Income derived from many commercial properties depends on occupancy by operating businesses. Some may be tenants; others may be property owners who own a company operating on the property. The operation of these businesses requires lengthy governmental approvals, occupancy permits, conditional use permits, and, in some cases, individual professional licensing before opening. Many permits, licenses, and approvals must be renewed annually with the payment of required fees.

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The impact of government regulations on commercial properties is significant. Federal, state, and local government employees, mostly labor union members, are involved. The U.S. devotes much of its gross domestic product and public expenditures to public-sector employees. When the state collects more taxes, those resources primarily expand the state's size. The expansion of government continues. Some argue that this growth is necessary for public welfare, while others view it as government overreach. This debate is ongoing, and these regulations' implications on America's business economic engine and corresponding efficiencies are complex and multifaceted.

Government permissions and licensing are necessary for generating stabilized income and maintaining high occupancy levels in commercial properties. While serving a regulatory purpose, these requirements also have significant financial and operational implications. Seeking permission for all actions can be seen as a necessary step to ensure compliance with the law. Still, it replaces free will, personal property rights, and the rule of law with a more regulated and controlled environment.

Pushback against prohibitive permissions, such as strict zoning ordinances or high licensing fees, or adverse consequences, like environmental violations or safety hazards, can lead to more rules and regulations. These additional regulations often require more public employees to enforce them, further complicating the regulatory landscape. The process of seeking and maintaining these permissions can be exhaustive and punitive, extending the vacancy period and transferring wealth from the private to the public sectors through taxation (fees).

During periods of vacancy, property owners and lenders are burdened with ongoing expenses such as monthly debt service payments, property taxes, insurance, utilities, maintenance, upkeep, capital improvements, and marketing costs. These financial burdens underscore the importance of maintaining high occupancy levels, emphasizing the financial risk involved in commercial property management.

The income stream from a property is a crucial factor in real estate purchasers' and lenders' lending decisions. Vacancies of any duration can significantly impact this income stream, highlighting the financial risk involved in commercial property management. Government regulations, such as zoning ordinances and conditional use permits, can delay the occupancy of a property, thereby affecting the income stream. This underscores the importance of understanding and navigating these regulations to maintain economic stability and make sound business decisions.

Properties likely to experience extended vacancies:

• Congregate care
• Hospitals
• Hotels/motels
• Restaurants
• Veterinary clinics
• Animal hospitals
• Daycare centers
• Private schools
• Liquor stores
• Gas stations
• Car washes

Understanding the lender's underwriting considerations is not just important; it's vital. This knowledge empowers you to make informed decisions confidently and navigate the complexities of commercial property regulations with a sense of control and assurance.

When a multi-tenant commercial property unit becomes vacant, finding a new tenant with a long-term lease can test patience and preparedness. The capital required and regulatory approvals can lead to potential delays that could extend for months or even years. Knowing this can help you plan and manage your expectations, fostering a sense of preparedness.

Even after finding a new tenant, regulatory approvals may delay business openings and the realization of rental income. Additional capital costs related to the regulations could further reduce profits, so factoring these potential expenses into your financial planning is necessary for maintaining economic stability and making sound business decisions.

Defining terms:

• Land use and zoning ordinances:
• Zoning ordinances are written regulations and laws that define how properties in specific geographic zones can be used. They specify whether the properties can be used for residential, multi-tenant, industrial, or commercial purposes. They may also regulate building and lot size, physical placement, bulk (or density), parking requirements, and the height of structures.
• Zoning ordinances are lengthy documents describing the acceptable use for specified areas of land and the procedures for handling infractions (including any penalties), granting variances, and hearing appeals. They apply to all property uses. Most interactions with municipalities require payment of fees.
• Variances from current zoning standards:

Zoning variances, a common aspect of commercial property regulations, are intended to provide equitable relief or deviation from existing requirements. The property owner or representative must demonstrate that the variance would not conflict with the public interest and that undue hardship or loss of financial return would occur should the variance not be granted. Building code variances may include exceptions to height restrictions, setbacks, moving demising walls, and noise attenuation, providing flexibility within the regulatory framework.

City-issued variances from zoning ordinances run with the land, not the applicant, and may be passed on to future property owners. However, they may also be revoked for many reasons. Please don't feel like a city council member, city planner, inspector, or a friend of the bureaucracy (FOB).

Conditional use permits:

A conditional use permit is issued at the local level. It is a permit, with conditions by the municipality, that allows some deviation from current standards. An applicant for a license must submit a set of plans and a statement of purpose to the proper municipal authorities. Once granted by the municipality, the conditional use permit is usually not transferable and is subject to revocation. Conditional use permits do not run with the land but are temporary approvals that can be terminated.

The process always requires the municipality to pay various fees. Relying on a conditional use permit is a significant factor in a credit decision or value conclusion and could substantially reduce the property value should the permit be revoked.

State licensing of the business operator:

Some properties, such as a senior care facility in an R-1 single-family, zoned neighborhood, may require a state license for the operator and a conditional use permit by the municipality to operate the facility. State licensing of the operator may require special training and testing to prove competency. The purpose is partly to ensure that the operator is qualified. The process also results in governmental entities collecting fees, holding power, and issuing monopoly directives.

Suppose the property is sold or a lender is underwriting it to make a loan. There will be concerns about property conformity, permitting, state licensing of the operator, and the impact on the value of a going concern. A 'going concern' refers to a property currently operating and generating income. The value of a going concern is often higher than that of a property that is not yet operational. Can the growing business create the revenue to pay for expenses and make the debt payments? The common practice is using an income approach with comparable lease rates of similar properties.

Underwriting may be problematic when performing a capitalization rate analysis if the property types differ significantly, even though the going concern business is the same. An example of an underwriting deviation would be comparing a congregate care business, one that operates out of a single-family home, and one that works out of a building that was zoned commercial and designed for the purpose. Both are licensed and meet all the regulatory requirements. Still, only the commercially zoned property can be valued using a capitalization rate analysis based on market rents and expenses to arrive at a net operating income. The single-family home has only alternative uses as an owner-occupied or rental home.

Most practitioners must obtain an individual state license to operate in their chosen field. Licensing is nothing more than a tax by state governments who use force as a mandate to enforce their monopoly. Government agencies are motivated by different efficiencies than private enterprises.

State licensing usually runs with the business operator and will terminate when the title of the property changes.

Zoning, Variances, Licensing, Use Permits, and Conditional Use Permits:

Interpreting land use and zoning, variances, conditional use permits, and municipal and state licensing for business operators becomes a giant maze of complexity. For those trying to start a business, the process becomes one of time, frustration, and fighting through the bureaucratic governmental morass with continuous fee-ee-ee-zzz to feed the beast.

Government agencies require different and sometimes redundant fees for lawfully running a business. They consider allowing the public the temporary privilege or license to operate rather than the natural lawful right to use, as would otherwise occur in a free country. The process is about control, redundant fees, or taxation.

Lawfully is subject to agreeing to pay the government agencies'  fees that they demand. Breakdowns of these approvals may rear their ugly heads for the lender on two occasions. During processing and underwriting, one is on the front to ensure the business operates legally. Multiple challenges can arise after a default occurs, and the lender takes the property through a successful trustee sale. The property becomes lender-owned at that point, and various challenges can arise.

Many businesses, such as restaurants, senior care, medical care, daycare, gas stations, and lab testing, possess a complex overlay of land usage regulations, which permits individual licensing and business operation licensing to function successfully. Many businesses and operators of these companies must seek approval from 20 or more separate government approval processes before opening. Each level of the government bureaucracy has a new application and a waiting period, dealing with a bureaucrat who rarely cares about time and efficiency and demands fees for the temporary privilege. The result is usually a bureaucratic quagmire as a prerequisite to owning and operating a potentially profitable enterprise.

Herein lies a problem for the real estate lender. They must understand all the regulations and licensing approvals required by the business occupant. Which authorizations and permits run with the land, meaning they still exist after the transfer of ownership, and which will terminate upon the property transfer? These barriers must be understood to close a loan successfully. In the unfortunate circumstance of a borrower default and a subsequent successful foreclosure, can the lender be confident that the protective equity is still there and cannot be unraveled by loss of previously obtained approvals?

Example:

Restaurant start-up: A partial list of approvals, licenses, and annual inspections are required.

It is challenging to open a restaurant business, get it started, pass the break-even mark, and maintain a profit over time. The breakdown may average 40% infrastructure cost, including labor, 20% food and liquor costs, and 40% gross profit markup.

Developing a business plan and marketing strategy, food and drink menu, food preparation, consistent quality, continuous regulations, employee hiring and retention, internal theft, and liability all pressure the operator.

Food markups and related costs vary significantly in privately owned and chain restaurants. If a coffee lover buys a 20-ounce cup daily from a cult-like national chain, they will spend $700 to $1,100 per year ($3 X 365 = $1,095), plus the wait and, in many cases, the wasted gas while idling in line for the coveted prize. The same cup brewed at home by the consumer may be 15-20 cents or $75 per year.

Because of the stress, many restaurants have changed to forms of additional charges and minimized portions. Liquor has a 200 to 575% markup. When drink portions go down, you may now trade in your old martini for an iced down (martini) and a glass of wine for a glass, but pay for a full glass. Taking your premium wine and paying a corkage fee becomes preferable. A short-poured martini (1.5 oz) with tax and tip could cost $20 to $25. At home, assuming a 1/2 gallon of Kettle One costs $30 and has 64 ounces. 2.5 oz of vodka, dry vermouth, and two green olives may cost less than $2. The $10 draft beer adds sales tax and tip, costing $15. The same beer may be purchased and consumed at home for $1.50 to $2.00.

Failure rates range from American Express's estimate that 90% of start-up restaurants will leave the business in the first year. The National Restaurant Association estimates a failure rate of 30% in the first three years. Requirements imposed by labor unions, such as the Service Employee International Union (SEIU), add to the pressure and failure rate.

Getting started can cost from a low of $250,000 up to $2,000,000 or higher with fancy tenant improvements (TIs), furniture, fixtures, equipment (FF&E), and start-up expenses. There are many sources of estimates.

Consultants are necessary to chart the approvals flow and expedite when possible.

Fictitious Business Name, Doing Business As

The Statement will be filed with the County Clerk-Recorder Fictitious Business Filing Division.

Municipal Business License-

This license is required for all entities within city limits or county unincorporated areas. For a restaurant, fees may be up to $7,000.

Obtain a business license from the local government. Pay a fee.

Obtain a business license from the county government. Pay a fee.

https://www.uschamber.com/co/start/startup/business-licenses-and-permit-guide

The California Department of Tax and Fee Administration administers 37 different taxes and fees. You may visit the U.S. Small Business Administration (SBA) to determine the state and city-specific rules for obtaining a business license.

Franchise State Tax Board:

State income tax registration requires filing appropriate forms to notify of incoming tax receipts. File with the State Franchise Tax Board within 40 days of starting the business.

https://www.ca.gov/agency/?item=Franchise-Tax-Board

Federal Employer Identification Number (EIN) filed with the IRS.

Employers with employees, business partnerships, and corporations must also obtain an EIN. An EIN is similar to an individual's Social Security number. The EIN must open a bank account, apply for a business license, and file a business tax return.

• https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online
• Air Quality Management permit to operate- inspect and permit process for installation according to new emissions standards:

https://www.aqmd.gov/home/permits/permit-application-forms

Building permits, plans for new buildings, renovations, and tenant improvements must be submitted to a long and arduous approval process in advance to obtain a building permit. Multiple fees are charged.

Every phase of building construction and tenant improvements requires a separate permit process and inspection for every completed component, and multiple fees are charged.

https://ocds.ocpublicworks.com/service-areas/oc-development-services/building-safety/building-grading-information/building-permit

https://ocds.ocpublicworks.com/service-areas/oc-development-services/planning-development/applications-and-forms

Wastewater Discharge Permit-Connection: The sewer system must exist or be established, and high volumes or unusual wastewater content require a permit with a fee.

https://www.epa.gov/npdes/npdes-permit-basics

https://www.waterboards.ca.gov/water_issues/programs/waste_discharge_requirements/

Dumpster Placement Permit: This is required to place dumpsters outside the kitchen area.

https://www.dumpsters.com/resources/dumpster-permits

https://ocds.ocpublicworks.com/service-areas/oc-development-services/permitting-services

Fire Prevention Permit: Each jurisdiction has a separate governing body. Orange County, California, has the Orange County Fire Authority.

Fire Prevention and Code Enforcement

Fire inspectors who work under a fire marshal are authorized to enforce specific codes.

Facility fire inspection- annual inspection

Fire extinguishers-annual inspection

Fire alarm permit- yearly inspection.

The fire sprinkler system permit is for annual inspection and testing.

https://ocfa.org/AboutUs/Departments/CommunityRiskReductionDirectory/PreventionFieldServices.aspx

https://ocfa.org/AboutUs/Departments/CommunityRiskReductionDirectory/PlanningAndDevelopment.aspx

Certificate of Occupancy- After the commercial space has been constructed, the final building inspection is done to receive the coveted Occupancy permit. You may pass after several inspections, including plumbing, electrical, fire safety, and building inspections.

Food Service License

An operator can expect regular health department inspections once this permit is obtained.

Please review the U.S. Food and Drug Administration's food vendor application and your state's requirements.

https://www.cdph.ca.gov/Programs/CEH/DFDCS/Pages/CertificatesandLicenses.aspx

https://www.calrest.org/food-safety/california-food-handler-card

Food Handler's permit

Referred to as an Employee Health Permit

The permit ensures that the facility meets regulations for food sanitation, storage, protection, and preparation.

ServSafe is an online source for learning about the requirements.

https://pos.toasttab.com/blog/on-the-line/food-licenses-and-permits-in-california

Building Health Permit Businesses preparing and selling food must have approved building plans and equipment and pass a facility inspection before commencing business with the Environmental Health Division Food Program Division.

Federal Bureau of Alcohol license and county Liquor license level- any person or entity seeking to sell alcoholic beverages must be licensed.

Each state has its own Alcohol Beverage Control Board (ABC)

On-premises license, off-premises, all liquor license, beer and wine only.

You can apply for the license in person, and it will be processed in 45-60 days at a minimum. However, the law precludes issuance in less than 30 days.

Alcoholic Beverage Tax- entities selling, manufacturing, importing, or distributing alcoholic beverages must register to collect taxes.

A resale permit that allows your restaurant to make certain nontaxable purchases of food products.

https://www.cdtfa.ca.gov/formspubs/cdtfa230.pdf

https://www.taxes.ca.gov/Sales_and_Use_Tax/Forms.html

Weights and Measures- Businesses using scales, fuel pumps, electronic or manual price lookup scanner devices, or other measuring devices must ensure proper calibration and pass inspections with the Public Facilities and Resources Department, Agriculture Commissioner.

• https://www.cdfa.ca.gov/dms/
• https://www.cdfa.ca.gov/exec/county/Exam_Weights_Measures_Inspector.html

Signage permit:

Traffic Study:

Live entertainment and music license:

Noise attenuation:

Valet Parking Permit:

Pool Table License:

Food truck permit, if applicable:

Workers' compensation files with the Department of Industrial Relations. Businesses with employees must maintain workers' compensation insurance, usually through the State Workers Compensation Insurance Fund or a private insurance carrier.

Why is this all important? Commercial properties containing operating businesses can be an excellent long-term investment strategy. However, the lenders' degree of sophistication requires a much higher understanding of the lengthy process.