hi, i recently found a commercial deal and having trouble figuring out expenses. ive learned that in multi family, it is usually good idea to expect 50% of income goes to exp. (of course it could be more or less). But, in other commercial deals expenses should be different right? i guess paying tax and insurance is same as multi, but management, repair fee and other fees should be much different? the deals im looking at is 2 unit and 4 unit retail buildings.
Expenses in commercial buildings can be a lot different than in residential units. Many commercial buildings have NNN (triple net) leases, which means that the tenant pays taxes, insurance, interior maintenance, and all utilities. The owner is only responsible for building maintenance. So, the expenses depend on the type of tenant, the type of lease, and the specific details of the lease.
This is how I define the different commercial lease types:
NNN - this is a true triple net lease or absolute net, the tenant is literally responsible for everything from the structure to the ancillary site improvements, this is the typical Walgreens type lease, the owner will have some administrative expenses and maybe minimal management expenses
NN (double net) - the owner is responsible for the structural components such as the foundation, foundation and exterior walls, roof and roof cover. The owner is also probably responsible for the mechanical (HVAC), electrical and plumbing systems. This is sometimes referred to as NNN. I like to call it NN.
Modified Gross - anything between NN and a true gross lease, the owner might be responsible for real estate taxes and/or insurance as well, this might also be called a NN lease, but I call it modified gross
Gross - the owner is literally responsible for everything, this is common in government leases
NN and modified gross are the most common types of leases. The perceived definitions of these terms usually vary from one market to the next and can vary from one investor to the next, but this is how I define them. In a small shopping center the tenants might pay 100% of their pro rated expenses or they might have an expense stop in their lease where the tenants are responsible for say, all expenses over $3.00/S.F.
Based on the properties you’re looking at, at a minimum, I would expect a vacancy and collection loss between 5-15%, a management fee of 3-5%, and an allowance for structural reserves (for short-lived items) of 2-4%. That’s a range of 10-24%. You might also have leasing fees or higher expenses based on the lease structure. Remember that vacancy also includes slow paying and non-paying tenants, not just physically vacant units. Buyers love to neglect the vacancy deduction but it’s not smart to do so.
Be sure there is no deferred maintenance when buying the property. A broker recently told me about a purchase where the owner had to replace all HVAC units for a multi-tenant office building at a cost of $200,000 right after the sale. The buyer wasn’t planning on this expense.