Chapter 23 Commercial Brokerage and Leasing “Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner

Major Topics Commercial Brokerage Functions Lease analysis from the tenants perspective Lease analysis from the landlords perspective Influences on effective rent Cash flow analysis and buyer/seller perspectives on proforma assumptions Cap Rate influences Before and after tax cash flow and resale analysis “Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner

Introduction and Overview Commercial brokers on average have far more training than residential brokers and tend to earn far higher earnings Good commercial agents will have a great deal of general business knowledge and tend to specialize by property type within a given market region Specializations may include office, retail, multifamily, industrial, agricultural or even recreational property “Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner

The Building Block of Investment Value Begins With the Tenant and Lease While in residential brokerage the qualitative factors may dominate value, but within the commercial brokerage industry it is the financial terms that dominate views on value The value of a building is primarily the summed value of the net productivity of leased space, as now constrained by lease contracts and as affected by operating expenses, market trends and longer term prospects “Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner

Investment Value (Contd.) LPV = Lease Present Value For the landlord, the appropriate discount rate, k, is based on the potential yield for similar risk investments in the capital market and for a similar term or time horizon Thus, k could be derived from the credit worthiness of the tenant as revealed through the tenants borrowing rate In any scenario k is derived from opportunities in the market adjusted for risk and timing “Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner

Types of Lease Analysis The net present value of the lease for the entire period of the lease The effective rent or lease costs per period on a level basis The total dollar outflow or to be received The net present value of the lease per square foot The effective level rent payment or receipt per square foot.

Key Terms Sector or Submarket Peer Group Analysis Discount Rate Tenant Improvements Landlord Concessions CAM CAM Proration Formula Caps on expenses or Expense Stops Effective Annualized Rent Effective Monthly Rent Effective Annualized or Monthly Rent Per Square Foot

Computing the "Effective Rent" of a Lease Simply comparing the initial or average base rent charged in two leases could be very misleading The effective rent is a way of expressing the net present value of the rental payments of the lease in an equivalent annual level payment (or "annuity") form The "effective rent" controls to some extent for factors such as expenses and different lease duration, and is therefore a measure that allows different types of leases to be compared

Effective Rent Calculation Procedure Step 1) Calculate the Lease Present Value, LPV, as described earlier Step 2) Calculate the Annualized Value ("Level Annuity Payment") of the LPV where "k" is the same discount rate as above, and "T" is again the term of the lease

Numerical Example of Effective Rent Calculation Lease "A": Term: 5 years Rent: $20/SF, net Concessions: 1 year free rent, up front

Effective Rent Calculation (Contd.) Lease “B": Term: 6 years Rent: $25/SF, net Concessions: 2 years free rent, up front Landlord would prefer Lease A over Lease B, even though lease B has a higher "nominal rent" ($25/SF vs. $20/SF) Similarly, the tenant would prefer Lease B

More In-depth and Detailed Lease Comparison and Submarket Analysis

Revisiting the Proforma, and Cap Rates for a Specific Building Value Estimation

Proforma (Contd.) Notice that in the next three years the projected NOI will decrease before it increases This is simply the result of flat leases that become below market over time (prior to turning over) and later on being adjusted towards market rent It is also the result of some assumed longer term vacancy rate of 5% which is not expected to occur for at least one year

Recap of Calculating Before and After Tax Cash Flow

Resale Proceeds Step 1: Estimate the resale price Step 2: Subtract expected selling costs and other transaction costs to derive Net Selling Price Step 3: Subtract the mortgage balance remaining at the projected time of sale and any prepayment penalties due on the mortgage, to derive the before tax resale proceeds. This is where the analysis would stop if the investor is not a taxable entity Step 4: Subtract the taxes due on sale to derive the projected after tax proceeds from resale

Sample Proforma “Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner

Tax Law Trends Matter to Investors and Commercial Real Estate Firms General income tax rates Capital gains tax rates Depreciation rules and economic life Passive loss limitations Tax Credits “Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner

Commercial Leasing and Brokerage Fees Like residential brokerage most commercial brokers or agents make their income mostly based on contingent commission fees Contingent fees are paid only if a lease is signed or a property is bought or sold These fees must include sufficient margins to subsidize the deals that don’t close and be large enough to cover overhead, research and support staff cost Fees vary significantly but typical fees for a lease might run 6% of the base rent calculated over the initial term of the lease for a newly signed lease, and 3 to 5 % for a renewal lease

Research Is Becoming More Valuable to Commercial Brokerage Firms CB Richard Ellis Colliers International Cushman & Wakefield DTZ Grubb & Ellis Jones Lang LaSalle Prudential Staubach Company Stiles & Riabokobylko Strutt & Parker Studley, Julien J. Inc

END “Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner