1. McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties: Leases, Rents, and the Market for Space

2. 9-2 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Property Types Residential  Single Family  Multifamily Nonresidential  Commercial Office Buildings Retail  Industrial Warehouse Space Manufacturing

3. 9-3 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Property Types Nonresidential  Hotel/Motel One-night stays Destination resorts  Recreational  Institutional Government Hospital University

4. 9-4 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Supply & Demand Equilibrium Rent Equilibrium Vacancy Rate Short-Run Supply Long-Run Supply Demand Factors

5. 9-5 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Location & User-Tenants Motivating Factors  Increase sales Business type where success requires a higher revenue stream and heavy pedestrian traffic  Reduce operating costs Business type where success is based on a lower cost structure and large amount of land  Clustering and submarkets Similar businesses and operating cost structures locate in similar locations

6. 9-6 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Popular Business Choice: Leasing More cost-effective than owning  Space requirements  Owning is a heavy capital investment  Stay out of the “real estate business” Maintenance and repair  Maintain operating flexibility This results in specialized real estate firms.

7. 9-7 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Real Estate Income Market Rent  Supply & demand for specific property type  Population demographics & income level  Economic base of the area  Economic forecasts Vacancy

8. 9-8 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Leases Lessor-Owner, Lessee-Tenant Qualify the tenant – underwriting  Financial capacity Some Lease Content Items  Parties, Dates, Length  Base rent & any adjustments, deposits  Allowable uses & restrictions

9. 9-9 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Lease Income Base Rent  Initial rent Flat Rent Leases  No rent change over lease term Step Up Leases  Specified rent increases at specified times Indexed Leases  Periodic rent adjustment-CPI Index Percentage Lease  Rent partially based on sales  Overage Rent

10. 9-10 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Leases & Expenses Gross Lease  Tenant pays rent only  Property owner pays all operating expenses Modified Full Service Lease  Tenant pays rent & specified expenses

11. 9-11 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Leases & Expenses Expense Stops  Tenant pays rent plus some pro-rated operating expenses Pass-Through Leases  Operating expenses paid by tenant  Net, Net-Net, Net-Net-Net Combinations

12. 9-12 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Effective Rent Used to compare different leases  Compute present value of rent stream  Convert present value to an equivalent annual annuity Example 9-1: Consider the following rent schedule  Year 1 = $12/square foot  Year 2 = $14/square foot  Year 3 = $15/square foot If the interest rate is 12%...

13. 9-13 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Effective Rent Step 1: Compute the present value = 0 = 12 = 14 = 15 = 12 = $32.55 C0 CPT C1 C2 C3 i NPV

14. 9-14 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Effective Rent Step 2: = $32.55 = 3 = 12 = $13.55 This is the effective rent for this rent schedule. n i CPT PMT PV

15. 9-15 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Effective Rent Use the same procedure to evaluate all potential lease alternatives. This measures the return to the lessor and cost to the lessee.

16. 9-16 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Pro-Forma Cash Flow Statement Rental Income + Other Income + Recovery of Expenses -Vacancy & Collections - Concessions ______________________ Effective Gross Income (EGI)

17. 9-17 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Pro-Forma Cash Flow Statement EGI - Operating Expenses ______________________ Cash Flow from Operations (NOI) -Lease Commissions - Recurring Capital Outlays - Nonrecurring Capital Outlays ______________________ Net Cash Flow

18. 9-18 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Office Leases Normally 3-7 Year Terms Renewal option Premium Rents Rent Discounts Right of first refusal Right to put back space Purchase option

19. 9-19 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Industrial Property Leases Similar to office leases Individualized and longer Tend to be pass-through Premiums & Discounts

20. 9-20 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Retail Leases Sales per Square Foot Provisions on operations Limits on Other Tenants Anchor and In-Line Tenants  Rent Differences Common Area Maintenance (CAM) Kick out clause Co-Tenancy clause

21. 9-21 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Apartment Leases Shorter Term Consumer protection laws Gross Potential Rental Income  Full occupancy Loss to Lease