What to Know and How to Begin Investing in Commercial Real Estate
Here are the steps you need to know when investing in commercial real estate and some tips to get you started.
So what do office-building property management services cost? The short answer is between 1.75% and 3% of collected rents. Of course, that’s a fairly wide range. Where you will fall on that percentage spectrum depends on many variables.
A Property Management Contract is a contract that exists between a landlord (or other types of the property owner) and a third party. Usually, the property management company is responsible for dealing with the day-to-day operations of the property, including dealing with vendors and contractors, addressing property problems, and interacting with tenants.
The typical management fee for a commercial real estate company will depend on several factors, including the type of property being managed, the location of the property, and whether the management is being paired with other services (like lease management). However, generally speaking, property owners can expect to pay about 3 percent as the management fee. The rates can be lowered when bundled with other services or in other exceptional circumstances.
Commercial office buildings add a whole new layer of nuance to the property management game. “Why pay someone to do what I could do myself?” doesn’t apply. Most of us can’t DIY commercial property management. Commercial leases are far more complicated. Do you go net lease? Triple-net? Flat rental rate? What term? Years? Decades? What leasing commission to pay to a commercial broker?
No set formula exists to calculate how much a commercial property manager will charge. The same management company may have different levels of service, each with different fees. The following factors influence what commercial real estate management will cost:
You may expect a smaller commercial building to command a lower percentage or flat fee, since it requires less work. However, a commercial property manager will most likely subcontract or personally oversee much of the management of a smaller building. Therefore, smaller buildings tend to command higher property management percentages, since they need to cover the manager’s time.
Larger properties may merit full-time staff—a building property manager, tenant coordinator, maintenance staff, janitorial staff, and so on. The salaries of these on-site people are paid separately by the owner. With larger properties, the property manager receives a management fee and is fully reimbursed for the cost of on-site salaries and burden.
EXAMPLE:
For a 4-unit office complex, the commercial property manager field all calls from the limited tenant base, show the property to prospective tenants themselves, and dispatch a preferred contractor to handle repairs. This manager might charge 6% of the gross collected rents, considering how much of her own time and the time is expended.
That same management company might collect 2% of the gross collected rent for a 400,000 square foot office building. Before you think that you got a steal of a deal, remember that the management company will hire a building manager, assistant manager, full-time maintenance engineer(s) and part-time maintenance support staff. The manager does all the hiring, firing, training, supervising, and payroll accounting, but those payroll expenses, including salary, medical, workman’s comp. etc. will show up as an extra expense on your P&L.
Sometimes “property management fees” and “payroll expenses” get conflated. Make sure to separate them out. Especially if a commercial property management company quotes you a low percentage, ask how much extra payroll expense you can expect and the job descriptions of each staff member.
Related: Commercial Real Estate Trends in 2020
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Ask a real estate enthusiast if they think they could fix a toilet. They will probably say “Yes.” Misplaced confidence or no, they at least know how to look up a YouTube tutorial or Google-search a nearby plumber.
Ask the same guy if they know all the boxes that must be checked before they can legally evict a non-paying tenant. Most real estate investors will be stumped.
Commercial real estate management compounds that skillset barrier with dozens of extra complications. Good commercial property managers require much more specialized training in the regulatory complexities, insurance requirements, and other nuances of commercial real estate to pair the right office with the right tenant, maintain that lease in good standing, and address problems effectively and legally.
Expect higher commercial real estate management fees and percentages your property is:
Newer properties tend to command lower percentages and fees for commercial real estate managers. There are several reasons for this, most of them intuitive. For example:
Properties located in desirable locations, like a city’s downtown or ritzy district, may command significantly higher rents. The same factors as above will apply—managers may charge higher percentages for far-flung, low-rent office space so they don’t work just as hard for less income.
The location of the commercial office property will affect the management fees in other ways. If you invest in a small office building, and the only commercial property manager you trust is far away, the commercial property manager may charge a higher fee to account for the time spent commuting to and from your investment property.
However, this disadvantage may disappear for larger, multi-tenanted office buildings. Remember that larger buildings often require their own salaried on-site staff. Such staffs are much easier for commercial property management companies to manage remotely.
Property amenities play a role in the assessment of real estate management fees. A commercial property that features many amenities, like a gym, water feature, on-grounds park, etc. might command higher fees from a commercial property manager because these amenities require more effort to manage.
However, properties with amenities also command higher rents. Extensive amenities tend to be found on newer, fancier properties. As we already know, higher potential rent collections and fewer ancient heating and air conditioning systems to break push management fees down.
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The more services your property management contract covers, the higher you can expect your fees to be.
Depending upon the type of lease involved, a commercial property manager may actually provide fewer services than you think. Some commercial leases guarantee the tenant four walls and a roof, and little else. Repairs and maintenance, utility payments, even property tax payments may actually be the tenant’s responsibility. The commercial real estate manager may have nothing on his plate other than filling the vacancies, collecting rents, and processing evictions. In this case, the property management fees will tend to be lower.
If repairs, utilities, taxes, tax protests, etc. falls to the property manager, expect to pay more.
You might think the size of the building plays a big role in determining the extent of services. This is not always the case. The number of tenants often matters a lot more. A huge warehouse with only one tenant may require a lot less effort to manage versus the equivalent sized office building that is leased to many tenants.
Most commercial property management companies collect a percentage of gross rent collected as their fee. This is advantageous to you as the investor, because the management company has an incentive to manage your property effectively. The more rent they collect, the more money the manager gets to collect. Meanwhile, you benefit from increased revenue.
A handful of commercial property managers may charge a flat monthly fee. Be wary of such an arrangement. Commercial real estate managers have less incentive to be good at their jobs if they will get paid the same contractual amount no matter what.
A “hybrid” arrangement is sometimes made, whereby a flat fee kicks in if rents collected fall below a minimum threshold.
EXAMPLE:
A manager charges a 3% fee on a gross potential rent of $30,000 per month. If the manager collects every dime, her company pockets $900 for the effort. If, however, they collect less than $15,000 in a month, a flat fee of $500 may kick it. This is understandable since there is a baseline level of human resources and expenses incurred in the management effort. However, if the property really is failing, the management company is at least guaranteed their minimum payout.
Related: What is a good cap rate in Commercial Real Estate?
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This is an exercise in carefully reading your contract and knowing what to look for.
We said above that most commercial property managers charge a percentage of rent collected. Be very cautious when you read the contract—try to catch whether or not it stipulates a percentage of rent due.
“Rent collected” consists of money the company actually collects and deposits into your bank account. Actual cash, checks, money orders, credit card charges, etc.
“Rent due” is how much rent the management company is supposed to collect according to the lease contract … whether the tenant pays up or not.
See the trouble brewing? Suppose your commercial property management agreement stipulates a fee of 5% of the rents collected. A tenant owes $5,000 this month. If the management company collects it all, whether amicably or by threats and admonitions, the company is entitled to $250 of that rent ($5,000 x 5%). If, however, the tenant comes up short and only hands over $4,000, with a promise to pay the rest next month, the manager only has the right to pocket $200 ($4,000 x 5%).
What if your commercial property management contract stipulates a fee of 5% of rents due? Let’s say you have the same tenant who owes $5,000 in rents for this month. Let’s also suppose that this tenant stiffs you completely. Doesn’t hand over a dime of the $5,000 he owes. Because your contract calls for a percentage of “rent due,” you owe the property manager the full $250.
We suggest you look for another company if the commercial real estate management company you audition presents you a contract calling for a fee based on a “percentage of rent due.”
Commercial real estate management percentages tend to start around 1.75%. Nevertheless, it makes good sense to kick that number up to 3% when underwriting a commercial property during your due diligence. There will be other fees. In a perfect world, you only get charged a fee when a property manager performs a service that actually makes you more money, thus justifying the fee. In practice, sometimes it does and sometimes it doesn’t.
This is a tough one. Evictions tend to be money pits. By the time you come to the point of eviction, the tenant has probably stiffed you on a lot of rent, or caused significant damage to your property or reputation. Laws prevent you from kicking your tenant to the curb on the spot. Court filings must be made, with all paperwork in order. The court has no incentive to rush just because you are bleeding money … and on top of all that, your property manager is going to charge you an extra fee?
Still, look at it from their perspective. Evictions take effort, and effort often merits compensation. The sooner the eviction goes through, the sooner the commercial property manager can install a tenant who (hopefully) actually pays her bills.
On the other hand, it may have been the property manager, or an employee under his supervision, who installed the deadbeat tenant in the first place. Consider pushing back against an eviction fee levied by your property manager, especially a fee over $500.
NOTE: Courts often charge a fee to file an eviction. Your property manager may pay an attorney to properly file the eviction. Believe us, you want that eviction filed properly, or a judge might throw it out and allow your tenant to stay whether they pay their rent or not. These filing fees and attorney fees will show up as an expense on your P&L. This is normal. What you want to look out for is an extra fee paid to your manager for the trouble of evicting a tenant that they should probably have screened better in the first place.
EXAMPLE:
Your commercial property manager charges $300 to process an eviction, in addition to $250 paid to an eviction attorney and $50 paid to the court to file the eviction. Not good.
This one is also sticky. Lease terminations usually herald a loss for the real estate investor. The unit is about to become vacant. It will probably require rehab, leasing commissions, and other expenses before another rent-paying tenant is installed. There isn’t the extra expense and headache of an eviction, but it still hurts the bottom line. Consider negotiating away a lease termination fee, especially if it is more than a few hundred dollars.
Lease renewals can be a beautiful thing. You have a great tenant relationship, rent might increase, you don’t have to rehab the unit, weather a vacancy, or pay a new leasing commission. Your property manager may charge you a few hundred dollars to process a lease renewal.
This falls under the happy category of expenses that actually help your bottom line. Consider, though—renewing an old lease requires significantly less effort on the part of your property manager compared to finding a new tenant. Renewal fees over a few hundred dollars should definitely be negotiated. At that point, you’re basically being charged for Xerox paper at $50 a sheet.
Consider negotiating this away. Late rent payments and the ensuing late fees still count toward a percentage of rent collected for the commercial property manager. They may assess late fees that they also collect a percentage from. Charging you, the investor, a fee to collect that late payment is serious double-dipping.
For each fee your commercial property manager asks for, consider whether the fee compensates a service that makes you more money, increasing your cash flow and the value of the investment.
One common fee is a “leasing fee” or “leasing commission.” Since you have no revenue without leases, this is a pretty easy fee to justify. Please note, however, what commissions the manager might be paying to commercial locating agents to refer tenants to you. If another real estate agent is the “procuring cause” of the tenant, they deserve the lion’s share of the fee. If the commercial real estate manager charges you a large leasing fee, consider asking them to absorb the commercial locator’s commission.
Remember that NOI isn’t just about increasing revenue—it’s also about decreasing expenses. Your commercial property manager may justify fees that reduce expenses.
EXAMPLE:
If you are on the hook for property taxes or utility expenses, your property manager may take on the task of protesting those taxes or undergoing energy-saving projects to reduce those expenses. They may propose a contract that entitles them to a percentage fo the savings—say, 20-30% in the difference between the tax bill before and after the protest.
Again, property management should be an acceptable expense that adds value and saves you time. It’s worth paying for that privilege, but don’t stand still if you think you are being overcharged.
Read your commercial property management agreement carefully. The management company may have a boilerplate agreement to show you, but everything is negotiable. Note every fee and protest any fees you think are too high.
An email or phone call is fine. Just ask “What is the purpose of this fee?” or just state, “I think the fee should be $XX.” The worst they can say is “No, sorry, that’s standard.” Ask again. If the person you are talking to says they don’t have the authority to waive the fee, ask to speak to someone who does. Remember, you hold the cards in this negotiation. The commercial management company wants your business.
Some fees to definitely question and push back against include:
All tenants have needs to service, but the stakes rise with commercial tenants. A plumbing mishap or broken HVAC may inconvenience a tenant; it may shut down or interrupt the business operations of a commercial tenant. These consequences can transfer to the landlord or investor group as well; if the tenant has a net lease, their decreased revenue is also your decreased revenue because rent consists of a percentage of business revenue. Too much downtime could cause a commercial tenant to close its doors for good, which is bad for everyone involved.
A lot is riding on a commercial property real estate manager to do his or her job well. Keep that in mind as we take a deep dive into commercial property real estate management fees and commissions …
Property management companies play a very important role within the commercial real estate industry. Most landlords do not want to deal with the day-to-day responsibilities that come with property ownership, such as dealing with tenants, vendors, contractors, and other parties that have an interest in the party. They can also help bring the landlord’s attention to any potential issues (or opportunities) that emerge on the property.
The CRE management industry is growing as fast as the commercial real estate itself—nearly all landlords will want to work with a property management company, despite the marginal costs that come with it. Working with a management company makes it easier for property owners to expand their operations and own multiple commercial properties at once.
Now, check out our portfolio of commercial office building properties and find out how to get started with Feldman Equities.
Related: What is the difference between Class A, B, and C properties?
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Here are the steps you need to know when investing in commercial real estate and some tips to get you started.
Real estate professionals tend to be old-school. A room full of investors, brokers, and mortgage lenders may resemble an episode of Mad Men more so than an episode of Silicon Valley, complete with the bourbon and the blue blazers. Real estate, they say, is a business of relationships—a series of handshakes, meetings, and phone calls, learning who can play ball and who can’t over luncheons, mixers, tee times, and kids’ graduation parties. That’s how deals get done.
The state of Florida and Tampa has one overriding major industry that is senior to all other industries. I call it the “population growth industry” 😊.