1. Chapter 9 Introduction to Income-Producing Properties: Leases,
Rents, and the Market for Space

2. Overview Property Types Supply & Demand Short-Run Supply
Long-Run Supply
Determinants of Supply and Demand for Major Property Types
Location & User-Tenants

3. Property Types

4. Supply & Demand Equilibrium Market Rent Equilibrium Vacancy Rate
Determined by the supply and demand for space
In the short-term supply of space is fixed
Equilibrium Vacancy Rate
Vacant space because tenants moving and the time it takes for newly constructed space to be offered for lease

5. Short-Run Supply

6. Long-Run Supply

7. Determinants of Supply and Demand for Major Property Types

8. 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

9. The Business of Real Estate
Most real estate used by firms is leased rather than owned
Leasing is more cost-effective than owning
Space requirement can be met without significant capital commitment
Stay out of the “real estate business”
Maintenance and repair
Maintain operating flexibility
This results in specialized real estate firms

10. Real Estate Income Market Rent Vacancy
Supply & demand for specific property type
Population demographics & income level
Economic base of the area
Economic forecasts
Vacancy
Allowance for unused space. It should always be included in cash flow projections
It is more predictable for space already in use
It is difficult to estimate for newly constructed properties

11. 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
Use of and maintenance responsibility for common areas
Responsibilities for specific expenses

12. Lease Income Base Rent Flat Rent Leases Step Up Leases Indexed Leases
Initial rent or minimum 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 – dollar amount of rent that exceeds the base rent

13. Leases & Expenses Recoveries Gross Leases Modified Full Service Leases
Operating expenses are usually shared with tenants
These operating expenses are prorated among tenants
Typical operating expenses:
Cleaning, repairs, maintenance, landscaping, water/sewer, security, management, real estate taxes, insurance
Gross Leases
Tenant pays rent only
Property owner pays all operating expenses
Modified Full Service Leases
Tenant pays rent & specified expenses

14. Leases & Expenses – Continued
Leases with Expense Recoveries in Excess of Expense Stops
Tenant pays rent plus some pro-rated “recoverable” operating expenses after an “expense stop” is reached
Pass-Through Leases
Expense pass-through leases that require tenant payments on expenses
Net leases – all operating expenses are passed to tenant with usually no expense stops
Net, net leases – all operating expenses plus property taxes and insurance costs are passed to tenant
Net, net, net leases (triple net) – in additions to all above expenses, tenant pays for maintenance, repairs, and building alterations (tenant improvements)
Combinations
Leases can be designed to serve for the best interest of parties involved and therefore they may have features that are not distinct

15. Effective Rent Used to compare different leases
Compute present value of rent stream
Convert present value to an equivalent annual annuity
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%, what is the effective rent?

16. Effective Rent – Continued

17. Effective Rent – Continued

18. Effective Rent – Continued

19. Effective Rent – Continued

20. Pro-Forma Cash Flow Statement

21. Office Leases Normally 3-7 year terms Renewal option of tenant
Premium rents for highly desirable space
Rent discounts for space
Right of first refusal
Right to rent contiguous space as it becomes available
Right to put back space
Purchase option

22. Industrial Property Leases
Similar to office leases
Individualized and longer
Tend to be pass-through or
Net
Net, net
Net, net, net leases
Premiums & discounts

23. Retail Leases Sales per square foot Provisions on operations
Limits on other tenants
Anchor and in-line tenants
Rent differences
Common Area Maintenance (CAM)

24. Apartment Leases Shorter term Consumer protection laws
Gross potential rental income
Based on full occupancy
Loss to lease - lease difference between new and old leases times number of old leases/units