"Property Play - A Primer for Investors who are considering commercial real estate to build up their nest eggs" by Kemba J. Dunham

In case you missed yesterday's Wall Street Journal article "Property Play - A primer for investors who are considering commercial real estate to build up their nest eggs", here is a review of this great introduction into real estate investing.

In this article, Kemba J. Dunham puts forth a basic outline to consider when looking at commercial real estate. Commercial real estate investments can range between retail strip malls, office buildings to real estate investment trusts (REITS), apartment buildings, and even five family residences. Unlike twenty years ago, financing is readily available for the purchase of commercial properites - making commerical real estate investing an option for the average American. However, as the article states commerical real estate investing is not for everyone and there are key considerations to follow.

First, Ms. Dunham states that every fledgling investor GET HELP. In every market there are commercial real estate brokers that can assist investors in selecting properties. They can add insight into local market rents, comparables, and even lenders. Other key advisors include a real estate attorney, and an accountant.

Second, the article points out several forms of ownership the investor should take title to the property. Direct Ownership or a third party vehicle, such as a Limited Liability Company or General Partnerships are the basic title considerations. Each form has its pluses and minuses. Direct Ownership is means that you take title to the property in your name. Some benefits include favorable tax consequences (consult a expereicned tax consultant), the ability to later conduct a 1031 exchange, and you're your own boss and don't have to share profits. The big downside to direct ownership is the liability - which is squarly on your shoulders.

Ms. Dunham provides a smart consideration to those investors that want to invest in commercial real estate but don't want the headaches of managing the property. In every market, there are capable property management companies that will manage the day to day on the property for a fee - usually 5% to 10% of the gross rent. The article suggest that "when hiring a management company, check out its references and see how well it is regarded locally".

Third, going alone scares many would-be investors, so partnering up with other investors makes sense. Partnering spreads the risk and lowers the personal contribution to get things going. However, an obvious drawback is the fact that you have to share the profits. The article suggests that those who don't want to go it alone find sponsors who buy commercial properties on behalf of small investors for a fee.

It goes on to suggests alternative forms of third party or sponsored ownership methods such as general partnerships, limited liability companies, or tenant-in-common arrangements (TIC). In a TIC arrangement each tenant owns a fractional share in the property. Limited liability companies offer the tax consequences involved in direct ownership while offering a direct liability shield against claims. There is a cost to set up a limited liability company or general partnership and a good commercial lawyer can assist in that process.

The last bit of advice in this great article focused on Triple Net-Lease Properties, which are properties that the tenant covers the utilities, taxes, and insurance in the rent. While the advantge to the owner is just collecting a check every month, the tenant would most likley require a long term lease as incentive to agree to those terms. As Ms. Dunham states in the article, "Because of the long leases, net lease properties can be very illiquid".

Overall, the article is a solid start for anyone looking to enter the commercial real estate market. The best piece of advice is get professional help - a commercial realtor, a real estate attorney, and an accountant.

How do I know I'm getting a good rate? Secrets your Banker doesn't want you to know.

The most obvious way to know if your getting a good deal on your interest rate is to obtain at least three offers from Banks. The second way is not so obvious and is something that your Banker probably would prefer you not know. Here is the quick test.

1) Find out what index or source of funds your loan is based on. Most proposal letters will (should) tell your that your ten-year loan is based on the Ten-Year Treasury, the Ten-Year Federal Home Loan Bank, the Bank's own Cost of Funds, or LIBOR. You can check these base rates on the Internet or in newspapers such as the Wall Street Journal.

2) Take the stated interest rate found in your proposal letter and subtract the base rate determined in Step 1 above. For example, your proposal letter might state a 12% interest rate based on the Ten Year Treasury, which is at 9% (for example only). So 12% minus 9% equals 3% and that represents the Bank's revenue on the loan - revenue not profit. The spread between your stated rate and the base rate tells you a couple of things. First, the greater the spread the greater perceived risk by the Bank on your loan. Second, if you have an existing relationship with a bank, the spread can tell you if they are taking advantage of your company's business.

A fair spread between the index and the stated rate in the proposal letter is usually 2.00% -2.25%. This would represent a normal risk profile and most likely equates to a decent profit for the Bank. Remember, your Bank needs to make money as well and a bank that's not making money on your account will not be that helpful if things go bad.

Spreads in-excess of 2.25% could represent increased risk in the transaction or aggressive profit taking by your Bank. Risky transactions might include acquisition financing, shareholder buy-out that will affect the balance sheet, or a loan to fund net losses in the business. If any of those factors are involved then the Bank is just trying to risk adjust the rate they are charging for the new risk involved.

If your loan request is a normal term loan to buy a new machine, a line of credit to fund growth and your leverage isn't that high (below 3.5x), and your making money, then a spread above 2.5% means that your Bank is trying increase the profit on your relationship. I would speak to your lender and remind him or her of your relationship and that the pricing of the loan doesn't reflect that relationship. The banker might be so embarrassed that he or she might lower the spread to 2.00% or better.

So remember, an interest rate spread above 2.50% requires you to ask questions and either gain an understanding and respect for how your bank is looking at your loan, or come to the realization that your bank is gauging your cash flow through higher than necessary interest rates.