10 Strategic Improvements For Commercial Real Estate Properties

Nov 15, 2017

Commercial real estate property owners are finding ways in which they can raise their property value and profitability.  You don’t need to have a Class A property in order to increase a property’s potential profitability.

One of the simplest ways to add value to a property is to make small improvements that make the building more appealing to tenants, but these don’t have to cost an arm and a leg.

These improvements can fall into one of two categories: 1) Leasehold or 2) Building Improvements. Leasehold improvements include benefits for the tenant, whereas Building Improvements include benefits that you do for the building.

The difference between the two is significant with regards to one very important factor: Taxes. That’s why it’s critical that you understand exactly what a leasehold improvement is before you try and claim it on your next income tax form. Both improvements are managed differently by the Internal Revenue Code.

Leasehold Improvements

Improvements made exclusively to meet the needs of a particular tenant

Leasehold improvements are improvements made exclusively to meet the needs of a particular tenant.

The most common example are build-outs completed when a new tenant moves into a new office or retail property. Historically the definition of a leasehold improvement changes frequently, and the IRS has changed the rules on what a leasehold improvement is five times from 2001 to 2015.

Right now the IRS uses three rules to determine whether or not an improvement falls under the umbrella of a leasehold improvement.

  1. First, the improvement cannot be done by anyone other than the tenant or the landlord.
  2. Second, the improvement must not be done to any common areas, and cannot affect any other tenant’s space. It also can’t change the structure of the actual building in any way.
  3. Third, the investment property has to have been in use for a minimum of three years.

Aside from the benefit gained by attracting quality tenants and the resultant increase in cash flow, leasehold improvements can be depreciated over 15 years. This means that if you spent $50,000 for a tenant buildout, you can claim $3,333 each year for the next 15 years.

Tax Treatment

The cost of leasehold improvements can be depreciated over 15 years. The rule regarding leasehold improvements can be quite complicated and dynamic. We would suggest that you consult with your accountant about the current state of law.

Inexpensive Building Improvements

small changes can transform a property from nondescript to memorable

Building improvements may not be able to be depreciated, but they still affect your bottom line. These small changes can transform a property from nondescript to memorable

10 Ways To Strategically Improve Your Property

1. Improve the lighting

Installing better lighting in more areas is one of the most cost-effective yet dramatic ways to improve the appearance of a space. In addition to adding light fixtures, consider adding energy-efficient light bulbs as well. LED’s, for example, use 25 to 30 percent less energy than incandescent light, and last 25 times longer. That’s a significant saving that increases your cash flow and your property’s overall value in the long-term.

Some specific changes to make:

  • Add recessed LED bulbs to maximize the light level without affecting the visual flow of a space.
  • Remember to choose the LED color temperature wisely. Light temperature depends on the Kelvin value of a bulb. A lower Kelvin value means the light will be warmer and more yellow, which comes out as a cozier light. A higher Kelvin value means the light will be bluer, considered an energizing light.
  • In general, office common areas look best with LED bulb values between 3500 and 4100 K, while bulbs with a value of 5,000 to 6,500K are best for office workspaces, medical facilities, garages, and warehouses.

2. Replace doors

Replacing doors from standard hollow core doors to sturdier, more visually appealing doors can also add a unique appearance to space. This tactic is especially effective in multi-family apartment buildings but can be utilized effectively in upscale office buildings.

3. New floors

Carpets, while relatively inexpensive in the short term, can add up when you consider the cost of replacing a carpet every two or three years. Residential wooden floors have the greatest appeal and match with both contemporary or traditional interiors. If you’d like to minimize costs, install linoleum, which can be purchased to look like wood, but without the price tag.

4. Update appliances

  • White and black appliances are out-of-date; stainless steel is the most popular finish
  • splurge on stainless steel refrigerators, microwaves, dishwashers, and ovens. Stainless steel has a long lifespan and won’t discolor as rapidly as colored alternatives.

5. Beautify molding (trim)

  • Contemporary spaces benefit from thin molding to create seamless home designs
  • Sand and stain wood molding to add rustic appeal to interiors
  • Faux, lightweight pieces can inexpensively and easily install detail along ceilings, floors and window frames

6. Improve the exterior

  • Clean, landscape and prepare the exterior of your building
  • Apply a fresh coat of paint or a deep clean,
  • Install a newly poured or rebuilt walkway
  • Upgrade lighting
  • Cut the Lawn
  • Hide garbage dumpsters or pick up stations from the street

7. Upgrade your building’s signage

This is typically the first thing that people will see as they approach or enter your building. A sign that is difficult to read, hidden by bushes and other landscaping elements or that needs a repair can decrease the value of your property.

8. Rename or name your property

This may also increase charm, character, and desirability.

9. Ramp up security

Measures like alarms, gates, and shutters can add a sense of safety.

10. Resurface your parking lot

If it’s in need of an overhaul, this can make a big visual difference. If you have a gravel parking lot, consider paving it and installing new lighting to not only improve its functionality but its appeal as well. Eliminate any weeds, rough patches and have the lines repainted.

If you don’t have a parking lot, considering renting space from a neighboring building or property to offer to potential renters or buyers as a valuable selling point.

Tax Treatment

Building improvements are depreciated over the same time period as the building is depreciated. Commercial real estate buildings last usually about 39 years. If improvements can be categorized as repairs or leasehold improvements, it means that you can get more tax savings.

To Wrap It Up

Before deciding on any property improvements, look carefully at tax implications (as each commercial real estate property improvement underlies different tax treatment).

Leasehold improvements are not always as simple as you may think. They require much attention as they are subject to constant change. In fact, the Internal Revenue Code changed its treatment of leasehold improvements over the past years.

Leasehold improvements favor the tenant and include benefits for a specific tenant. Such improvements may be replacing a carpet in an office with a laminate flooring. It is the tenant who decides what he/ she will replace.

When it comes to building improvements, they may include replacement of lightning with new high-efficiency fixtures, renovation of the lobby, or installation of a new roof. Moreover, the tenant may request some improvements that are not in his/her space but are still considered as building improvements. Such improvements may be a renovation of a common bathroom, installation of an elevator or escalator.

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