First, some background.

BOMA (Building Owners and Managers Association) is an association of commercial real estate property managers, vendors and owners – although I see very few (to zero) owners at these events. It is one of the larger associations supporting the commercial real estate industry, in particular office properties. The BOMA 360 program is in addition to the long-standing TOBY (The Outstanding Building of the Year) award BOMA bestows on properties annually.  The TOBY awards are a competition among properties in specific categories: corporate facility, earth, government, historic, industrial office, medical, renovated, a few suburban office categories and categories grouped by square foot.  Where the TOBY awards go through a review process and judging at local, regional and international levels, BOMA 360 uses much of the same information, but not on a competitive level.  Any project that meets the requirements is able to receive the BOMA 360 Performance Building designation.

I’ve done work while on a committee in our local BOMA chapter to encourage participation in both the BOMA 360 designation and the TOBY awards process. The TOBY documentation is relatively similar to the data required for the BOMA 360 designation. We developed a simple chart that highlights the similarities and differences:

There’s a bit of additional work on the BOMA 360 side of things with regards to the several categories, but the nice thing about the 360 program is the fancy binder, professional photos, binder compilation and property tour are not required.

What BOMA 360 Designation Means…

A BOMA 360 designation demonstrates your expertise in the property management field. It indicates, the group that manages this asset took the time and has the knowledge to write, develop and implement the necessary practices for operational excellence. This subtle message may not be recognized by your tenants, it does make for a nice story about property and the team responsible for the day-to-day operations.

How to Get the Designation:

Hopefully it’s clear the designation is a good thing.  If you have a solid management program in place it’s easy to gather the documents required to submit and the costs are minimal.

If you’re interested in exploring further, I created this checklist as a guide to figure out what you need to do. The checklist breaks down each category and the exact requirements. Run through each section, identify the points you already have (via a yes, no and maybe rating) and get an idea for the work required to wrap up your submission and complete the designation. This checklist should make it easy to figure out where you are, what you need and how to move forward to submission.

If you need help, want guidance or you are missing a document, I can help.

California is in a severe drought and most water districts have enacted mandatory restrictions designed to reduce water consumption and encourage conservation. In the bay area, there are multiple water districts, serving unique areas and utilizing difference reservoirs to supply water. Some of these districts are more advanced, providing gray water (recycled water) for landscaping and non-potable purposes, while others are severely lacking. In Pleasanton, Zone 7 is just starting to implement recycled water for city owned parks and direct access to this water (via the water system) for public use is a long way off.

The lack of investment in the water infrastructure has required Zone 7 customers to cut back water usage more than other water district customers. Contra Costa Water District is requesting (meaning voluntary) a 10% cut back. East Bay MUD (Municipal Utility District) has a required 10% reduction. Zone 7 has a strict 25% reduction requirement and severe penalties for those that don’t meet it.

While the intent of the mandatory reduction is good and I fully support it, the process in determining each customer’s success is significantly flawed. To determine if a water account has met the required 25% reduction, water usage for the current period is compared to water usage from the same time period one year prior. This may work well for residential households with limited to no fluctuation in occupancy, from a commercial building standpoint, it doesn’t work at all.

First, Pleasanton Corporate Commons has been actively working towards reducing domestic (water use inside the buildings) water consumption since the first LEED certification done in 2007. Second, the property’s occupancy has increased several percentage points since last year. Third, density (the number of people in the buildings) has increased as well. Finally, we’ve done all we can from an engineering perspective to eliminate or reduce water usage.

This arbitrary approach to measuring water reduction fails to consider all of the above items. In fact, it penalizes properties that have been forward thinking and taken action prior to now to conserve water. Perhaps most annoying about this, are the articles in the local weekly paper highlighting large business parks that have reduced water consumption by more than 70%. “Some have done much more, he said, including Koll Center, a business park that has reduced its consumption by 71% over its 2013 usage” (link). I’m sorry, but if you can reduce water consumption by 70% year over year, you’ve clearly been overusing water in years past.

Irrigation usage is much the same. Our conservation efforts from prior years are now being penalized. Pleasanton Corporate Commons has taken many measures to reduce irrigation usage through the removal of plant material, installation of EvapoTranspiration Controllers (ET Controllers) and more efficient sprinkler nozzles.

The water municipality and City should develop an alternative method for measuring water reduction requirements. A more intelligent and advanced approach would be to compare the current case water usage (for domestic water this would be based on occupancy and fixture types, for irrigation it would be water coefficient, plant type and coverage, evapotranspiration rate and irrigation efficiency) against base case usage to determine total percentage of reduction. Granted this method is not as straight forward as simply comparing year over year usage, but it’s much more accurate.

One final thing before I stop ranting about water usage. Actively managing water use is one of the many things good property managers and firms do when overseeing the operation of a property. I can’t help but wonder how much higher operating expenses are in a property that is overusing water by 70%+. That not only makes the cost of occupancy higher for the tenants, but it hurts the valuation of the project during an appraisal or sale. And if water is being mismanaged, what else is?

The Annual Plan development starts with a complete review of the property’s current performance – marketing, finances, operations and construction – and how that relates to the current year’s budget. The projections that are compiled help forecast what the activity will look like for the remainder of the current year. The projections function as a good gut check on the status of the current year against the goals established for the year during last year’s Annual Plan process.

With the current year projections complete, it’s time to begin developing the Annual Plan for the upcoming year.

Property Condition Assessment

Projects that have traded recently can leverage the third-party Property Condition Assessment (PCA) report for potential items to include in the budget. In many cases the PCA can serve as a reference when developing a capital improvement plan for the immediate years following the report’s creation.

In the instances where a recent PCA is not available, Property Managers are tasked with developing the 15 year capital plan and necessary operating expenses to maintain or improve the property’s appearance, performance, marketability, etc. This process creates the foundation for the development of the property’s Annual Plan.

What makes up the Annual Plan?

Aside from the financials, there are a number of other components that make up a property’s Annual Plan.

• Executive Summary – essentially an overview of the project, ownership, size, debt and other key facts about the project that aid in summarizing the asset.
• Org Chart – highlights the roles of the onsite team, but also covers the details of those that support the onsite team or provide guidance, contract approval and other keys roles for the asset.
• Vision – perhaps unique to Hines; each year we define the vision we have for the project and how we plan to operate the asset in upcoming year. In 2014, the vision we set for Pleasanton Corporate Commons was: To Maintain High Water Mark Rental Rates and Enhance the Property’s Profile With Leading, Innovative, Sustainable Programs and Amenities
• Stacking Plan – A visual aid showing the tenant mix, expiration dates and current lease rates.
• Lease Related Information – Over several pages we review the tenant mix, lease expiration dates, revenue projections, debt coverage and other key financials important to fiscal and operational health of the asset.
• Team Triumphs – The teams big wins for the past year.
• Best Practices – With over 270 operational and engineering best practices developed, this takes a look at how well we’re doing implementing those practices at the property.
• Three Way Comparison – A detailed financial breakdown showing the current year’s budget numbers vs. current year’s projected numbers vs. upcoming year’s budget numbers. Significant variances are analyzed and explained.
• Value Creation – How world class operational platform impacts the overall value of an asset.
• Market Comparables – On a dollar per square foot basis, how are we performing against similar assets in the market? This is important because operating expense make up a portion of the tenant’s rent (in some leases) and it confirms spending in each category is appropriate in line.
• Annual Plan Slide – A look at what was accomplished in the past year and the defined goals that will be accomplished in the upcoming year.

While the time spent creating the budgets, annual plan and other supporting documents is immense, the package that results in the end is extremely valuable. I am a big fan of the entire goal creation and management process. Writing goals down is a practice very few people do, but has been shown to be a big driver in creating results. Adopting this concept at the building level makes a ton of sense and provides a good guide for the onsite team in the upcoming year.

Are there items you include in your budget preparations that I’ve left off this list?

The operating expense reimbursement is a payment that occurs in addition to the base rent the tenant pays. At the beginning of each year, an operating expense estimate is provided to each tenant with their annual rent letter detailing the monthly payment based on the current years budget.  Each tenant pays an amount based on the percentage of the building they occupy. An example might help explain this better:

The sample rent letter above outlines the annual payments for the tenant on a monthly basis.  In this example, the tenant’s lease is a base year lease, meaning the tenant pays for the increase in costs above the base year as established in the lease (which is typically the year the tenant moves into the building unless they negotiated a new base year during a renewal).  This $250,000 increase is multiplied by the tenants proportionate share of the building, 2.00% (3,000 RSF / 150,000 RSF = 2%).  Divide that number by 12 and you have the monthly operating expense payment the tenant pays.

Where the Gross Up Comes In…

The gross up clause (let’s use 95%) affects the $250,000 escalation number. In instances where the Weighted Average Occupancy of a building is less than 95% (in some leases this number is 100%), then variable operating expenses (those expenses change as a result of more people being in the building) are grossed up as if the building were 95% occupied. Variable operating expenses would include expenses such as utilities (electricity, water, gas), cleaning costs and supplies, and trash removal. Expenses that do not change as a result of occupancy are taxes, insurance, landscaping and some repair accounts.

The variability of operating expenses can be challenging to figure out. In a suburban campus setting, using the operating expenses from a vacant building is the ideal scenario. In a high-rise office tower, it gets more complicated. One approach to determining the variability is by measuring the operating expenses of a vacant floor. With some adjustments, the cost to operate the building when vacant can be reasonably determined. The same method can be done in reverse for a full building and once you have the respective expenses you can determine the variability.

Putting the expense variability aside for the time being, a high level example may help explain the impact of grossing up the costs a bit better[1]:

When the property is 50% occupied, the $2.50 that would be the Landlord’s costs shrink to $0.50 with the gross up provision.

Is This Just Good for the Landlord?

While the gross up clause seems to favor the landlord, it does protect the tenant from receiving significant bumps in the operating expenses charges each year.  In the instance of a base year lease, the tenant pays only for their percentage share of the escalation above the base year costs.  As long as the base year costs are also grossed up, the tenant shouldn’t experience a huge increase in their operating expense charges. This method also makes it easier for the tenant to budget for rent related expenses.

How the Weighted Average Occupancy Fits Into This

How do you know if the building is 95% occupied? It’s not simply a matter of comparing the total occupied square feet to the total rentable square feet at the end of the year.  The percentage of time occupied also needs to be considered. This is where the Weighted Average Occupancy calculation comes into play.  With each tenant, the percentage of the year occupied is calculated and then multiplied by the tenants proportionate share of the building. Thus if the 3,000 RSF tenant we saw at the beginning occupied the building from January 1 – September 30 we would take that into account for the total occupancy calculation.

The math looks like this: (3,000 RSF / 150,000 RSF) * 75% (occupied Jan – Sep) =  1.5%.

Tenant’s proportionate share of the building * Percentage of time occupied = Percentage contribution to the overall building occupancy for the year

The sample tenant would contribute 1.5 percentage points towards building occupancy for the entire year.  Adding together that same calculation for the remaining tenants in the building will result in the Weighted Average Occupancy. And, if it’s less than the gross up percentage in the lease, then there’s further gross up work that needs to be done. If occupancy exceeds the gross up percentage, then the actuals are used for the operating expense estimates and eventually reconciliations.

References:

[1] Holland & Hart has a good post on Gross Up Provisions. I borrowed the table above from their write up (with a few modifications).

The other night, I finished reading Do the Work by Steven Pressfield. It’s a super quick read – less than 100 pages with some sentences in 20+ point font. Despite the lack of words (and probably the worst book cover I’ve seen), the content is exceptional.

Over the years, I’ve had a lot of various side projects or good ideas that I’d like to execute. Sometimes – to the detriment of my personal growth and development – those good ideas don’t get out of the idea stage. It could be for a number of reasons, but one key reason is resistance. And resistance, what it is, how it works and how to overcome it, is the heart of Steven’s book.

Do The Work is written with the context of helping you work through a project. The primary focus is with writers, but really the concepts could be applied to any project. The book starts with an orientation on our enemies and allies. The list of each is really quite ironic. Enemies include: resistance, rational thought and friends and family. Allies include stupidity, stubbornness, blind faith, passion, assistance (the opposite of resistance) and friends and family. To start, we must understand how resistance instills negative thoughts, questions, and discomfort when we are pursuing that new idea or being vulnerable.

Resistance comes from “any act that rejects immediate gratification in favor of long-term growth, health or integrity.”

With the orientation of the good and bad complete, the remainder of the book is broken down into three distinct sections (Beginning, Middle and End – no joke) with motivational and inspirational quotes scattered throughout.

The Beginning

The beginning is about starting. Putting words to paper. Not over analyzing. Not researching. Just letting the thoughts flow. And while you’re at it, swing for the seats. Think big, plan quickly and get going. Don’t let the resistance creep up. If it does, recognize it and shut it down. Doing everything you can to ignore any sign of resistance is key in creating momentum.

The Middle

Now that the momentum is going and progress is being made, gradually start to think about the work you are doing. Start to fill in the gaps. Continue the progress, don’t stop the work from happening, but fill in the gaps as they come up. All the while, be ready for the resistance to creep back up. Finally, be ready for what Pressfield terms as “The Big Crash.” You start to second guess your work. You share your product with others and they hate it. Recognize this will happen, identify the problem, fix it and move on.

The End

Finally, the end. Now it’s time to ship (Seth Godin is all about shipping). Overcome the fear of rejection. Set aside thoughts of being judged. Not shipping is resistance last final effort. Finish it and ship it.

Again, great book, full of inspirational quotes will motivate you to work on that project. Probably something that is worth revisiting multiple times throughout the duration, just as a reminder of how resistance can affect those goals that could make a significant impact in your life.

You can see why this information might be valuable… knowing who the decision makers opens the door to potentially earning their business.  Before sites like ProspectNow, this information was gathered via business relationships.  Now, there’s the potential to expand the potential business prospects without calling in a ton of favors.

As I mentioned last week, new business is a key factor in growing a real estate career.  The post covered the management side of the business, but frankly it’s true regardless of what you’re doing.

ProspectNow pitches itself as an “online commercial real estate database of six million building owners, including phone numbers, mailing addresses ,building details and 30 million tenants.” To get a better handle of what exactly this means, I took it for a spin.

My primary interest is in building ownership… specifically those that own buildings and hire firms to manage the asset.  I firmly believe the work we are doing in Pleasanton can be replicated at other assets to improve their performance, occupancy and value. To prove this, I need to find the right people to talk to.

I setup a trial account with access to data in the local county.  The first county is included in the monthly $89 fee, each additional county is an additional $10/month. There are other nuances with the pricing structure that I didn’t see spelled out on their website. Credits are distributed each month to be used for obtaining phone numbers and email addresses.  More credits can be purchased.  Likewise, exporting data is limited to credits on hand.

Using the comprehensive search, I looked for commercial office projects over 100,000SF in size.  The search returned a list of the assets in the county in a map and table.  As I clicked through each property, I’m able to identify the ownership entity and in some cases the individuals associated with that entity.  For the larger assets, it’s hard to know for sure if the person and contact information listed is accurate. In many cases, the ownership entity may include registered agent information and not the asset manager that manages the day to day decisions. This was the case for the properties I’m currently involved in.

The four properties that make up Pleasanton Corporate Commons are listed individually, all with the same ownership entity (an LLC not directly associated with the REIT that owns the project).  The address of the LLC in ProspectNow brought up the registered agent in Carlsbad, CA. I wasn’t able to tie the project back to the company or people who I deal with directly.  But that’s not always the case, the office project next to PCC has the contact information listed and the appropriate people to contact. So, some assets will likely be duds, while others will put you directly in contact with the people you want to talk to.

I’m encouraged by the data ProspectNow put together and plan to test several of the leads I pulled from the site to see how well it does work.  Having the opportunity to tell our story to other office owners would be well worth the monthly investment.

Personally, I’ve consciously sought growth in each of these categories for a while, but it wasn’t until recently I started to fully understand the challenges of professional growth in the commercial real estate industry.  On the property management side, the single, most relevant challenge real estate companies have in supporting employee growth beyond certain levels of responsibility is directly related to the size of the portfolio the company manages.

This is one of the HR challenges leaders in our industry face. As employees learn, grow and earn additional responsibilities, the ability to provide that growth is not always readily available.  In fact, it only becomes available under a few different scenarios.  Companies with great leadership can hang onto employees while they wait for growth opportunities to materialize.  Those that have leadership or cultural challenges, may not fair as well.  The list below outlines four potential growth scenarios for Property Managers in the industry, the first three of which are internal growth strategies.

Someone retires, joins a different firm or quits. There will always be employee turnover.  As the baby boom generation begins to retire, opportunities for advancement will open up and trickle down as the higher ranks are filled. (There’s been the threat of a talent shortage in CRE for years now.) When an employee leaves to join a different firm or quits, a vacancy is created. In some cases, it’s a direct replacement. In other cases, it opens up an opportunity to reorganize and potentially find ways to support the growth of several employees.

A new building is bought or brought online. When a new building is added to a portfolio, either via acquisition or a new development transitioning to operation, opportunities open up.  Sometimes the project doesn’t warrant an additional staff member but rather a partial allocation of an existing person.  Spreading the salary of a property manager across multiple assets allows for a bump in compensation and possibly a reduction in operating expenses to the respective buildings. Other times an additional staff member is warranted, but perhaps at the assistant level (Assistant Property Manager).  This could be a promotion opportunity for a Property Manager to a more senior level to oversee the new asset and team as well as retain primary responsibility on the existing portfolio. There are other factors at play here as well, including the location of the new asset in relation to the Property Manager looking for an expanded role.

A new management agreement is awarded. An alternative to adding square feet under management via acquisition or development is by expanding the “first-party” (commonly referred to as third-party in the industry) management portfolio. A new client and new project creates opportunity for advancement. This is easier said than done however.  The competition to manage assets can be very competitive and the industry juggernauts (CBRE and JLL) often compete strictly on pricing. Changing property management is a multi-hundred thousand dollar contract and with any decision that big, it isn’t taken lightly. A successful pitch however, can be the start of a great relationship that may make your career.

A growth opportunity at another firm becomes available. In a hot economy, in the right market, this is a common occurrence. Another firm in the industry has an open spot to fill as a result of someone leaving, new business or a new development. This could be an advancement opportunity that may not be available at the employees present company for some time. In fact, this is probably the most common way employees experience significant professional growth.  I see this a lot in a hot market and improving economy.  An anecdotal study of my LinkedIn feed showed a number of contacts changing positions.  A few weeks ago, I had four different calls from recruiters about open opportunities in the area. No doubt, a sign of the times and hot market.

As I look at this list, I can’t help but ask myself, which of these can I control?  I’m not directly involved in acquisitions, nor can I force someone into retirement or leaving the firm.  I don’t have any plans to move to another firm, so that leaves me with one option: new management opportunities.  This isn’t necessarily something that I’ve done before, but if it is the only way to actively pursue career growth, it’s time to take action.

I’m curious however, how are you pursuing growth opportunities in your career?  Is it one of the items listed above or did I overlook an approach?

What is the lease abstract? The lease abstract summarizes all the key financial, legal and operational data points from the lease for quick reference. Secondly, the abstract will incorporate any items that may have been negotiated outside of the standard lease language. The value of the lease abstract is to keep things short and simple. It’s to be used as a reference only and any items that require more than a cursory refresher should consult the lease. A lease abstract covers all of the lease data in a short two to four page document.

The lease abstract summarizes both the important and non-standard portions of the lease. The format of the abstract will vary between companies and software packages used to generate the abstract, however the primary business terms should always appear. The list below (modified from the information provided by Lease Probe Abstract Services) captures all the possible lease abstract items. Those items identified with bold text are the key business terms.

Basic Information:

Term:

Financials:

 Percentage Rent(typically found on retail leases):

 Additional Rent:

 Tenant Options:

 Landlord Options:

 Use / Restrictions:

 Legal / Financial:

 Miscellaneous:

 Additional Info:

Why spend the time creating the lease abstract? Lease abstracts are valuable tools to use during staff transitions, property acquisitions or mergers. The documents summarize and provide references to the essential elements of the lease and will call out anything that is out of the ordinary. Abstracts are also used by the property manager and team frequently. A quick check of the abstract can return a lot of the essential lease data needed to update the leasing broker, owner or other essential party inquiring about a tenant’s lease.

There are a number of software packages as well as third-party services that support creating lease abstracts.  I shy away from outsourcing the lease abstraction process.  Leases are the products that make up the substantial value of a real estate asset.  I prefer handling those documents and parsing the data in-house.  I do like the software packages, however. These products tend to be more robust than an excel or word template.  Additionally, a few packages will integrate nicely with accounting software and other value add services like generating critical date notifications, ensuring critical lease dates are not overlooked.

Lease Abstract Software Packages

An incomplete list of products that you can use to generate lease abstracts.  Third party services that generate abstracts can be found with a simple Google search.

Realogic Lease Abstracts – a SaaS (Software as a Service) lease abstracting package

JD Edwards Enterprise One – a complete accounting solution that provides lease abstracting as one small element in the package

Yardi – Voyager Commercial – another accounting package that provides lease abstracts

A number of companies and university employed researchers are developing transparent solar technology that will be embedded in glass and installed as windows in buildings.  This makes a ton of sense from a building perspective.  Office buildings have a tremendous amount of windows.  Could there be a better place to embed this technology?  This could turn major, necessary building surfaces into renewable energy generators.

The manufacturing of this technology is in its infancy and the efficiency of the product is not near traditional solar panels.  What is interesting however, as the CEO of Oxford Photovoltaics shares in this video, is the windows can operate without direct sunlight.  The potential market for such a technology in the US alone has to be incredibly large.

I requested a quote from a company (not Oxford Photovoltaics) that produces transparent PV glass as a direct replacement for the existing glass on the office projects at Pleasanton Corporate Commons.  Unfortunately, the efficiency of these products producing power has a long ways to go.  While it may make sense to evaluate these products as a competitor to traditional glass replacements, the payback isn’t there from a sustainability perspective.  A $1,000,000 investment in these products returns 22,000 KWH annually or roughly $45/KWH.  We pay on average $0.16 – 0.18/KWH currently from PG&E.  If the efficiency can get to the level of solar panels and payback periods reduced to 10 years or better, this product will be a game changer.

Utility Impact?

I can’t help but think about the impact to the utilities business if this technology is highly adopted.  Utilities have developed their infrastructure and capacities to meet peak demand needs.  Similar to the number of lanes of a highway.  The four or five lanes are constructed to accommodate rush hour traffic (peak demand) and are dramatically under utilized outside of rush hour.  If adopted, utilities will see a dip in ongoing electrical demand and peak demand until a cloudy day comes along (when the four lane highway will need to be six lanes to support the draw from utility customers).  Utility providers are surely building this into their power supply models, but it’s not hard to imagine a time when utilities rely on customers generating a portion of their energy needs (what happens when one of two highways feeding into a city closes down for construction?).

Utilities already have heartache with purchasing power from commercial and residential customers that have PV panels and sell it back to the grid at the same cost as buying it.  The fees the utilities are paying to their customers not only include cost of production, but also transmission, peak demand needs and their profit.  It’s a net loss.  While publicly PG&E will fully support solar projects, they’ve got to be pushing back on the current structure behind closed doors.

Demand for electricity from utility providers must be slowing as additional options for renewable energy become available.  At some point in the future, utility demand growth will go negative. Basic economics implies the utility rates will decline as a result, even if supply remains flat.  Utilities will be shuttering power plants as a result of over capacity.

 Photo credit: UCLA

This third and final post on jobs in commercial real estate covers the financial side of the business. While this short series doesn’t cover all the jobs that serve the trillion-dollar CRE market (for example all the services on the operational side: security, landscaping, elevators to the numerous consultants that exist: sustainability, solar, appraisers, etc.), I did take a shot at including the main players that work directly with commercial real estate assets.  The financial gurus represent both the debt and equity sides of the business. These groups manage large sums of money and decide how they will invest the money to generate a return for their clients. To understand a little more, it helps to examine both the debt and equity sides of the business.

On the debt side, you have the most common avenue for lending: banks and other financial institutions.  There are other players on the debt side as well: REITs (Real Estate Investment Trusts), insurers (life insurance companies) and possibly crowd funding campaigns one day.  All of these players have idle money and need to place it somewhere to generate a return. One way this is achieved is by lending the money to real estate firms for a specific property. Lending the money provides a semi-guaranteed return for a certain number of years. The returns of the loan are not guaranteed because the loan could potentially be defaulted on by the borrower.  In this scenario, the property would be turned over to the lender.  This is known as securitization.  The loan is secured by the value of the property.

Years ago, banks were willing to lend up to 100% of the value of the project, sometimes even more if the buyer planned to rehab the asset. After the Savings and Loan collapse in the 80’s and recessions like the most recent one (2009-2011), banks have become more conservative with their cash and typically require 20 – 30% equity or a loan-to-value ratio of 70 – 80%. The money that is lent has a predetermined interest rate and a period. Unlike the most common 30 year fixed mortgage on residential loans, commercial debt may be amortized over 30 years, but the balance will be due in 5 to 7 years resulting in a balloon payment.

The equity side can be a bit different. The returns are generally less predictable on the equity side because the money is tied up buying the asset and returns are generated from its performance in the market. As an example, purchasing an office tower for $100MM would require an equity investment of at least $20-30MM. The returns generated on this investment could be substantially higher than the return of the $70MM in debt that is on the asset, but the risk can also be greater. The lender will do everything it can to limit the downside of their investment including personal guarantees. At the end of the day, the loan is secured by the real estate. The equity investment could all be lost if the asset doesn’t perform as projected and the lender forecloses on the property.

There are different strategies used to generate returns on the equity sides of the business. In recovering markets, like the current economy, many investors have substantial amounts of cash on hand that they would like to generate a return from.  It’s in these times of the real estate cycle when core assets (those class A, stable properties) sales prices will be bid up significantly.  These purchases are effectively cash flow plays.  By placing a substantial sum of money, the owner is buying into the cash flow from the asset over the hold period.  Typically, the buyer anticipates zero to possibly negative appreciation in the value of the property over the hold term.  Other investments will focus on maximizing the Net Present Value (NPV) of the investment and may have a different strategy (think fix and flip versus buy and hold).

Having a strong foundation in financial accounting and understanding the details of the calculations and what they mean are vital to a successful career in real estate finance.