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Basics of leases.

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Presentation on theme: "Basics of leases."— Presentation transcript:

1 Basics of leases

2 Introduction to Leases
A lease is a legal contract between a tenant (lessee) and landlord (lessor) Specifies the rights and obligations of the owner and user A lease divides the “bundle of rights” in real estate into two interests Owner’s Leased Fee Interest Tenant’s Leasehold Estate

3 Subleases A tenant typically has the right to sublease space – unless noted otherwise. Often the landlord will have some right to refuse sub-lease tenants but must be reasonable in accommodating requests. Subleases do not eliminate the tenants (lessee) requirement to guarantee the rent is paid, unless the landlord releases the tenant and then it is no longer a sublease. Page

4 Requirements of a Valid Commercial Lease
Names of owners & tenants with authority to contract Description of property Consideration (deposit or something of value) Legality of leased space (building and zoning code compliance, etc.) Offer and acceptance of the contract Page 2.4

5 Building Measurements
Term Measure Definition and Use Gross Building Area Gross Square Feet (gsf) or GBA Includes all enclosed area Total Rentable Area Rentable Building Area or RBA Gross less vertical penetrations (i.e. stairs, elevator shafts) Common Area aka “Core Space” at CoStar Area shared by all tenants Common areas of the floor like hallways, bathrooms. Building Common Area % (CoStar “Core Factor”) Aka “Load factor” or “Loss Factor” Floor and Building Common area relative to Rentable Area Common area use of the building (does not include vertical penetrations) Efficiency Ratio Ratio of RBA to GBA More efficiency means more rent per GBA but less architectural interest and less common space.

6 Rentable, Usable and Common Space
Not Rentable Usable Common B Elevators Lobby Hall Bath Bath Storage Stairwell C Hall

7 “Core” or Load Factor Rentable Usable Load factor
Calculate the load factor: A Landlord quotes 22,000 SF of Rentable space with 20,000 SF of Usable. Calculate the the “load-factor.” This is a simple problem for review that can be brought to a higher lever.. Points for discussion: How many decimals should you go out. Give an example if you rounded to What would happen to if you had 100,000 SF building? Discuss the add on percentage that is used in some markets. What the add of factor is called in different markets. Focus on hold the three formulas are interrelated. 22,000 = or 10% “load” 20,000

8 ER Efficiency Ratio or inverse of Load factor Rentable Usable
20,000 = 90.91% 22,000

9 Expense Terminology in Leases Types of Leases
Gross Lease Landlord pays all real estate operating expenses to maintain and operate the property including property taxes, insurance, cleaning, painting, landscaping, repairs and sometimes utilities aka “Full Service Lease” Triple Net Lease Tenant pays all of the operating expenses. Net lease – need to see lease to define what is passed through and what is paid by the landlord. Discuss the text book definitions and the local market definitions. Compare and contrast the :full service lease and the gross lease. Page 2.17

10 Commercial Leases Commercial leases can be gross “full service” leases or triple net leases. Most multi-tenant buildings use some sort of net lease, but single tenant buildings are more likely to be triple net. Most Common Most leases fall between the two “Net Lease” where we pay see some pass through items (i.e. property taxes and insurance) Triple or Absolute Net Lease Gross Lease

11 Expense Terminology in Leases
Expense STOP: The point where the landlord stops paying operating expenses, i.e. up to some dollar amount per sq ft. Expense Pass- Through : Operating Expenses that passed to the tenant, sometimes with an admin charge tacked on, esp common in retail shopping centers. Common Area Maintenance: “CAM” Tenant Improvements: “TI s” Concession’s: Ex: TI’s, free rent, free parking spaces.

12 Key Rent Terms Fixed Rental: fixed for period of lease
Step Leases: Often stepped up with pre-negotiated % increases at set intervals Indexed Leases: Often indexed to the CPI Percentage Rent: Also known as “overage rent” based on sales above a defined break point. Lease Renewal Options: Includes new time periods and basis for new rent determination. Expansion options, termination and relocations Options Effective rent: see next slide Discuss how the total effective rent can be adjusted throughout the entire term of the lease. CPI what is it, which one would you use and how does it apply. Discuss the break point and how retailers derive their breakpoint. Sources for industry standards are published by the ULI in Dollars and Cents.

13 Effective Rent Calculation for the landlord
CF2 CF CFt LPV =CF 1+k (1+k) (1+k)t-1 CF is the net cash flow received after all periodic operating expenses CF1 is the net cash flow to the landlord at the beginning of the lease in month 1 While CFt is the net cash flow in the last month of the lease at time t. From the tenant perspective the cash flow is not the net received but the total paid. K is the discount rate used to bring the cash flows back to present value. Last we convert this present value to a level annuity like a flat payment as follows: k(LPV) Effective Rent per period = (1+k)[1 - 1/(1+k)T] This could be monthly or annual. Confusing? Try a visual example……

14 Rent Pattern is converted to an equivalent flat payment for the entire lease period.
2 3 4 5 TI = $25 PSFT No rent Free rent Rent $40 PSF Rent $50 PSF Rent $60 PSF $60 $50 $40 -$25 Effective Rent Annual Calculation using 10% discount rate = $20.77 Could you guess at $20.77 from the above pattern or compare to another lease with a different pattern? That is why we need the calculation, so we can compare Leases. Note: discount rates need not be the same for landlords and tenants.

15 Thank You! Reference texts:
Real Estate Principles for the New Economy by Miller and Geltner (Southwestern/Cengage) or Commercial Real Estate Investment and Analysis by Geltner and Miller (Cengage)

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