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.