Best wishes to everyone for a very happy, healthy, safe and prosperous New Year.
Beverly Hills Realty Advisors
Charlie Hoffer Fenning
Best wishes to everyone for a very happy, healthy, safe and prosperous New Year.
Beverly Hills Realty Advisors
Charlie Hoffer Fenning
Last spring, word came that a West Hollywood fixture, French Market Place, would close for a “renovation,” but our friends at Eater found that workers’ rumblings suggested a more permanent closure was on the horizon. Turns out, they were right. At a public meeting next month, prolific local developer Jason Illoulian of Faring Capital will present his company’s plans to redevelop French Market Place and an adjacent building that once housed the Voyeur and DBA clubs, reports WeHoville; Faring Capital bought the properties earlier this year. The gist is that the DBA building will stay and the French Market space will be replaced by a mid-rise mixed-user with space for restaurant, retail, and offices.
The Arts District, just east of downtown LA has become one of the hottest real estate markets in Los Angeles. About 30 years ago, artists who were being priced out of areas like Santa Monica, Silverlake and other artsy areas of LA found that the old factory lofts in the district were reasonably priced and would make good artists lofts. Now it is a trendy up and coming area. RENTV has produced a film of the area. If you have interest in this part of Los Angeles, spend a few minutes watching this video.
MINIMUM INVESTMENT AMOUNT STAYS AT $500,000
After much speculation and debate, the U.S. Congress has extended EB-5 U.S. Investor Visa Program until September 30, 2016. As recently as last Monday December 14, 2016, the draft legislation would have raised the minimum investment required in Targeted Employment Areas to $800,000 from the current $500,000 and also would have implemented a new $10,000 filing fee per investor but the draft fell apart last minute.
Thus, on December 15, 2016, Congressional leaders finalized the legislation and the current provisions the EB-5 program will continue as is without any changes.
While we would have liked to see some permanency to the EB-5 investor visa program with meaningful changes, this is certainly good news for investors that took the wait and see approach and that have been on the fence about investing for U.S. immigration purposes.
Commercial real estate jargon is second nature to practitioners, but it probably sounds like a foreign language to occupants who are negotiating their first lease or purchase.
This column is designed to provide a “one-stop glossary” for those terms most commonly used in “the trade.”
NNN: Also called “triple net,” this refers to the way property taxes, property insurance, and maintenance of the foundation roof and walls are paid by the tenant. Generally, these sums are paid as due and are “net” of the base rent – in addition to – but in some cases, the owner will collect a monthly estimate of the annual expenses in addition to base rent.
Modified Net: Similar to NNN but one or two of the “n’s” are included in the base rent.
Gross: Property taxes, property insurance, and maintenance of the foundation, roof and walls, and other maintenance of the property are included in the base rent. Gross lease rates are generally higher than NNN lease rates.
Industrial gross: Similar to “gross,” but in this case the tenant is generally responsible for some property maintenance in addition to base rent. These leases include a “base year.”
Modified gross or MG: Property taxes, maintenance of the foundation, roof and walls, property insurance, or other maintenance of the property are paid in addition to base rent.
Full service gross or FSG: This is generally an “office” term and refers to the gross expenses plus janitorial and utilities included in the base year. These leases have an “expense stop” and a “base year” for expenses.
Base year: Used in FSG, MG, and industrial gross leases, this is the first full year of the lease. The tenant pays increases in expenses over the base year.
Expense stop: Used in a FSG lease, the expenses of the base year (first full year of the lease) are calculated and the tenant pays increases above this “stop.”
Lessor: Landlord or property owner
Lessee: Tenant or entity that leases or rents the location
Master lessor: Property owner
CAM: Refers to common area maintenance and is generally in addition to base rent and commonly found in MG, or industrial gross leases
TIs: Tenant improvements
Bumps: Increases in the base rent that occur throughout the term of a lease
COLA: Cost of living adjustment
ROFR: The right of first refusal is a tenant’s right to buy the property in the event an acceptable offer (from another party) is received by the owner.
ROFO: The right of first offer is the tenant’s right to submit an offer in the event an owner decides to sell the property.
Option to renew: A tenant’s right to extend the term of the lease at pre-negotiated points.
Option to purchase: A tenant’s right to purchase the property at pre-negotiated points.
LOI: A letter of intent expresses, in a nonbinding fashion, the occupant’s desire to lease or purchase the property.
Due diligence: A period of time negotiated in a purchase and sale agreement for the purpose of studying the property to determine its suitability for financing, occupancy, title, etc.
Loan contingency: A period of time used for securing financing.
Prelim: A preliminary title report outlines matters of record – loans, ownership, recorded easements, liens, etc.
Free rent: A period of a lease that is free.
Abated rent: In the event of tenant default, an owner can sue for repayment of abated rent.
NOI: Net operating income is the rent on the property, less any expenses stated on an annualized basis.
Cap rate: The NOI divided by the purchase price.
Congratulations! You now can speak commercial real estate.
Sam Zell was recently interviewed on Bloomberg’s “GO” TV. The beginning of the post are some selected quotes from the interview. I also provide a link to the full transcript.
Wednesday morning, Sam Zell, billionaire chairman at Equity Group Investments, spoke with Stephanie Ruhle and David Westin on Bloomberg’s “GO” TV.
Zell discussed a wide variety of topics from the Federal Reserve rate hike, the risk of a near-term recession, real estate, energy, and various foreign investment ideas. The interview was before the Fed announcement.
I put a spotlight on some interesting Zell ideas. Everything below is a selected quote except for two comments by me in braces.
It was a fascinating 2-hour interview. I stripped off the intro, the rest appears below. It’s well worth a read.
For the full transcript go here.
The Los Angeles City Council on Wednesday unanimously approved a developer’s plan to demolish Studio City’s landmark Sportsmen’s Lodge event center and replace it with a nearly 100,000-square-foot outdoor mall.
The proposed $60 million Sportsmen’s Landing retail center by Weintraub Real Estate Group of Malibu will feature five restaurants, 20 shops and a 40,000-square-foot Equinox fitness center.
The project will be not break ground immediately, however.
A lawsuit challenging previous planning commission approval of the project has been filed in Los Angeles Superior Court by the owners of the adjacent, 39,000-square-foot Sportsmen’s Lodge Hotel. In May, Ventura Blvd Associates LLC, a North Hollywood holding company representing the New York family that has owned the hotel since 1961, sued Weintraub and the city to stop the development.
Land use attorney Alicia B. Bartley, who represents Weintraub, said she expects the lawsuit to get a court date sometime in the first half of next year. L.A. Superior Court Judge John Torribio is hearing the case.
Earlier this year the project drew opposition from neighbors, who said they had not been adequately notified about the development and complained that it would worsen traffic and parking congestion in the neighborhood.
Read on for a deep dive into the net operating income, including step by step calculations, a full example, and common misconceptions.
Understanding net operating income (NOI) is essential when it comes to investment commercial real estate. Without a firm grasp of net operating income, commonly referred to as just “NOI”, it’s impossible to fully understand investment real estate transactions. In this article we’ll take a closer look at net operating income, discuss the components of NOI, and also clear up some common misconceptions.
Net operating income (NOI) is simply the annual income generated by an income-producing property after taking into account all income collected from operations, and deducting all expenses incurred from operations. The net operating income formula is as follows:
Net operating income is positive when operating income exceeds gross operating expenses, and negative when operating expenses exceed gross operating income. For the purposes of real estate analysis, NOI can either be based on historical financial statement data, or instead based on forward-looking estimates for future years (also known as a proforma).
Net operating income measures the ability of a property to produce an income stream from operation. Unlike the cash flow before tax (CFBT) figure calculated on a typical real estate proforma, the net operating income figure excludes any financing or tax costs incurred by the owner/investor. In other words, the net operating income is unique to the property, rather than the investor.
Before we go over each of the components of NOI, let’s first take a quick detour into the world of commercial real estate leases. Lease analysis is the first step in analyzing any income-producing property since it identifies both the main source of income as well as who pays for which expenses. As you can see from the net operating income formula above, understanding this is essential to calculating NOI.
While there are many industry terms for different real estate leases, such as the modified gross lease, triple net lease, or the full service lease, it’s important to understand that these terms all have various meanings depending on who you are talking to and which part of the world you are in. It’s critical to remember that you must read each individual lease in order to fully understand its structure.
At a high level, leases can be viewed on a spectrum of possible structures. On the one hand you have absolute gross leases where the owner pays all of the operating expenses related to the property. On the other hand you have absolute net leases, where the tenant is required to pay all operating expenses. Everything else falls in between these two extremes and is considered a negotiated or hybrid lease.
Calculating net operating income is relatively straightforward once you break out each of the individual components. The components of net operating income consist of potential rental income, vacancy and credit losses, other income, and operating expenses.
Potential Rental Income – Potential Rental Income, or just PRI, is the sum of all rents under the terms of each lease, assuming the property is 100% occupied. If the property is not 100% occupied, then a market based rent is used based on lease rates and terms of comparable properties.
Vacancy and Credit Losses – Vacancy and credit losses consist of income lost due to tenants vacating the property and/or tenants defaulting (not paying) their lease payments. For the purposes of calculating NOI, the vacancy factor can be calculated based on current lease expirations as well as market driven figures using comparable property vacancies.
Effective Rental Income – Effective rental income in the net operating income formula above is simply potential rental income less vacancy and credit losses. This is the amount of rental income that the owner can reasonably expect to collect.
Other Income – A property may also collect income other than rent derived from the space tenants occupy. This is classified as Other Income, and could include billboard/signage, parking, laundry, vending, etc.
Gross Operating Income – This is simply the total of all income generated from the property, after considering a reasonable vacancy and credit loss factor, as well as all other additional income generated by the property.
Operating Expenses – Operating expenses include all cash expenditures required to operate the property and command market rents. Common commercial real estate operating expenses include real estate and personal property taxes, property insurance, management fees (on or off-site), repairs and maintenance, utilities, and other miscellaneous expenses (accounting, legal, etc.).
Net Operating Income – As shown in the net operating income formula above, net operating income is the final result, which is simply gross operating income less operating expenses.
It’s also important to note that there are some expenses that are typically excluded from the net operating income figure.
Debt Service – Financing costs are specific to the owner/investor and as such are not included in calculating NOI.
Depreciation – Depreciation is not an actual cash outflow, but rather an accounting entry and therefore is not included in the NOI calculation.
Income Taxes – Since income taxes are specific to the owner/investor they are also excluded from the net operating income calculation.
Tenant Improvements – Tenant improvements, often abbreviated as just “TI”, include construction within a tenants usable space to make the space viable for the tenant’s specific use.
Leasing Commissions – Commissions are the fees paid to real estate agents/brokers involved in leasing the space.
Reserves for Replacement – Reserves are funds set aside for major future maintenance items, such as a roof replacement, or air conditioning repair. While the textbook definitions of NOI usually exclude reserves from the NOI calculation, in practice many analysts actually do include reserves for replacement in NOI. For example, most lenders will include reserves for replacement into the NOI calculation for determining debt service coverage and the maximum loan amount. This makes sense because lenders need to understand the ability of a property to service debt, which of course has to take into account required capital expenses to keep the property competitive in the marketplace. To see how much confusion and disagreement there is on this, just take a look at all of the various answers you see here on this LinkedIn thread.
Capital Expenditures – Capital expenditures are expenses that occur irregularly for major repairs and replacements, which are usually funded by a reserve for replacement. Note that capital expenditures are major repairs and replacements, such as replacing the HVAC system in a property. This does not include minor repairs and maintenance which are considered an operating expense, such as replacing doorknobs and lightbulbs.
While many of the above items are almost always excluded from net operating income, it’s important to remember that some are open to interpretation depending on the context. Keep this in mind when building your own proformas and when evaluating NOI calculations performed by others.
The following is an example of a typical real estate proforma that would be commonly used by lenders, investors, developers, brokers and appraisers. It breaks out how net operating income is calculated and presented for an example warehouse property.
As shown above the net operating income line follows the above NOI formula by deducting vacancy and credit loss from gross potential rental income, then subtracting out all operating expenses. Also, note that the debt service and leasing commission expenses are not included in the NOI calculation.
The much-publicized EB-5 “Immigrant Investor” program is set to expire this week, putting billions of dollars for commercial development at risk.
EB-5 gives visas to foreign investors who invest $500k in projects that create at least 10 American jobs. When the program first passed in 1990, it required investors to spend $1M but was later adjusted to allow investors to spend half in rural or high-unemployment areas, CNBC reports.
Its popularity has soared in recent years—sparked in large part by Chinese investors, who account for around 90% of all EB-5 visas granted—causing it to hit its visa limit of 10,000 per year in 2013 for the first time. (In 2007, only 700 visas were issued.)
The US Citizenship and Immigration Service estimates that EB-5 has brought in more than $2M and created more than 77,000 jobs, although those numbers are up for debate.
But some are concerned that more EB-5 money is being spent on projects in wealthy areas like New York City’s Hudson Yards or San Francisco’s Hunter’s Point Shipyard.
This week the Securities and Exchange Commission announced enforcement actions against lawyers charged with defrauding the system. A developer was also charged with using $6M from Chinese investors for a building conversion that never happened.
But on the flip side, EB-5 money has been beneficial, with projects like Washington DC’s Uline Arena (pictured), which is being converted into an office and retail center, as part of a project to rejuvenate the entire area.
Angelique Brunner, president of EB5 Capital, says the program needs more regulation so it can focus on the reason it was created, which was to spark economic development in distressed areas. One possible solution is a bipartisan proposal spearheaded by Judiciary Committee Chairman Chuck Grassley and Ranking Member Patrick Leahy. The proposal would increase the minimum investment in rural and high-unemployment areas to $800k and would reserve 4,000 of the 10,000 EB-5 visas for rural and high-unemployment areas. [CNBC]