Transcript Slide 1

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Introduction to IncomeProducing Properties:
Leases, Rents, and the
Market for Space
©2008 The McGraw-Hill Companies,
All Rights Reserved
McGraw-Hill/Irwin
Property Types
• Residential
 Single Family
 Multifamily
• Nonresidential
 Commercial
• Office Buildings
• Retail
 Industrial
• Warehouse Space
• Manufacturing
9-2
Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved
Property Types
 Hotel/Motel
• One-night stays
• Destination resorts
 Recreational
 Institutional
• Government
• Hospital
• University
9-3
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Popular Business Choice: Leasing
• More cost-effective than owning
 Space requirements
 Owning is a heavy capital investment
 Stay out of the “real estate business”
• Maintenance and repair
 Maintain operating flexibility
• This results in specialized real estate
firms.
9-4
Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved
Leases
• Lessor-Owner, Lessee-Tenant
• Qualify the tenant – underwriting
 Financial capacity
• Some Lease Content Items
 Parties, Dates, Length
 Base rent & any adjustments, deposits
 Allowable uses & restrictions
9-5
Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved
Lease Income
• Base Rent
 Initial rent
• Flat Rent Leases
 No rent change over lease term
• Step-up Leases
 Specified rent increases at specified times
• Indexed Leases
 Periodic rent adjustment-CPI Index
• Percentage Lease
 Rent partially based on sales
 Overage Rent
9-6
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Responsibility for Expenses
• Gross / full service lease
 Owner/landlord pays all expenses
• Net lease
 tenant pays all operating expenses
• Expenses stop
 Owner pays up to the “stop”
 Expenses in excess of the stop are “passes
through” to tenants
 The stop is typically the expenses per s.f. in the
first year of the lease
 There can be a “cap” on the amount passed
through
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Example of Expense Stop
• A tenant has an expenses stop of $5 per s.f.
based on expenses the first year of the lease
• Expenses per s.f. are currently $7 per s.f. and
the tenant has 15,000 s.f. of leaseable area
• How much does the owner and tenant pay in
expenses for this tenant’s space?
• A: The owner pays $5 x 15,000= $75,000
The tenant pays ($7-$5) x 15,000= $30,000
9-8
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Pro-Forma Cash Flow Statement
Rental Income
+ Other Income
+ Recovery of Expenses
- Vacancy & Collections
- Concessions
______________________
Effective Gross Income (EGI)
9-9
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Pro-Forma Cash Flow Statement
EGI
- Operating Expenses
______________________
Cash Flow from Operations (NOI)
- Lease Commissions
- Recurring Capital Outlays
- Nonrecurring Capital Outlays
______________________
Net Cash Flow
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Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved
Effective rent
• We need a single measure to compare
leasing alternatives
• To calculate effective rent, we need to:
 Calculate the PV of expected net rental
stream to the owner of the building
• Net of any operating expenses paid by owner
 Calculate an equivalent level annuity over
the term of lease which has the same PV
• This measures the return to the lessor
and cost to the lessee.
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Effective rent - Examples
• What are the effective rents for the following 6
5-year leases at 10% discount rate?
• 1. net lease with steps
 $10 / sf for 1st year and increases by $1 each of the
following 4 years
 Tenants pay all operating expenses
9-12
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Effective rent - Examples
• 2. net lease with one year free rent
 Free rent in the 1st year
 $14.50 / sf for 2st year and increases by $1
per year thereafter
 Tenants pay all operating expenses
9-13
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Effective rent - Examples
• 3. net lease with CPI adjustments
 $11 / sf for 1st year and increases by CPI in
each following 4 years
 Tenants pay all operating expenses
 CPI is expected to grow at 2% during year
2, 3% year 3, 4% year 4 and 5% year 5
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Effective rent - Examples
• 4. gross lease
 $17.50 / sf for 1st year and stays flat
 Lessor responsible for all operating
expenses
 Expenses estimated to be $4 in year1, and
increase by $0.50 each year
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Effective rent - Examples
• 5. gross lease with expense stop
 Base rent $15.5 / sf for 1st year and stays
flat
 Lessor responsible for operating expenses
up to an expense stop of $4/sf
 Expenses expected to be $4 for year 1, and
increase by 50 cents each year
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Effective rent - Examples
• 6. gross lease with expense stop and
CPI adjustment
 $14.5 / sf for 1st year and increases by CPI
changes in each of the following 5 years
 Expense stop at $4/sf
 CPI is expected to be 2% during year 2, 3%
year 3, 4% year 4 and 5% year 5
 Expenses expected to be $4 for year 1, and
increase by 50 cents each year
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Office Leases: Load factors
• Load factor for floor =

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Rental area per floor
Usable area per floor
Example: a floor has 20K rental area and
2K common area, or 18K usable area.
Q: What is the square footage that a
tenant with 4,500 sf usable area need to
pay for?
Load factor = 20K/18K = 1.11
4,500 * 1.11 = 5,000
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Office Leases: Load factors
• Load factor for building can be
calculated similarly
• Example: 200K rentable sf over 10 floors and
a first floor lobby/common area of 20K.
• If $20 per sf base rents, what is total rents for
4,500 sf?
• 20K/200K = 10% (building load factor of 1.1)
• Revised load factor = 1.11*(1+10%) = 1.222
• Rentable sf = 4,500*1.222 = 5,500 sf
• @ $20/sf, the rent is 5,500*20 = $ 110,000
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Retail Leases
• Overage Rents
 Assume 1,000 sf of rentable space with a
base rent of $35/sf and 8% overage rents
at breakpoint of $900K. If the expected
sale is $1 million, what is the expected
rents?
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Retail Leases
Common area maintenance (CAM)
 Anchor vs in-line tenants
 CAM /sf for in-line space =
total CAM expenses – contribution by anchor
Total rentable space by in-line tenants
Example: A a million sf mall, of which 1.2 million is
rentable, costs $5 million per year for CAM
expenses. Of the 1.2 million rentable anchors
occupy 700K sf, and pay $2/sf CAM charge.
Q: what is CAM charge per sf for in-line tenants?
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