McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties: Leases, Rents, and the Market for Space

9-2 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Property Types Residential  Single Family  Multifamily Nonresidential  Commercial Office Buildings Retail  Industrial Warehouse Space Manufacturing

9-3 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Property Types Nonresidential  Hotel/Motel One-night stays Destination resorts  Recreational  Institutional Government Hospital University

9-4 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Supply & Demand Equilibrium Rent Equilibrium Vacancy Rate Short-Run Supply Long-Run Supply Demand Factors

9-5 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Location & User-Tenants Motivating Factors  Increase sales Business type where success requires a higher revenue stream and heavy pedestrian traffic  Reduce operating costs Business type where success is based on a lower cost structure and large amount of land  Clustering and submarkets Similar businesses and operating cost structures locate in similar locations

9-6 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved 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.

9-7 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Real Estate Income Market Rent  Supply & demand for specific property type  Population demographics & income level  Economic base of the area  Economic forecasts Vacancy

9-8 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

9-9 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

9-10 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Leases & Expenses Gross Lease  Tenant pays rent only  Property owner pays all operating expenses Modified Full Service Lease  Tenant pays rent & specified expenses

9-11 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Leases & Expenses Expense Stops  Tenant pays rent plus some pro-rated operating expenses Pass-Through Leases  Operating expenses paid by tenant  Net, Net-Net, Net-Net-Net Combinations

9-12 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Effective Rent Used to compare different leases  Compute present value of rent stream  Convert present value to an equivalent annual annuity Example 9-1: Consider the following rent schedule  Year 1 = $12/square foot  Year 2 = $14/square foot  Year 3 = $15/square foot If the interest rate is 12%...

9-13 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Effective Rent Step 1: Compute the present value = 0 = 12 = 14 = 15 = 12 = $32.55 C0 CPT C1 C2 C3 i NPV

9-14 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Effective Rent Step 2: = $32.55 = 3 = 12 = $13.55 This is the effective rent for this rent schedule. n i CPT PMT PV

9-15 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Effective Rent Use the same procedure to evaluate all potential lease alternatives. This measures the return to the lessor and cost to the lessee.

9-16 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Pro-Forma Cash Flow Statement Rental Income + Other Income + Recovery of Expenses -Vacancy & Collections - Concessions ______________________ Effective Gross Income (EGI)

9-17 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Pro-Forma Cash Flow Statement EGI - Operating Expenses ______________________ Cash Flow from Operations (NOI) -Lease Commissions - Recurring Capital Outlays - Nonrecurring Capital Outlays ______________________ Net Cash Flow

9-18 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Office Leases Normally 3-7 Year Terms Renewal option Premium Rents Rent Discounts Right of first refusal Right to put back space Purchase option

9-19 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Industrial Property Leases Similar to office leases Individualized and longer Tend to be pass-through Premiums & Discounts

9-20 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Retail Leases Sales per Square Foot Provisions on operations Limits on Other Tenants Anchor and In-Line Tenants  Rent Differences Common Area Maintenance (CAM) Kick out clause Co-Tenancy clause

9-21 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Apartment Leases Shorter Term Consumer protection laws Gross Potential Rental Income  Full occupancy Loss to Lease