CHAPTER 9 INTRODUCTION TO INCOME-PRODUCING PROPERTIES AND VALUATION FUNDAMENTALS Property Types: Residential- Single family Multifamily Nonresidential- Office Retail Industrial Hotel/Motel Recreational Institutional Mixed use Developments
Regional Economic Influences on Property Values “when undertaking a real estate analysis, the analyst must identify the regional economic drivers and make a judgment about whether these drivers will provide a source of growth or decline in a region.” Why do certain kinds of economic activity tend to “cluster” more in some regions and urban areas than others?
Comparative Advantage Comparative Advantage- some geographic regions have a comparative advantage over other regions in that certain goods/services can be produced more efficiently and profitably in that region than in other regions. Reasons: Transportation Natural Resources Climate Leadership Labor Force Educational Skills
Economic Base Theory Many analysts rely on employment data to evaluate a region’s comparative advantage. One widely accepted approach in regional economic analysis is to calculate what are referred to as location quotients for a region. (Regional Employment in a particular sector/Total Regional Employment) (U.S. Employment in a particular sector/Total U.S. Employment) If this ratio is greater than 1, then the sector would be identified as a base or driver industry for a region because it employs a greater than proportionate amount of workers in that industry than is the case for the U.S. as a whole.
Economic Base Theory Employment Multipliers- Used to estimate how total employment in the region is affected by changes in base employment. Relate total employment to base employment, calculate the ratio; estimate increase in base employment ; estimate the increase in total employment. Using this type of macro analysis can help real estate investors identify the potential demand for various types of real estate.
Supply and Demand Analysis
Location and User-Tenants Successful real estate investors and developers realize that location as viewed by user-tenants is also important to recognize. They must understand the business operations of potential tenant-users and how certain locations will appeal to those users. This process of profit analysis and competition by many different firms for space in locations that tend to maximize profits produces certain general land-use results in real estate markets.
Lease or Purchase ? Most tenants find leasing to be more cost-effective than owning. Why? Owning requires a large commitment of capital Owning puts the user in the real estate business Owning may reduce operating flexibility Owners must operate, maintain, and repair the building
Chapter 9 - Continued Introduction to Leases, Projecting Cash Flow and Investment Value
Leases: Longer terms than 1 year normally Base Rent - specified dollar amount of initial lease. Step-Up Provision - specify that rents will increase (step-up) periodically by predetermined amounts over term of lease. CPI Adjustment - periodic increases tied to CPI (protects landlord against inflation. Percentage Rent - Landlord shares in tenants sales - typical for shopping centers - Adv/Disadv? - Share in Gross, net, are what?- verifiable? - Min + % (called overage) - can be sliding scale.
Net Leases - Lessee pays some or all of the expenses - Who covers expenses on building? (property taxes, insurance, utilities, & maintenance) Gross Lease - Lessor (landlord) pays all expenses ->risky on L-T Leases that don’t have escalation clauses. Net Leases - Lessee pays some or all of the expenses - Net - property taxes Net-Net - property taxes + property insurance Triple Net - property taxes, insurance and maintenance. (or all expenses except debt service.
Expense Stops - Lessor pays operating expenses up to a specified amount, then expenses “pass-through” Expense Pass-Throughs - if tenant (s) lease only a portion of the building --> their proportional share pass-through.
Lease Considerations/Concessions: Free Rent - used in tough times, high vacancy rates --> “Get them in the building and hope you can keep them.” Tenant Improvements – lessor usually pays for improvements. Face Rents/Asking Rents - Quote standard rates before discounts are given. Rent Premium or discounts- based on unit location Signage Non-Compete Clauses Lease renewal options - allows tenant to lock space in future at specified rate. Right of First Refusal Tenant Relocation Option - allows lessor to move tenant within building during lease terms Everything is negotiable!!
Lease Terms by Property Types Hotel/Motel: daily/weekend/weekly - the ultimate inflation protection Apartments: 6/12 month terms, renegotiated at end of lease term. Office: 3-5 years, options possible, may include rent increases or tied to CPI, may be net leases or expense pass-throughs. Retail: vary considerably, smaller retailers=short terms (1-2 yrs.), larger retailers (1-20 yrs.). Malls often percentage leases with floors. Industrial: Highly individualized. 3-5 years or longer. Typically triple-net leases.