Leases
RM/FIN 460 Real Estate Financial Analysis - Jiro Yoshida
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Course Code: RM/FIN 460
Course Title: Real Estate Financial Analysis
Instructor: Jiro Yoshida
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Section 05-1: Lecture Topics
Cash Flow (CF) – Income
Income
Costs
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Commercial Real Estate Cash Flows
Potential Gross Income (PGI): Calculated as follows
Vacancy Allowance (VA): To account for expected vacancies
Effective Gross Income (EGI):
Other Income (OI): Sources such as parking and reimbursements
Operating Expenses (OE): Costs to operate the property
Net Operating Income (NOI): Final income after expenses
Capital Improvement Expenditures (CapEx): Long-term investments are deducted from the NOI to find the Property Before-Tax Cash Flow
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Additional Resources:
Link: Breaking into Wall Street
Focus on:
Absorption & turnover vacancy
Expense reimbursement
CapEx, Tenant Improvements (TI), and Leasing Commissions (LC)
Definitions from Geltner and Miller are essential for this course.
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Related Terms:
Income: Revenue generated from property.
Lease: Contractual agreement for property use.
Contract: Binding agreement.
Urban: Related to a city or town.
Location: Geographical area of property.
Downtown: Central area of a city.
San Francisco Market Condition: Specific conditions pertaining to San Francisco real estate.
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Motivating Questions:
Current NOI is $1M with a 0% vacancy.
Questions to analyze:
What will NOI be if operating expenses increase by $200K?
What will NOI be if the vacancy rate reaches 50%?
Required knowledge to answer these questions:
Understanding of operating expenses impact and vacancy rates.
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When Do You See Reimbursements?
In financial calculations, reimbursements are observed under certain conditions.
For example, under a Gross Lease vs. Net Lease (NNN), the equation alters based on whether reimbursements are added:
For Gross Lease:
For Net Lease:
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Income Composition by Property Type (2021):
2022 Operations Benchmark
Various pie charts detail income types among property categories (Apartment, Industrial, Office, Retail).
Breakdown of income types:
Base Rent
Contingent Rent
Reimbursement Income
Other Income
Percentages reflecting sampled incomes by type illustrate trends in real estate earnings.
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Average Vacancy Rates:
Historical average ranges:
2% to 18%
Average Occupancy Rates (for various years from 1990.Q2 to 2023.Q2)** shown graphically to illustrate trends.
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PENNSYLVANIA COMMERCIAL LEASE
Gross Lease:
Tenants are not liable for expenses beyond Base Rent.
Responsibilities for major systems:
Maintenance of the structure and systems including heating and electrical infrastructure lies with the landlord.
The Lessee must hold liability insurance of at least $1,000,000 naming the Lessor as an additional insured.
Modified Gross and Triple Net Leases:
Modified Gross Lease: Tenants pay Base Rent + specified monthly expenses.
Triple Net Lease (NNN): Tenants bear responsibility for all operating expenses, including property taxes, insurance, and maintenance.
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Example: NNN Lease
Analysis of a 100K sq. ft. building at 100% occupancy illustrates financial impacts:
Effective Gross Income (EGI): $1,000K at $10/sf; Operating Expenses (OE): $200K yielding a Net Operating Income (NOI) of $800K.
Renter Reimbursement distribution among tenants A, B, C calculated based on their occupancy percentages (50%, 25%, 25%).
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Example: NNN Lease with Cost Increase
Effects of increasing OE from $200K to $400K, leading to lower NOI and overall financial structure adjustments showcased.
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Example: Gross Lease
Gross Lease analysis of a 100K sq. ft. building showing EGI $1,200K and OE $200K leads to NOI determining protocols.
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Example: Gross Lease with Cost Increase
Similar to previous, demonstrating revenue and expense shifts due to increased operating costs.
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Example: Gross Lease with Expense Stop
Evaluating cap structure when owner's expenses are capped at $2/sf outlines the impact of financial responsibilities for each entity.
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Example: Gross Lease with Expense Stop & Cost Decrease
Calculating scenarios where expenses decrease, emphasizing the revenues from operating strategies in the commercial leases.
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Example: NNN Lease with Cost Decrease
Understanding the impact of cost structures in a NNN lease provides insight into profitability.
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Example: NNN Lease with Vacancies
Assessing vacancy impacts when 50% occupancy reflects adjustments in revenue and expenses.
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Example: Gross Lease with Vacancies
Similarly demonstrates effects of vacancy on overall financial structures.
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Owner’s NOI and OE Analysis
A comparison chart illustrates structural differences in NOI based on occupancy percentages and operational costs.
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Gross vs Net Comparisons Overview
Discusses variations in rent derived from operating expense adjustments, risk compensations and overall lease negotiation strategies illustrating economic theories.
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Cost Structure by Property Type (2021)
Detailed analysis of allocation among Capital Expenditure and Operating Expenses across various property types including Apartments, Industrial, Office, and Retail.
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Answers to Motivating Questions:
The effect of increasing operating expenses on NOI showcased through calculations estimating reductions and overall profit margins.
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FIN415 Course Contents
Elements of investment analysis focusing on CapEx, Opex, and revenues including case studies for Baldwin company.
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Operating Expenses Defined
Lists regular costs associated with property operation including Property Taxes, Insurance, Utilities, and Property Management Expenses.
IMPORTANT: Exclusions such as income taxes and capital expenditures are emphasized.
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Operating Expenses by Property Type (2021)
Various property categories analyzed to reveal percentage distributions of different costs.
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User Cost Representation
Discusses user cost equations defining property taxes and other operational expenses summed for evaluation.
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Khan on Depreciation Concept
Example of a truck purchase and related costs illustrating how depreciation fits into cash flow statements.
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No Depreciation in Cash Flow Statements Overview
Comparison of depreciation methods across various countries illustrating global approaches to depreciation in property contexts.
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CapEx Explanation
Differentiate between Major Repairs and Long-Term Tenant Improvements as they relate to regular operation costs.
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Operating Expenses and Fixed Structures:
Explanation of fixed nature in property taxes, insurance, and property management related to stability performance.
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Risk Analysis in Real Estate
Outlines relevant risks associated with rent inflation, vacancy, risk sharing, and concessions.
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Rent Revision Types
Various methods of rent adjustments explained: Flat, Percentage, Indexed, and Graduated with contractual stipulations.
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Example Retail Lease Contract
Basic components such as date, names, term, rent, operating expenses detailed for clarity on lease structures.
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Risk Stability Analysis
Discusses stability in gross revenue versus indexed rent, evaluating net operating performance over time.
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Occupancy Rate Impact on Costs
Analyze changes in Effective Gross Income (EGI) and NOI when occupancy rates adjust significantly.
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Mathematical Breakdown of Changes
Numerical examples demonstrating percentage changes in EGI and NOI based on occupancy dynamics.
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Operating Leverage and Risk
Discusses the sensitivity of NOI to occupancy changes and corresponding leverage ratios.
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Operating Leverage Ratio Definitions
Detailed equation breakdown linking NOI, rental income, variable costs, and occupancy effects.
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Percentage Rent Agreements
Describes how percentage rent is structured in retail leases aligning tenant and landlord interests together.
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Rent Concessions Overview
Indicates various forms of concessions offered to tenants such as free rent, moving costs, and improvements allowances.
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Free Rent Trends in Office Markets
Data showing average free months offered across different gateway office markets concludes timeframes and execution gaps.
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Effective Rent Calculation
Formula explaining effective rent as a net present value calculation of future payments adjusting for rent discounts.
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Constrained Cash Flow Analysis
Questioning future tenants' NOI projections based on renewal probabilities and CapEx considerations illustrated.
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Calculating NOIs and PBTCF Examples
Utilizes different expected scenarios for renewals or non-renewals to present comprehensive cash flow calculations.
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Vacancy Allowance Analysis
Example forecasting of NOI per unit after controlling for vacancy allowance nuances given market dynamics.
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Final Calculation from Example Scenarios
Detailed calculation revealing accurate NOI forecasts after taking into account various allowances and expected increases in rents adjusted accordingly.