% leased”. 

• % Occupied:occupied square feet divided by total square feet. Example: “the property is 95% leased, but only 90% occupied because one of the tenants moved out before their lease expired”. 

• WALT (weighted average lease term): Average lease term based on lease length weighted by tenant square feet. Bigger tenants have more impact on the WALT than smaller tenants.

• Rollover Retention Ratio: percentage of tenants (by square feet leased) whose lease expired and renewed. This is expressed for a specific time (ex. one year) and calculated based on square footage. Example: “the rollover retention ratio is 65% for the last year”. 

• % Above (or Below) Market: comparison of rent for in place leases vs. market rent. Example: “market rents have gone up so much that in place rents are now 30% below market”. 

• A/R (Accounts Receivable): we introduced this in Due Diligence: Your Property Investigation Checklist. This shows which tenants have underpaid (or overpaid) their rent and other charges.

• Tenant Ledger: we introduced this in Due Diligence: Your Property Investigation Checklist. This shows all the charges and payments associated with each tenant. The A/R report is a moment in time. The tenant ledger is the full history.

• General Ledger: this shows the charges and payments (debits and credits) associated with ALL property activity, not just the tenants. Example: it includes expenses charged and paid.

• NOI (Net Operating Income): we went through most of this in Due Diligence: Your Property Investigation Checklist. NOI = revenue minus operating expenses. NOI is used to value properties under the cap rate methodology as discussed in Cap Rates: The Simple Math of Real Estate Investing. A couple more specifics:

  • Gross Potential Rent: if all units were leased at market.

  • EGI (Effective Gross Income): all the revenue for a property beyond just rent but subtracting vacancy and collection losses.

  • Operating Expenses: day to day expenses to operate the property such as utilities, maintenance, repairs, insurance, property taxes, and property management fees. It does not include capital expenses, tenant improvements, commissions, or debt service. These are “below” the NOI and factored into the calculation of net income.

• Net Income: NOI minus capital expenses, tenant improvements, commissions, and debt service.

• Gross Receipts: the rents actually collected for a given period (ex. one month). This is typically used for the calculation of the property management fee. Example: $10,000 gross receipts x 5% fee = $500 property management fee that month.

• Income Statement: this shows the revenue, expenses, net operating income (NOI), and other activity, usually according to some chosen accounting rules like GAAP (generally accepted accounting principles). These are usually presented in a monthly format with an annual total.

• Cash Flow Statement: similar to an income statement, but this will show the actual cash activity. You may care more about the cash flow statement if you are an investor who wants regular cash distributions from your property.

• Budget: whereas income statements and cash flow statements show the actualactivity, a budget shows the projected activity. It is usually done 12-24 months at a time.

• Cap Rate and Return on Costs: I did a whole newsletter on this Cap Rates: The Simple Math of Real Estate Investing. If you are at all in doubt, I suggest revisiting it.

• Cash on Cash Return: annual distribution to investors divided by original equity. Example: $10,000 distribution divided by $100,000 original equity investment = 10% cash on cash return.

• Equity Multiple: total cash returns from an investment divided by original equity. Example: $200,000 total distributions (annual plus proceeds from sale) divided by $100,000 original equity investment = 2.0 equity multiple.

• IRR (Internal Rate of Return): time weighted calculation of all distributions to an investor, including from the sale, relative to the original equity investment. Ex. 18% IRR over the 5 year hold period.

• Hold Period: how long the investor owns the property, from acquisition date to sale date. Ex. 5 years.

• FMV (Fair Market Value): what the property could sell for today. Ex. $200,000.

• Cost Basis: total equity invested plus the loan balance. Ex. $100,000.

• Tax Basis: for income taxes based on tax rules. Remember: depreciation reduces your tax basis. Ex. $85,000.

• PSF (Per Square Foot): usually a dollar amount divided by the square footage. Ex. “I bought the property for $100 psf” or “the lease rate is $1.25 psf per month”.

• Capex: Capital improvement costs. Examples: roof replacement, tenant improvements, asphalt replacements, building painting.

Leasing

Leasing is a critical function of real estate operations. Here are the key terms to know.

• Exclusive Listing Agreement: agreement between a landlord and listing broker agreeing that (a) broker is the exclusive agent for the leasing (not necessarily the sale) of the property, (b) the fee that the listing and procuring broker will be paid when they lease the space and (c) the duration of the agreement.

• Listing Broker: broker representing the building owner aka landlord in a transaction. The listing broker markets the property on behalf of the owner.

• Procuring Broker (aka Tenant Rep Broker): broker representing the tenant or buyer in a transaction.

• MLR (Make Lease Ready) aka White Boxing: proactively performing tenant improvements to a space before there is a tenant. This helps with marketing.

• LOI (Letter of Intent): a typically non-binding agreement between owner and prospective tenant that outlines the key terms of the transaction such as lease rate, annual increases, duration of the lease, tenant improvements, options, etc.

• Lease: a binding agreement, typically 15 pages with 20+ pages of exhibits documenting in detail the terms of the lease. For industrial, office, and retail leases, this is typically prepared and negotiated with the assistance of legal counsel.

• LC (lease commissions): commission on the total base rent the tenant pays during the term of the lease (before any renewal term). Typically paid 50% upon lease execution and 50% upon tenant occupancy.

• TI (tenant improvements): one time cost at start of lease, often expressed as a certain amount psf.

• Starting Rate: initial lease rate over the term of the lease.

• Effective Rate: average lease rate over the term of the lease.

• Lease types relative to expense pass through under a lease:

  • NNN (Triple Net): typically for industrial and retail; 100% pass through of property operating expenses such as common area maintenance, property tax and insurance.

  • Base Year/Stop (typically for office): 100% pass through of expense increases over the year in which the tenant first occupied the space (e.g., at the end of the first year of the lease/base year, the actual operating expenses are calculated and become the tenant’s base year; at the end of consecutive years, the tenant will pay all amounts above the established base year amount) .

  • Gross: no pass through of expenses to the tenant. Typical for residential rentals.

  • Modified Gross: pass through of some but not all expenses directly related to the leased premises.

• MLA (Market Leasing Assumptions): key lease terms from the underwriting or budget; include starting lease rate, growth in lease rate per year, free rent, tenant improvements, make lease ready costs, commissions and lease term.

• Loss to Lease: gap between today’s market asking rents and the average in-place rent.

• Lease Trade Out: difference, usually in a %, between the previous lease rate and the new lease rate at time of renewal or replacement tenant.

• Stacking Plan: visual summary of where tenants are located in a property, usually color coded by lease expiration date.

• Rentable Square Feet: the square footage of the leased premises for which rent is charged; Includes a portion of the building’s shared/common area space. Different from…

  • Usable Square Feet: the square feet of the leased premises exclusively controlled by the tenant as opposed to part of the common area. Both used to calculate…

  • Load factor: percent increase of rentable square footage over usable square footage minus 100%. Example: “the building has a 15% load factor”.

Debt

We covered a lot of these in Debt: An Amazing Tool with Strings Attached.

• Term: the length of the loan, typically expressed in years. (e.g. “3+1+1” is a three year loan with two one year extensions.)

• Fixed Rate Loan: interest rate is fixed for the entire loan. Fixed rate loans tend to be longer than floating rate loans.

• Floating Rate Loan: interest rate changes at a fixed frequency (ex. monthly) in accordance with an index.

• Index: a specific measure that changes over time.

  • 10-Year Treasury Rate: example of an index. Comes in other durations like 1 and 5 years. Reflects the “risk free” rate because tied to the US government. 4.34% as of this writing. 3.38% as of March 2023.

  • SOFR (Secured Overnight Financing Rate): example of an index often used for floating rate loans. Replaced the index LIBOR. 3.64% as of this writing. 0.30% as of March 2022.

• Fed Funds Rate: reflects the costs banks charge each other to borrow funds overnight. When people say “the fed increased interest rates”, this is what they are referring to. The federal government uses this to control inflation (increase) and stimulate the economy (decrease). 3.64% as of this writing. 0.25% as of March 2022.

• Basis Points or “bps”: a portion of a percentage point where 100 bps is equal to 1.00%; often used in relation to the interest rate on a loan (e.g., “250 bps over SOFR” means 2.50% over SOFR).

• Point: 100 bps or 1%. (e.g., “The lender is going to charge a point origination fee”.)

• Spread: the interest rate above an index. Examples:

  • SOFR + 2.50% = 2.50% above the SOFR rate of 4.80% = 7.30% interest rate (floating rate).

  • 5-Year Treasury + 1.90% = 1.90% above the treasury rate of 3.30% = 5.20% interest rate (fixed rate).

• Origination Fee: fee charged by a lender to give the loan.

• Interest Only Loan: a loan without amortization (repayment of principal each month).

• Amortizing Loan: a loan with amortization (repayment of principal each month).

• Hedge: typically a cap or a swap.

  • Cap: an agreement between a borrower and a 3rd party to establish the maximum amount a floating rate index (SOFR) can increase. (e.g. a 6.00% cap on SOFR for 2 years). The borrower pays a one-time fee to the 3rd party providing the cap.

  • Swap: an agreement between a borrower and a 3rd party to convert a floating rate index (SOFR) to a fixed rate for a specific period of time. Money is exchanged between parties whenever the index adjusts. Both parties are making a bet on whether interest rates will increase or decrease. A borrower may want a swap to reduce uncertainty.

Equity and Joint Ventures

We haven’t gotten to equity and joint ventures yet, but here is a preview for some of the terms we will cover.

• GP (General Partner) or Operator: company or individual that operates the property day to day.

• LP (Limited Partner) or Equity / Money Partner: company or individual that provides money to buy the property. They could have many or no approval rights.

• Major Decisions Rights: rights the LP has to approve certain decisions. 

• JV (Joint Venture) or LLC (Limited Liability Company) Agreement: agreement between GP and LP that details all the terms under which the partners will operate. 

• SPE (Special Purpose Entity): legal entity, typically a limited liability company (aka LLC) that the partners are members of through which they own the property. They use this to shield their liability exposure to just this investment.

• Entity Organizational Chart: boxes and arrows showing the legal ownership structure.

• Signature Block: legal structure of entities authorized to sign on behalf of the legal entity.

• Fees: fees paid by the property to the operator for certain functions. These are negotiated between the GP and LP. These fees and functions are in addition to those performed by a broker. All investors (both GP and LP) pay the fees. Examples are shown in the table below.

Table: Example Fees Charged by a GP

• Promote: money that the GP earns if the investment does very well. Example: GP invests 5% ($50K) of the $1M equity required. LP invests $950K. GP gets 20% of all proceeds above an 8% IRR.

What to Make of All These Terms

Is your head spinning yet?!

You just read a glossary of real estate terms. Well done!

Will there be a test? 

No.

But…

You will come across many of these as you invest and work in the commercial real estate industry. You will remember some and forget others. 

Just know that this set of information is here for you when you need it. Download an editable file of the glossary on the downloads page.

Add to it as you discover new terms.

Remember that the key is to pay attention, be patient, and ask questions. Asking questions is not a sign of ignorance. It is a sign of being a learner. This is a good thing.

Always be learning!