Off-market commercial real estate is the practice of purchasing or selling real estate without the assistance of an authorized real estate agent. Off-market possibilities may take many forms, including properties that are for sale by the owner (FSBO), properties in trouble that are more suitable for off-market transactions, or real estate auctions where investors compete for properties (often seizures) than other bidders.
Why Properties Are Sold Off-Market?
New commercial real estate investors often ask why a property would be sold out of the market if it can be sold on the market by a real estate professional. There are several reasons for that.
First, the seller may not wish to pay a fee to a real estate broker for the sale of the property. Realtors charge a fee to the seller, which is generally calculated as a percentage of the selling price of the property. A 6% commission on a $1MM sale means the salesperson pays the realtor $60,000. Some vendors believe they should not pay this commission to sell their property successfully.
Second, a distressed property could be unsuitable for sale in the marketplace. For example, if there is a multi-family commercial property that has been seriously neglected by the owner for many years, the property may be uninhabitable until the defects are resolved. Many lenders will not loan against a property that is in bad shape and cannot be used. This makes homeownership a better candidate for off-market selling where spot buyers or buyers supported by private lenders are common.
Third, properties sold through special circumstances, such as foreclosure auctions or other alternative formats are non-market transactions. Some investors orient their investment strategy around these types of purchases, but it takes a lot of experience because the purchaser is usually limited in the extent to which they can do their due diligence. For example, seizures can be unavailable until they are purchased.
On-Market vs. Off-Market Properties
The term "in the marketplace" refers to properties that are listed on a multiple listing service. Investors that choose to look for investment properties in the marketplace work with real estate agents. Real estate brokers can access the multiple registration service, this refers to numerous local property databases that are officially listed for sale by authorized real estate agents.
There are many advantages to looking for investment properties in the marketplace:
Multiple listing is the only place an investor can go to see a lot of ads in a single location. Most investors find that most properties listed on the market are not making good investments. However, some investors choose to concentrate on searching for investment properties in the market and are very successful with them.
The purchase of market transactions, both residential and commercial, generally means that the investor will work with a licensed real estate agent.
Real estate agents can assist in finding the property, negotiate on behalf of the purchaser, and provide advice during real estate transactions.
There are also disadvantages to seeking transactions on the market:
The biggest drawback of searching for offers in the market is that many other investors are also searching. There is even more competition because investors sometimes must compete with potential homeowners when it comes to housing. Investors are less inclined to find properties with difficulty on multi-listing services.
Usually, realtors concentrate on selling properties that attract the largest segment of buyers. It is therefore logical for them to enumerate properties that are in good condition.
From an investor's perspective, these properties may require little upfront investment in capital enhancements but are likely to be sold at a higher price.
The term "off-market" means properties that are not listed for sale on a multi-listing service.
Investors looking for these properties are generally not working with a real estate agent to identify the properties.
The most important thing that attracts investors seeking out-of-market agreements is that there is no or limited competition from other investors. As a rule, where an investor finds an out-of-market transaction through their advocacy, networking, and exploration efforts. While this may be possible, it is less likely that another investor will focus on the same property compared to market listings that may receive offers from multiple buyers. Investors who specialize in researching out-of-market properties can trade directly with the owner. This can be a benefit for an experienced trader who knows how to trade. These owners are not represented by a real estate broker, nor do they have a real estate professional who negotiates for them. In many cases, a prudent investor can negotiate advantageous terms.
There are a few drawbacks associated with researching off-market properties.
The biggest obstacle investors must overcome when seeking out-of-market real estate transactions is that they need to understand how to identify owners or owners of commercial properties that are ready to sell. Even if an investor with experience in direct dealing with sellers could prosper in that situation, a more recent investor or a person without strong trading skills could be disadvantaged. In an out-of-market negotiation, potential buyers, generally do not have real estate agents who deal on their behalf.
How to Find Off-Market Property Deals?
One of the advantages of focusing on off-market transactions is that an investor can find several ways.
Top performers are generally good at networking with others in the industry and their local market. Investors connect in two ways: in person and online, typically via social media. Investors use networking events and social media to trade commercial real estate investment strategies, successes, failures, and most important, out-of-market transactions. Craigslist and other online markets are an alternative way for investors to find, out-of-market properties for sale and meet investors in their local markets.
Commercial Real Estate Brokers
Commercial realtors specialize in assisting commercial real estate investors to purchase and sell properties. They can help with transactions in the marketplace, but many also choose to focus on transactions outside the marketplace. One way to get there is to use a strategy called wholesale. In the world of CREs, wholesalers are intermediaries who obtain a property under contract for purchase, usually as part of an out-of-market transaction. Then they flip around, find a buyer, and contract the same property for sale to the investor who will eventually own it. The wholesaler does not take possession of the property and earns only the difference.
What they accepted to pay for the property and why they could sell it. The other way in which commercial real estate brokers can help investors find, out-of-market offers is by offering pocket ads, sometimes referred to as exclusives. Pocket listings are listings that brokers do not market through a multiple listing service. Instead, the broker sells the advertisement to investors within their professional network. The investors who benefit the most from the out-of-market ads are the ones who have the best relations with the broker and who have demonstrated over time that they have the capital available to them to purchase properties with a high degree of certainty. The broker usually goes to the pocketbook market to the most reliable investors first.
Some investors choose to implement their marketing campaigns to reach vendors in markets where they want to purchase goods. One of the most popular marketing strategies is referred to as a direct mail campaign. Investors will find or create a list of properties and then send postcards or letters to homeowners expressing an interest in buying the property. There are numerous ways to create property lists, including buying them from third-party list providers. Regardless of how the list is created, it will often be based on publicly available documents, such as tax records, which include the landlord's mailing address. Some successful investors have large-scale direct mail campaigns where they can send thousands of postcards or letters each month. This can be a great way to meet prospective salespeople and acquire off-market properties.
Another strategy to find properties outside the market is known as cold calling. Like direct mail, cold calls require that the investor has a list of properties, owners, and the phone number of each owner. This enables the investor to call the owners and find out about the purchase of the property. Cold calls may work well if the investor keeps the landlord on the telephone. Because it takes a long time to call a whole roster of homeowners, some investors will hire staff to make calls and provide robust leads to the investor for increased awareness.
Auctions can be an excellent way to buy rental goods at a reduced price. When a property is sold at auction, it is usually auctioned off through a process called foreclosure. This means that the previous landlord was not able to make their monthly loan payments, so the lender auctions the property to collect the debt due to them. Auctions are held in person or online, but in one way or another, investors can assist and bid on the properties to be purchased. There are a couple of things that investors should know about auctions. First, when a property is bought at auction, the purchaser typically must pay cash. This means that investors cannot borrow money to purchase a property at auction. Second, properties that are auctioned frequently cannot be seen in advance. It is therefore difficult to determine in which state the property is located.
Travel the Area
Investors who want to invest in a particular city or city can find properties to buy simply by traveling through the region. Sometimes investors target a specific sector based on their previous research or based on information they have received from word of mouth. Investors can drive, cycle, or walk and look for properties that seem to be good candidates for off-site acquisition. When an investor finds a real estate asset of interest to them, there are online tools.
The Benefits of Finding Off-Market Properties
We discussed some of the advantages of finding properties outside the market. Firstly, investors are attracted by out-of-market transactions because there is little or no competition from other investors. Secondly, investors who are good traders can negotiate directly with the seller to obtain the best possible offer. Both benefits provide the opportunity to purchase property below fair market value, which distinguishes highly successful investors from the rest. Thirdly, there may be a limited inventory of multiple listing services, this means investors have limited options available through market channels and end up fighting for the same properties, driving prices higher. Having the ability to find, out-of-the-box properties can be beneficial during periods when market stocks are smaller than usual.
Consider Investing Through a Real Estate Syndication Instead
It can be very rewarding and profitable to find and invest in off-market transactions. That said, there is a great deal of work to be done to find, out-of-market properties. Investors usually must talk to a lot of potential sellers and could end up looking at dozens of properties before finding one. That is good ground for their thirstier investment to have the time or the knowledge to find and buy off-market offers.
An alternative consists of investing in commercial real estate syndication.
Syndication is a structure of commercial real estate transactions that allows individual investors to purchase a fraction of a commercial real estate asset. In this structure, the head of the business or "union" form a corporation, LLC, or partnership and uses it to buy commercial real estate. They then sell shares of the company, LLC, or partnership to a group of investors whose combined equity is used to help finance the purchase of the property. Real estate syndications are available for all types of commercial properties, including apartment buildings, offices, and retail properties.
Many important advantages come with investing in syndication.
Passive income: Firstly, by investing in syndication as a sponsor, the investor may generate passive income. This means that they derive revenue from the rents generated by the property. Without doing any extra work, the investor gets a check in the mail each month for their share of the profit.
Portfolio diversification: Investing in syndications provides investors with an easy way to diversify into several properties. Instead of putting all their capital in a single property, as is often the case for out-of-market transactions, investors can buy in multiple syndications. If one of the syndicated buildings did not perform as expected, the investor allocated capital to two other buildings that could perform better.
Tax advantages: A unionized investment comes with two very significant tax advantages.
First, the accounting rules allow owners to take a certain amount of depreciation every year to consider the physical deterioration of an asset. Since impairment is a non-monetary expense, it reduces taxable income. Secondly, if the syndicate sells the property for a profit, they can defer capital gains tax by reinvesting the proceeds of sales into a similar property through a transaction called "1031 Exchange".
Summary of Off-Market Commercial Real Estate Deals
Off-market transactions refer to properties that are not listed for sale as part of a multi-listing service. Investors in search of these properties generally do not work with a real estate agent to find and purchase the properties. Instead, investors use one or more strategies to generate their leads and then negotiate directly with sellers to purchase a home.
Investors should know the advantages and disadvantages of non-market transactions before deciding to concentrate the time and effort needed to be a successful off-market property investor.
Investors who are looking for the advantages associated with real estate investment without the time of commitment and hassle may opt to invest by commercial real estate syndication. They offer passive income as well as tax and diversifying benefits.
What is Percentage Rent Real Estate?
The rental percentage is an expression used in commercial real estate leases to specify. The monthly rent paid by the lessee to the landlord is based in part on a percentage of the gross income generated.
Typically, under this agreement, there are two portions of the total monthly rent paid by the tenant – there are the base rent and the percentage rent. It is more common for larger tenants to pay a percentage of the rent to the homeowner, but sometimes smaller tenants are also required to do so. It is also more common to see the percentage of rent used when tenants in a specific investment building are retail tenants.
Percentage Rent in Addition to Base Rent
The basic rent is a set amount that the tenant pays every month, regardless of their sales. This amount is agreed to in the lease contract. It is generally based on market rent in the local housing market and is often expressed in square meters (rent per square foot). The rent percentage is a supplementary amount of rent paid by tenants when their turnover, or gross income, at the place exceeds a certain amount. The percentage rate and the sales threshold, or break point, are agreed upon in the lease contract.
Percentage Rent as the Total Rent
It is unusual, but not unheard of, that rental leases are based solely on the percentage of rent and completely omit the base rent amount. In this case, no sales threshold must be exceeded before the entry into force of the percentage rate. Each dollar of gross income at the site will be included in the monthly rent calculation.
How does Percentage Rent play into Commercial Real Estate Investing?
Percentage rental terms are included in many retail leases, particularly for large retail renters. Those tenants are required under the terms of the lease to pay a specific amount of the basic rent, and then a percentage of the after-sales sales pay a predetermined amount. It is an important concept for commercial property investors to understand because. It can be very beneficial to receive a percentage of sales from a tenant who is doing well and experiencing rapid growth. It gives the owner a kind of synthetic interest in one or more of the tenants occupying their rental buildings. Because the owner gets a share of the tenant's sales when the threshold is reached. That's a very powerful model, especially for large landlords. Who rent retail space to multiple tenants and even to tenants who have locations across the country, such as us. It is also important for commercial real estate investors to understand that there is a risk in structuring a lease to include rental conditions on a percentage basis. The annual base rent may not change from year to year and, indeed, may even increase because commercial leases often have rent indexation factors. The fact remains that the percentage of rent can vary from year to year, depending on the tenant's performance. If the tenant’s sales continue to grow, then the landlord will be entitled to a larger dollar amount of percentage rent over time. However, if sales start to go down, then the amount of rent received by the landlord will go down as well.
Another thing to know about using the rental percentage in a lease is that it's harder to evaluate the property. In commercial real estate, properties are assessed by a measure called net operating income (NOI). Net operating income is calculated as gross rent less all operating expenses, including real estate taxes. Volatility in tenant sales may result in volatility in the landlord's gross rent, resulting in year-over-year fluctuations in net operating income. When real estate investors assess commercial properties through due diligence, they establish a pro forma financial statement. It becomes more challenging when gross rent is prone to volatility.
The breakpoint is defined as the number of sales that the tenant must hit each month before the rental percentage begins. In other words, until sales reach the hold point, the lessee pays the landlord only the lower base rent. Let's examine three important points to understand when it comes to the breaking point of a rental contract.
Natural vs. Fixed Breakpoint
First, it's important to know that there are two ways in which owners can define the breaking point in a rental agreement. The first method consists of using a "natural breaking point". A natural breakpoint is expressed in the lease as a multiple of the basic rental amount. This means that the natural breakpoint is calculated by dividing the base rent by a pre-determined percentage. In addition, some leases include a "fixed breakpoint" which is simply a dollar amount negotiated between the owner and the lessee. It is not based on the base rent amount and does not include a calculation.
How to Calculate the Breakpoint
The percentage of rent the tenant pays to the lessor is equal to the number of sales above the threshold multiplied by the pre-determined percentage. Let's give you an example. Suppose a commercial lease stipulates that the lessee will pay 8% on sales above the natural break point. This means that if the annual base rent is $250,000, the natural cutoff would be $250,000 8%, or $3,125,000. A set hold point does not need to be computed because it is negotiated directly between the landlord and the tenant. In this scenario, the renter would pay the base rent until the revenue reaches $3,125,000. On sales greater than this amount, the lessee would pay additional rent as a percentage equal to 8% of sales greater than 3,125,000. So, if the tenant's gross annual income is $3,750,000, then the tenant would pay the homeowner $250,000 in base rent plus $50,000 as a percentage of the rent, or $300,000 in total. The rent percentage is based on: (3,750,000-3,125,000) x 8%.
Negotiations on the Breakpoint
Negotiations regarding hold points and usage of rent as a percentage. In a business, the lease can be seen on the tenant's side as well as on the landlord's side. Renters, or lessees, generally prefer not to include rental conditions as a percentage of the lease. Because they would prefer to pay the minimum rent available, which is generally only the base rent. However, there are situations where it is advantageous for a tenant to agree to include rental conditions as a percentage of a lease. One of the most common examples is where the tenant is in competition with other tenants for prime space in a high-traffic area.
In this case, the tenant can differentiate himself in the eyes of the owner by accepting the rental conditions as a percentage. Even if the tenant agrees to pay the rent in percent, there is still room to negotiate on the breaking point. For the lessee to pay a percentage rent in a reasonable amount of gross income. Landlords, or lessors, like the rental percentage idea because it brings the opportunity to earn additional income from tenants who manage to generate sales above the breakpoint. Despite earning additional income can be a pleasant benefit to the owner, they should be careful not to go too far. The rent percentage is typically reserved for large retail tenants because they have the resources to pay the additional amount in exchange for a location of choice. At a multi-tenant mall, many small business owners may not have the resources to complete a lease that forces them to pay the rent as a percentage. The landlord must ensure that small space rental businesses in the center are not stifled.
There are both advantages and disadvantages to be used part-time leases in commercial real estate. And it is often difficult for small groups of investors to track tenant sales in a manner that ensures the rental percentage is paid properly. Investors who are interested in the rent percentage might benefit from an investment with a private equity company that has experience with rent leases as a percentage.