real estate question 1

REAL ESTATE 431: COMMERCIAL REAL ESTATE INVESTMENT

INSTRUCTOR: TRACY GREEN, M.P.A., B.A.

Readings

1. Read Roos, Chapters 5 thru 9.

Additional Resources

AIR Commercial Real Estate Association http://www.airea.com/HOME/Home.aspx

CCIM Institute http://www.ccim.com/

National Association of Realtors http://www.realtor.org

California Association of Realtors http://www.car.org

The National Bureau of Economic Research http://www.nyber.org

Weekly Overview

During week 2 you are required to read Chapters 5 thru 9. These chapters will give you

an overview of overcoming the disadvantages of commercial real estate and introduce you to

tenant selection and increasing rental income. Tax consequences should be taken into

consideration when evaluating your rental income. Under federal tax laws, property is divided

into four classifications: personal residence property, investment property, trade or business

property, and dealer property. The tax laws vary as to each classification. With respect to

investment property such as rentals, an owner’s tax liabilities are contingent upon whether the

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property qualifies as a capital investment. If property qualifies as a capital investment, income

from that property is taxed at the lower capital gains tax rate of 15 percent rather than the higher

ordinary tax rate, which could be as high as 36 percent. Generally speaking, real property that is

not inventory property may qualify as capital investment property. Investment property owners

can claim deductions for mortgage interest, property taxes, operating costs, insurance premiums,

and depreciation, the latter of which may be spread out over time. Investment property owners

may also engage in certain tax-sheltered and like-kind exchanges and seek low-income housing

tax credits. Investors use like-kind exchanges to defer, or delay, their tax liabilities by

exchanging their properties for other properties. There are important time deadlines that apply to

these types of transactions. A low-income housing tax credit may be available to an investor who

makes low-income housing available in the community. In order to take advantage of the credit,

the investor must satisfy a cost test and a use test. This credit may be used to offset taxes that are

due on all types of income.

When an owner rents property, the owner—or landlord—and tenant enter into a lease

arrangement. Under a lease arrangement, the landlord transfers his or her right to possess and

enjoy the property to the tenant. In exchange, the tenant pays the landlord rent. A lease

agreement contains several essential elements. For example, it describes the premises, transfers

possession of the property to the tenant, specifies the term of the lease, and contains the

signatures of the parties; the agreement may also contain other standard clauses relating to

security deposits, the right of the landlord to enter the premises, and the liability of the tenant for

damaging the property. Like any other contract, a lease agreement requires the parties to possess

contractual capacity, requires consideration, and requires a lawful objective. If the tenant

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breaches the lease agreement, the landlord may be entitled to an eviction, which refers to the

process of removing the tenant from the property.

There are different types of tenancies, including a tenancy for years, a periodic tenancy, a

tenancy at will, and a tenancy at sufferance. And different lease arrangements may be made,

including gross leases, net leases, percentage leases, graduated leases, index leases, and

reappraisal leases. Moreover, leases may be classified by their function, such as sale and

leasebacks, ground leases, and vertical leases. Leases are governed by landlord-tenant laws,

which further define the rights, duties, and obligations of tenants and landlords. In some

communities, rent control measures have been implemented. These laws place restrictions on the

amount of rent a landlord may charge a tenant.

There are four types of tenancies. A tenancy for years describes a tenancy that has a

specific starting and ending date. It does not matter whether the specified term is for a year or

more. For example, a lease that commences on July 1, 2007, and ends on September 1, 2007, is a

tenancy for years, even though the term of the lease is two months. A periodic tenancy is created

when the parties agree to a specific rental period on a period-by-period basis, such as a month-to-

month lease. This type of tenancy automatically renews itself for a successive period if it is not

terminated by the parties. Termination requires sufficient notice be given to the other party. A

tenancy at will is created when the tenant possesses the landlord’s property with the permission

of the landlord but without a specific lease term. This means that the tenant leases the property at

his or her will and at the will of the landlord, either of whom may terminate the lease on

sufficient notice. A tenancy at sufferance occurs when a tenant remains on the leased premises

after the lease expires. Such a tenant is commonly referred to as a holdover tenant.

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A landlord and tenant may agree on different rent schemes. For instance, a gross lease

requires the tenant to make specific rental payments at certain intervals, such as weekly or

monthly; the landlord pays the property taxes, assessments, insurance, and major repairs. In a net

lease, such as a triple net lease, the tenant is responsible for paying the rent, property taxes,

property insurance, and maintenance; these types of leases are commonly used for commercial

properties. Under a percentage lease, the tenant’s rent is based on a specified percentage of the

tenant’s sales; these types of leases may be used in shopping centers. In a graduated lease, the

rent payments increase over time, usually to account for inflation. Under an index lease, the rent

payments fluctuate in direct proportion to a specified economic index, such as the Consumer

Price Index. And in a reappraisal lease, the amount of rent is contingent upon future appraised

valuations of the leased premises; that is, rent is directly related to the value of the property.

Leases may also be classified by their function. A sale and leaseback is created when the

owner sells the property to the buyer, who leases the property back to the seller, who may also be

given an option to repurchase the property. A ground lease is created when a property owner

leases land to a tenant on a long-term basis. The tenant develops the property and receives

income from it. At the end of the lease period, the property reverts back to the owner. Finally, a

vertical lease involves leasing property that is located below (subsurface rights) or above (air

rights) the land.

REFERENCES

Larsen, J. E. (2007). Real Estate: Building Strong Foundations. New Jersey: Wiley.

Nemeth, C.P. (2011). Reality of Real Estate (3rd ed.). Boston: Pearson Prentice Hall.

De Ross, D. (2008). Commercial Real Estate Investing. New Jersey: Wiley.

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