KS

14 - Leasing

Review of Financing

  • Common Legal Entities for Real Estate Investment:

    • Individuals
    • Partnerships
    • Corporations
    • Real Estate Investment Trusts (REITs)

  • Impact of Increasing Leverage:

    • Increases Return on Equity (ROE) due to larger cash flows from a higher total asset base.
    • Financial risk increases as debt obligations grow, potentially leading to liquidity issues.

  • Lender Mitigation Strategies:

    • High down payments to ensure skin in the game.
    • Prepayment penalties to discourage early pay-off of loans.

Pro Formas in Commercial Real Estate Sales and Operations

  • Pro Forma for Sale (Final Period):

    1. Gross Sale Price
    2. - Deductible Sale Expenses
    3. = Net Sale Price
    4. - Mortgage Balance
    5. = Before Tax Cash at Sale (BTCS)
    6. - Tax bill at sale
    7. = After-Tax Cash at Sale (ATCS)

  • Pro Forma for Operations (Multiple Periods):

    1. Gross Income
    2. - Operating Expenses
    3. = Net Operating Income (NOI)
    4. - Debt Service
    5. = Before Tax Cash Flow (BTCF)
    6. - Tax Bill
    7. = After Tax Cash Flow (ATCF)

Key Income and Expense Dynamics in Leasing

  • Gross Income:
    • Directly affected by lease agreements.
  • Expenses:
    • Operating expenses reduce net operating income (NOI) leading to lower cash flow.

Key Components of Leasing Agreements

  • Parties Involved:
    • Lessor (Landlord)
    • Lessee (Tenant)
  • Lease Structure Details:
    • Description and allowed use of space
    • Maintenance obligations
    • Use of common areas

Types of Rent Structures in Leases

  • Base rent:
    • Minimum fixed charge.
  • Graduated Rent:
    • Specified increases over time.
  • Flat Rent:
    • No changes in charges.
  • Indexed Rent:
    • Variations based on Consumer Price Index (CPI).

Rent Dynamics by Building Floor

  • In tall buildings:
    • Rents decline quickly from the 1st to the 2nd floor (approx. 50%).
    • Rents increase on higher floors, typically 0.6% per floor.

Lease Types Based on Expenses

  • Gross Lease: Landlord covers all operating costs.
  • Net Lease: Tenant pays property taxes.
  • Net-Net Lease: Tenant pays property taxes and insurance costs.
  • Triple Net Lease: Tenant covers all operating expenses including maintenance.

Lease Duration Across Property Types

  • Hotels: 1 week to 1 month.
  • Apartments: 1 year (typical).
  • Offices: 3-10 years.
  • Retail: 2-5 years (for small) or 5-15 years (anchor tenants).
  • Industrial: 5-20 years.

Lease Breakage Observations in NYC Storefronts

  • 55% of tenants exit leases within 5 years; 75% leave by year 8.
  • Common reasons for breaking leases include changes in market conditions or personal circumstances.

Lease Option Value Calculations

  • Benefits of Long Leases:
    • Protects against abrupt rent changes.
    • Higher vacancies accepted during tenant search phases.

Lease Concessions and Renewal Options

  • Concessions:
    • Free rent periods, TI allowances, and covering moving costs.
  • Options:
    • Rights for renewal, relocation, or expanding leased space.

Contract Rent vs. Effective Rent Calculations

  • Effective Rent Accounts for concessions and total payments over time:
    Total Effective Rent = NPV ext{(Payments - Concessions)}
  • Equivalent Level Rent (ELR): This is constant and matches NPV.

Examples of Asking vs. Effective Rent per Sector

  • Office: Effective rent is ~80% of asking rent.
  • Retail: Effective rent is ~87% of asking rent.
  • Apartment: Effective rent is ~96% of asking rent.

Revenue Sharing in Retail Properties

  • Typical leases have a combination of base rent and a percentage of tenant sales, aligning incentives for both landlords and tenants.

Summary Points on Leasing Contracts

  • Leasing contracts can vary widely; crucial to analyze concessions, allowances, and potential cash flows.
  • Common area allocations can impact effective rents, especially in comparison to occupied spaces.