Common Cap Rate Mistakes

The capitalization rate, or cap rate, provides investors and landlords with valuable insight regarding the specifics of commercial real estate investments. If interpreted properly, the cap rate can be used by investors to compare and contrast similar investment opportunities, and landlords can include it in their decision as to whether or not to sell a commercial property. There are several instances in which cap rate can be leveraged as an effective metric, but it is often misinterpreted, misunderstood or misused. Below are the most common mistakes associated with cap rate in terms of commercial real estate investments.     

Mistakes Calculating Cap Rate

Though the cap rate formula is straightforward on the surface, its very few components, net operating income (NOI) and overall property price, are comprised of complex elements. A cap rate is often a projection of future expectations, and inaccurate NOI estimates will significantly affect the resulting percentage.

The factors involved in calculating NOI include complicated and ambiguous terms such as expected vacancy or alternate income. These pieces are influenced by an overwhelmingly large pool of external forces and can fluctuate frequently and unexpectedly. It’s imperative to precisely calculate each step of the NOI formula before determining a property’s cap rate.  

Misunderstanding Limits of Cap Rate

Cap rate should never be used as the sole deciding metric for an investment property. Countless other factors must be considered before choosing to buy or sell commercial real estate. Cap rate alone is not an effective assessment for short-term investments as it does not account for the value of potential improvements or appreciation.

Additionally, cap rate on its own does not consider the time value of money, which makes it difficult to apply to long-term investments. A cap rate serves merely as a glimpse at the one-year expected rate of return based on previous averages and should not be used for more than it’s intended.

Furthermore, cap rates are limited indicators, as they can be considered high in one market, and low in another. Location, supply and demand, types of property, types of leases and other factors all have a significant impact on the cap rate value and worth.         

Misinterpreting a High or Low Cap Rate

One of the most common mistakes investors make when interpreting cap rate is assuming that a high cap signifies a better investment. Though a high cap rate does present the opportunity for higher returns and a lower overall purchase price, it also indicates a higher risk. A property with a high cap rate may be in a less desirable location and have a higher vacancy and older amenities, whereas a property with a low cap rate is often well-managed, up to date and in a popular neighborhood with hardly any vacancies. As a general rule, a high cap rate signifies higher risk and a low cap rate signifies lower risk.

Interested in commercial real estate investment? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to find out more about our current listings!


How to Calculate a Net Lease

Triple net leases, or NNN leases, are common commercial real estate contracts for those organizations and companies seeking rental spaces to grow their business and provide steady financial growth with low-risk factors. A triple net lease transfers all of the additional expenses associated with owning and operating the property from the landlord to the tenant. These expenses include the net real estate property taxes, net building insurance and net property maintenance. Because the tenant assumes these additional financial responsibilities, triple net leases generally have the lowest rental rates. How does the landlord determine these rates and expenses? Here is how to calculate a net lease.

Expenses and Payments Associated with Triple Net Leases

Triple net leases require the tenant to pay all three of the additional expenses associated with the property, while single and double net leases only require the tenant to pay a portion of these fees. The landlord may prefer the tenant to make these payments directly each month or to cover the costs of these expenses through adjustments made at the anniversary of the leasing term–whether the lease is terminated or renewed. As property taxes fluctuate annually, the landlord should provide the tenant with a property tax statement and the portion of taxes the tenant is responsible for when renting in a multi-tenant building.

Calculating a Triple Net Lease

Triple net leases are calculated by adding the yearly taxes on the property and the insurance for the space together and dividing that amount by the building total rental square footage. The process of calculating a triple net lease is simplified when an entire building is leased to one tenant.

However, in multi-tenant buildings, it’s important to take account of the maintenance and upkeep of common areas within the space. These common areas include spaces such as lobbies, courtyards, communal bathrooms and hallways. Determine the yearly cost of maintaining and operating these common areas and divide that total by the amount of rental square footage within the building. Then, take this number and add the total amount for property taxes, insurance, maintenance expenses and common area expenses and divide the total by 12. This number is the monthly cost. Add this monthly cost total to the monthly rental rate per square footage and multiply this number by the number of square feet each tenant leases to determine the triple net lease amount for each tenant in your building.

Understanding how rental expenses are charged within different leases is a crucial component of responsibly renting commercial real estate spaces. Interested in commercial real estate investment? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to find out more about our current listings!


What is a Percentage Lease?

When renting commercial real estate spaces, it’s important to understand the different types of leases to ensure the most practical and beneficial contract between the landlord and the tenant. Of these different lease types, net leases and gross leases are the most commonly known. However, percentage leases are also widely used in commercial real estate because of the beneficial properties they offer both the tenant and the landlord. Find out what you need to know about percentage leases.

What are the features of a percentage lease?

A percentage lease is a contract between a landlord and tenant where the tenant agrees to pay a predetermined rental rate in addition to a percentage of the sales earned while conducting business on the rental property. Because of these provisions, this type of lease is used exclusively in commercial real estate–particularly in retail mall outlets and companies with high sale volumes.

How is a percentage lease calculated?

Percentage leases have a predetermined base rental rate. The percentage of sales the landlord receives is determined once a base amount of gross sales is met. This base amount is called the breakpoint. Two different types of breakpoints exist to accommodate different calculations of a percentage lease.

An artificial breakpoint is a set dollar amount of sales both the landlord and the tenant agree on. This means a percentage of sales that exceed the set dollar breakpoint amount is paid to the landlord in percentage rent. In contrast, a natural breakpoint is when the base rent is divided by the established percentage to determine the breakpoint amount. This calculation ensures that a tenant only pays a percentage expense on the sales that exceed the amount required to pay the predetermined rental rate.

What are the benefits of a percentage lease?

Some tenants may be attracted to the terms of a percentage lease because these contracts typically have a lower fixed rental cost each month. In addition, the percentage lease is commonly used in multi-tenant buildings, which means these shopping centers or retail malls are a natural draw to other businesses in the building and can benefit tenants with both large and smaller sales.  

Percentage leases can also benefit the property owner because they have the ability to choose the type of businesses and companies that are placed within the retail space. Accordingly, strategic leasing can attract more customers to the space, which gives the landlord the opportunity to negotiate a percentage of sales.

Interested in commercial real estate investment? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to find out more about our current listings!


What is a Double Net Lease?

A net lease is a popular form of a commercial real estate lease where the tenant assumes certain financial responsibilities in addition to the pre-determined rental rate. Different variations of net leases exist to accommodate specific building expenses–single, double and triple net leases. The biggest difference between these net lease variations is how the additional expenses are divided between the landlord and the tenant. Here is everything you should know about double net leases.

What are the features of a double net lease?

In a double net lease, the tenant agrees to pay the property taxes and insurance fees in addition to the pre-determined rental rate. A double net lease gives the tenant more financial responsibility than a single net lease, but also requires the landlord to handle repairs and pay any necessary maintenance fees. In a multi-tenant building, the property taxes and premiums for property insurance can be split on a pro rata basis between the other tenants renting within the building.

What are the advantages of a double net lease?

Landlords may use a double net lease because it shifts most of the financial responsibility, and thus much of the organizational pressure and stress that comes with managing and paying multiple property expenses. However, as landlords remain responsible for the upkeep and maintenance of the property, they still assume a certain level of control over how the space is used and maintained. Additionally, tenants may opt for a double net lease because these contracts typically have a lower rental rate than a single net lease and less financial management than a triple net lease.

What are the considerations of a double net lease?

While a double net lease limits the financial risk for landlords, property taxes and insurance fees typically still pass through them to ensure these important expenses are paid correctly and in a timely manner. Accordingly, this can complicate this process instead of simplifying it. Additionally, tenants need to consider the property taxes and insurance fees and understand that the responsibility of these additional expenses may outweigh the lower rates in rent in some cases.

Interested in commercial real estate investment? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to find out more about our current listings!

 


What is a Pass Through Lease?

In the world of commercial real estate, leases primarily fall into one of two groups–a net lease or a gross lease. A gross lease is a contract that includes a predetermined rental rate regardless of the cost of additional property expenses. In contrast, a net lease, a popular form of commercial leases, requires the tenant to pay the rental rate in addition to a portion or all of the expenses associated with operating the property. Specific pass-through provisions can exist in commercial net leases to streamline this process. Here is everything you should know about leases containing pass-through components.

What is a pass-through lease?

A pass-through lease is a contract where specified operating expenses “pass through” from the landlord to the tenant. These additional expenses can include any combination of property taxes, insurance, maintenance, repairs and utilities. Pass-through leases can be found in both single-tenant and multi-tenant buildings. If one tenant is leasing the entire building, the additional financial responsibilities typically include the maintenance and care of the landscaping and exterior upkeep. In multi-tenant buildings, tenants only pay these additional expenses in proportion to their usage of them.

What does a pass-through lease mean for the tenant?

While a pass-through lease requires the tenant to assume more financial responsibility, it also allows the tenant to gain more freedom and control over operational costs that affect their business directly. Smart tenants know that the more financial control they have over the space their company operates in, the easier and more beneficial these expenses can be for their business. Accordingly, tenants can use the advantages of these pass-through provisions to leverage their business’s environment and rental space.

What does a pass-through lease mean for the landlord?

Pass-through leases relieve the landlord of a significant amount of financial and organizational responsibility when it comes to handling additional expenses and coordinating maintenance and repair services. Landlords generally prefer the pass-through leasing components to be as inclusive as possible because this allows the landlord to pass off almost every operating expense to the tenant.

Interested in commercial real estate investment? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to find out more about our current listings!


What is a Net Lease?

Commercial real estate leases fall primarily into two categories—either a net lease or a gross lease. The most common type of lease in commercial real estate is a net lease because it relieves landlords of serious financial responsibilities and gives tenants more control over how much they’re spending on certain services. But what exactly Is a net lease? Read on to find out everything you need to know about net leases in commercial real estate.

Features of a Net Lease

On top of the pre-established based rent, a net lease requires the tenant to assume responsibility for at least one, if not all, of the additional operating expenses associated with the property. Three different types of leases exist to determine which portion of these additional expenses are to be paid for by the tenant. A single net lease requires the tenant to pay both the rent and the property tax on the property, while a double net lease requires the tenant to pay the rent, the property taxes and property insurance for the space. A triple net lease requires the tenant to pay all of the expenses associated with the property, including the rent, property taxes, insurance, maintenance costs and repairs.

Advantages of a Net Lease

A net lease is a common type of lease in commercial real estate because it benefits both landlords and tenants. For landlords, it alleviates significant financial responsibilities of owning and operating the property. Net leases streamline the process of paying insurance and property taxes and make paying these expenses less complicated and stressful for the landlords. In addition, net leases give landlords a predictable source of income because they eliminate unexpected expenses and alleviate the financial responsibility of property taxes and insurance, which typically fluctuate over time.

Tenants experience significant benefits of net leases as well. Because tenants assume the responsibilities of additional expenses, net leases generally result in lower rental rates of the actual property. Additionally, net leases give tenants more property control because they are held accountable for at least a portion, if not all, of the property expenses. Accordingly, a considerable amount of property control is allotted to the tenant. Renting under a net lease gives tenants a closer experience of property-owning than a typical renter.

Considerations of a Net Lease

Net leases also can have some drawbacks if the building or property is not properly maintained and managed. For tenants, the maintenance costs might outweigh the lower cost in rent if there are constant major repairs. Likewise, most landlords prefer insurance and tax payments to pass through them to ensure the amount is correct and on time, which at times may complicate the process more than simplify it.

Interested in commercial real estate investment? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to find out more about our current listings!


The Difference Between Gross and Net Lease

Leases are not all the same. Different types of commercial leases exist to accommodate different types of businesses and properties. Leases vary based on the rent calculation method used to determine how the space will be paid for as well as the taxes, insurance and maintenance expenses. At the highest level, there are two different types of commercial leases based on the rent calculation method—a gross lease and a net lease. Read on to determine the difference between gross and net leases.

Gross Lease

A gross lease has a predetermined set rent regardless of how high or low other costs are for that month. In a gross lease, the landlord pays any and all of the additional expenses associated with owning, maintaining and using the property. These additional costs typically include expenses such as tax, insurance, utilities and maintenance repairs.

A gross lease is beneficial for both the tenant and the landlord. For tenants specifically, a gross lease makes budgeting each month much easier because the price and expenses of renting and using the space don’t fluctuate depending on the cost of use and repairs. Tenants pay a predetermined fixed rate every month, while the landlords assume complete responsibility for the building. Landlords may find a gross lease particularly beneficial if they plan on maintaining energy-efficient operations within the property. Since the tenant pays a fixed price every month, the tenant can subsidize or contribute to the cost of utilities.

Net Lease

A net lease is the opposite of a gross lease in terms of payment for utilities, taxes, repairs and any other additional expenses. In a net lease, the predetermined rent is typically lower and the additional costs aren’t included in that set rate. The tenant assumes responsibility for a portion or all of the utilities, repairs or other property expenses associated with the property. These additional costs can include property taxes, insurance, operations, maintenance, services, utilities and repairs. Different levels of net leases exist to clarify which of these expenses the tenant is responsible for paying.

Because tenants are responsible for a portion or all of the utilities in a net lease, they may be more motivated to conserve their utility use and end up paying less than they would in an all-encompassing gross lease. Additionally, with a net lease, tenants have more responsibility and, thus, more control under a net lease. On the other hand, landlords may prefer a net lease because of the reduced level of responsibility and cost they incur for  upkeep and maintenance of the property, depending on the agreed terms.

Understanding how rental expenses are charged within different leases is a crucial component of responsibly renting commercial real estate spaces. Interested in commercial real estate investment? Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to find out more about our current listings!


What are the Benefits of a Triple Net Lease?

When considering a triple net lease, or NNN lease, it is important to understand the parameters of the contract at hand. A triple net lease, unlike a single or double net lease, removes the responsibilities associated with the NNN lease property and transfers them directly to the tenant. The nature of a triple net lease allocates three especially significant financial responsibilities to the tenant, including net real estate property taxes, net building insurance and net property maintenance. The duration of a triple net lease extends anywhere from 10 to 15 years and involves set terms agreed upon by the investor and tenant on the rent cost and potential of rent increase over time. Triple net leases are ideal for those seeking real estate investments that provide steady financial growth with relatively low risk and the potential for possible capital appreciation of the property. Below are a few of the benefits that make them so appealing.

Simplicity

Triple net leases require low-maintenance upkeep that cannot be found in single and double net leases. The main responsibilities of taxes, maintenance and insurance are shifted to the tenant for a locked-in term of 10 to 15 years with the investor having little to no responsibilities to manage on a regular basis.

Consistency

The nature of a triple net lease is to have agreed upon terms for the duration of the lease with any set rent increases drafted in the contract. The purpose of this type of an agreement is to ensure that both parties have an awareness of the fiscal elements of the term with no unexpected alterations. The investor then benefits from a consistent and reliable stream of income while the tenant is guaranteed a known price for the duration of the term.

Low Maintenance

As with any property, NNN lease properties require management, maintenance and repairs. Triple net leases mean that fixing leaky faucets and scheduling lawn work are no longer a burden on the investor. Instead of having to micromanage these time-consuming and expensive responsibilities, a triple net lease property investor gets to allocate them to the property’s tenant.

No Surprise Expenses

A triple net lease releases all of the maintenance, repair, taxation and insurance concerns to the tenant, leaving the investor free of any unforeseen costs. Additionally, if the NNN lease property is sold, the investor has the ability to transfer his or her capital into a different triple net lease investment with no taxation thanks to a 1031 tax-deferred exchange.

Easily Maintained  Residual Value

A triple net lease generally extends over a 10- to 15-year term in which value is easily maintained with little risk. The steady nature of this long-term lease provides consistent income with minimal surprise and little to no upkeep on behalf of the investor.

Understanding how rental expenses are charged within different leases is a crucial component of responsibly renting commercial real estate spaces. Ground + Space is a leading commercial real estate brokerage firm that specializes in single-tenant and retail NNN investments. Contact us today to find out more about our current listings!