Real Estate Brokers’ Program

2. Real Estate Brokers’ Program COMMERCIAL REAL ESTATE Barbara Grodaes

3. Scope - Commercial Real Estate • Industry requiring warehousing, manufacturing, integrated office space and yard storage. • Businesses requiring merchandising or retail facilities as well as office space – included are those people seeking to buy or sell existing businesses. • Investors seeking an income and/or capital appreciation and/or tax benefits from money used to purchase real property.

4. Scope – Continued … • Industrial Real Estate (SIOR) Society of Industrial and Office REALTORS. • Leasing (more lease transactions completed than there are sales – office and retail being the most significant. • Property and Asset Management. • Business Brokerage (deals with the sale of ongoing businesses with or without real estate assets) – has securities law implications.

5. “Security” AB Securities Act The broad definition includes (plus stocks & bonds): • Investment contracts • Fractional interest in oil and gas properties • Interests in profit sharing arrangements • Evidence of indebtedness, and several other items • Condominium apartments, when sold in with a developer-sponsored rental pool or hotel operation • Interests in limited partnerships • Other interests if involving the three elements of an investment contract • Other interest in ownership entities involving profit sharing arrangements, but not profit sharing retirement plans.

6. Investment Contract • Critical test in any real estate transaction is the manner in which the property is marketed. Is the property alone offered, or it is offered with management or in an entity arrangement sufficient to constitute an investment contract? • Securities law will apply every time the 3 elements of an investment contract exist. They are: • Investment in a common enterprise. • Profit motive; and • Expectations that the profit would derive from the efforts of the seller (sponsor) or a third party.

7. Scope – Continued … • Investment – Investor is essentially buying an income. Sales cover the sale of income-producing projects to investors looking for 3 things: a good rate of return on capital investment, security of that rate of return and potential for investment to grow in value. Users simply look for property to house business and concerned with location. • Land Sales – Industrial Land Sales, Commercial Land Sales, Sale of Residential Subdivision Land to Developers or Builders and Design Build.

8. Investment • Purchase of a property with the expectation of future profit to maximize wealth. Obtain the highest return (income plus capital appreciation) over an extended period of time. • Influencing factors include (RALMY) Risk, Appreciation (inflation/deflation), Liquidity,(Marketability), Management, Yield. • Investment Considerations Comparison Chart (rating high, moderate or low) is used to show relationship of risk versus return.

9. Fixed Return vs. Variable Return • Fixed Return Investment means rate of return is established at the beginning of the investment and is committed for a specific period of time. • Variable Return Investment means rate of return varies according to the performance of the investment. • Remember, real estate generally is a variable return investment. • “How much additional risk is acceptable for a 1% increase in the expected rate of return?”

10. Real Estate Investment • Any real property bought with the intention to accumulate wealth or to gain a profit – the buyer’s intention for use of property rather than the actual nature of the property. • Single-family home as investment real estate is purchased with the intention of buying, holding and renting it for investment purposes and hoping it will increase in value. • Investors concerned primarily with a return of (and on) their investment through cash flow from operations and sale proceeds.

11. Amenity PropertiesCharacteristics • Amount of financing is based on the ability of the owner to generate income. • The market is primarily local. • Ownership is usually individual or corporate. • The property is usually owner-occupied. • The value is usually based on market and replacement costs (including land).

12. InvestmentPropertiesCharacteristics • The amount of financing based on the ability of the investment to produce income as well as owner’s credit worthiness. • Generally, the market is local except very large investments where market is national/ international. • Ownership rights are either fee simple (freehold) or leasehold and can be held individually, corporately, or through joint-venture or syndications. • The property usually leased to third-party tenants. • The value is based on investment value. The return is anticipated from operations and/or eventual sale.

13. Areas of Consideration • Return is usually commensurate with risk. • Potential Income Stream can affect the investor’s perception of risk, according to the following 3 characteristics of income: • Quantity of the net income (how much?) • Quality of the income (how good?) • Certainty of the net income (how long?) • Appreciation of both land and buildings. • Liquidity (readily convertible to cash) – Real Estate has limitations but has partial liquidity as owner can obtain a loan on property.

14. Consideration Areas, Continued … • Management involvement – degree can be controlled by nature of the investment. • Yield (result of the investment) varies. • Return OF is the return of the amount of money invested over the life of the investment. • Return ON is a return for the use of that capital over the life of the investment. • Leverage (use of borrowed funds to finance a portion of the cost). • Taxation (how the investment income is affected by all forms of taxation).

15. Investment Advantages • High degree of personal control. One ccan sell, redevelop, refinance, effect changes, obtain new tenants, etc. • Potential tax advantage. • Better than average after-tax retun on investment through operations, a retirement of debt (mortgage), and positive financing leverage. • Potential to increase the property value through change of use or physical upgrading.

16. Investment Disadvantages • There is risk – always a possibility of a downturn in income and value. • Limited liquidity – real estate may not be liquid because it can’t be disposed of quickly. Stocks are liquid. • Requires personal involvement – real estate ownership requires more personal attention and involvement partly because one can have more control. Don’t forget about property management for cost.

17. Elements of Investment • Real Estate Investment - package comprising land, buildings, equipment, financing/yield & sometimes management. • Land (valued by highest and best use) determined by location and zoning or land use designation. • Buildings (main producers of income) have a limited life. • Equipment usually has a shorter life. • Financing - value by itself can make or break a deal (low downpayment = higher price).

18. Types of Investors • Speculators – buy and hold property for resale. • Users – buy & retain property for business. • Investors – buy & retain property for income from operations and eventual sale (private or institutional). • Land developers – buy, subdivide, promote and sell on completion. • Builder developers – invest in land and construct buildings for resale. • Dealers(flippers) buy for turnover/profit.

19. Investors’ Behaviour • Prudent investor will prefer the investment with the following: • Smaller initial cash investment • Largest periodic cash flows • Largest proceeds from disposition • Earliest cash flow • Safest cash flow. • Primary motivation is to obtain the future cash flows the investments produce – “more is better than less”.

20. Responsibilities of Agent • Understand the investment objectives of the client. • Analyze properties that suit these objectives. • More businesslike and unemotional approach to sales is required. • Have a good knowledge of clients (financial needs, desires, tax position, present and expected income, etc., motivation and type). • Develop strong relationships with specialists to provide proficient service to your client.

21. Selling Investment Property • Buyers and Sellers are the decision-makers in investment real estate. • Industry members are facilitators for them in the investment decision-making process. • Agents act to support buyers/sellers by gathering and present information. • Cash flow (before and after tax) for annual income. • Sale proceeds is the amount of income generated by a sale.

22. Cash Flow Analysis • Annual Property Operating Data Form (APOD) provides a marketing tool describing income and financial data to develop an operating statement and to determine cash flow before taxes. • It is standardized and communicates with buyers in selling and supporting value and presents owner’s cash flow (before taxes) with existing/alternative financing. • You need to know what each line is used for and how it is used.

23. Cash Flow Analysis Formula • Effective Rental Income = Scheduled Rental Income – Vacancy & Credit Loss • Gross Operating Income = Effective Rental Income + Other Income • Net Operating Income = Gross Operating Income – Total Operating Costs • Cash Flow Before Taxes = Net Operating Income – Annual Debt Service.

24. Reconstructed Statement • Developing a Reconstruction Statement (proforma) allows the forecasting of the property’s cash flow before taxes under normal market conditions for the coming year. (Buyers are paying for future potential) • Aids present or potential owner in understanding the future investment potential of the property. • To develop, listing information (personal knowledge and research), brokerage files and interviews can be invaluable.

25. Investment Measures • Value is directly related to use. Market Value, Assessed Value, Reproduction Cost, and Value in Use - ways to determine value. • Time is money. Agent must be able to adequately forecast revenue and expenses (income streams). • Present day value can be put on a future benefit. • If you know income stream and desired return, through methods of discounting and compounding, you can arrive at a present day value on an investment.

26. Discounting/Compounding • Money has a ‘time value’. • Compounding is the amount a dollar will grow over a given number of periods at a given rate of interest, if the total investment including interest is left in the investment. • Discounting (reverse of compounding) is computing the value of a dollar to be received in the future at a given discount rate. • Not having money at hand is opportunity cost.

27. V = I V=Value R I=Net Operating Income R=Capitalization Rate R = I V This formula is used when an investor uses a capitalization rate I = R x V with the net operating annual income to determine the NOI maximum an investor can pay to achieve the value . Cap Rate Value Rate of Return Formulas

28. Formulas Continued … (ratios) • Gross Rent Multiplier .. GRM = Price / Scheduled Rental Income • Capitalization Rate or Yield Rate .. Capitalization Rate = NOI / Value • Cash-On-Cash Rate .. COC = Cash Flow Before Taxes (CFBT) / Initial Investment • After Tax Cash-On-Cash .. COCAT = CFAT / Initial Investment • Equity Return Rate (ERR) .. ERR = CFAT + Principal Payment +Change in Value / Initial Equity Investment

29. Financing Investments • Financing of real estate investments is generally based on the ability of the property to generate sufficient income to repay funds. Several variable items are significant: • Rate of interest on the loan. • Ratio of the loan amount to the value of the property. • Term of the loan or the period over which the loan is made and the method of amortization of the loan. • Ratio of annual debt service to net operating income or the coverage factor. • The higher the interest rate, the lower the ratio of the loan amount to the value of the property – safety of investment decreases.

30. Principles of Leveraging • Positive leverage – borrowing at interest rate below the overall rate of return. • Neutral leverage – borrowing at interest rate equal to the overall rate of return. • Negative leverage – borrowing at interest rate higher than the overall rate of return. • Loan-to-Value Ratio = Loan Amount / Property Value. • Annual Debt Service (ADS) – total principal and interest payments for year. • Debt Coverage Ratio (DCR) = NOI / ADS (DCR >1 if NOI is > than ADS)

31. Terms & Sources • 3 General Types typically available being: Interest-Only Loan, Fully Amortized Mortgage Loan, and Amortized Mortgage Loan With a Term. • Variety of sources including Institutional Lenders, Private Investors and sometimes by the seller of the property. • There are additional costs and expenses involved because of the financing and should be evaluated so that the investor can measure potential yield on amount invested.

32. Loan Application Process • Primary Application, Interim Submission, Final Submission (broad checklist). • Overview of the Project, Market Studies, Feasibility Study, Site Location, Geo-Technical Surveys, Plan for Building, Cost of Project, Management Plan, Ownership Information, Description of Loan Terms Requested, Appraisal, Real Property Report, Environmental Audits. • Consideration for submission to a lender in obtaining loan for investment property.

33. Environmental Audits • Three-Phased Approach • Sampling and/or Testing required in Phase II may include Sampling Plan, Analytical Plan and Health and Safety Plan and then reported in a Final Report. • Phase III is remedial action plan which may include Repair, Isolation, Encapsulation, Enclosure, Removal & Disposal, hopefully limiting a problem of Stigma – market-imposed penalty which affects property known to be/was contaminated. Stigma is intangible but decreases value of property because of the fear of future hazards.

34. Investor Considerations • Many elements critical to the financing structure of a real estate investment opportunity include: • Term of the Loan, Method of Payment, Default Conditions and Procedures, Insurance Required, Tax and Insurance Payment Required, Provincial Laws Under Which Leases Will Be Interpreted, Assignment of Rents, Exculpatory (hold-harmless) Provisions, Assumption and Assignment, Recourse. • Above list is not inclusive but will help the agent assist the investor in reviewing what is necessary.

35. Leasing • The field of leasing open to the commercial industry is literally unlimited. • The only alternative to leasing is ownership. • 3 Basic types are retail, industrial and office. • Lease is a contract between the lessor and lessee for a term. • Tenants receive the use and possession of the premises for which they pay rent to the landlord.

36. Types of Leases • Net Lease (net net lease or triple net lease) requires tenant to pay all ancillary expenses except structural repairs, landlord’s income taxes and the landlord’s debt servicing costs. • Gross Lease requires tenant to pay all-inclusive amount to the landlord. • Semi-Gross Lease requires landlord to assume specified portion of operating costs. • Percentage Rent Lease is a form of rental directly related to the tenant’s sales.

37. Elements of Valid Lease • Identity of the Parties (clearly described) • Description of the Leased Premises • Terms and Commencement Date • Description of Rent, Rent-Free Period • Percentage Rental • Use of Premises • Any Lease Schedules (plot or site plan, breakdown, legal description, building plan) • Quiet Enjoyment, Restrictions and infinite number of variations.

38. Trends • Power Centres (strip malls) • Big Box (no-frills warehouse-like) • Loft Condominiums (vacant warehouse-type space in urban centres to residential usage) • Hotelling (sharing office space) • Commercial Condominium (attractive and advantageous to owners which want to control costs or generate profit in the event real estate values increase). • Basics for success constant – personal ethics, people skills and good work habits.