Session Plan
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Chapter Five:
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Importance of Market Research
The Anatomy of a Lease
Mini-case on reading a lease
Location & Tenants
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Individual Households
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Firms
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Seek to avoid transportation costs, want to locate
close to economic centers
Seek proximity to customers, suppliers, and work
force
Land Prices
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Price of land decreases with further distance from
economic activity centers.
Local Market Studies
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Real Estate Brokers typically have regional or submarket related information available for their
customers (for a fee).
Local appraisers can also be hired to conduct market
studies for an investor
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Study vacancy, rental, and expense rates in area
Determine level of new construction approved or underway
Provide analysis of demographic information
This is similar to your WFU Off-Campus Student
Housing Occupancy Studies
Kick the Tires Yourself
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Nothing beats visiting the property yourself,
obtaining pictures of the property, and
assessing the neighborhood and overall
location of the property being considered as
an investment.
Pictures in broker packages often represent
the “best case” view of a property, so as an
investor, seeing is believing!
Importance of Leases
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Lease represents the “duration” of the income
stream for an investment property
Lease is an agreement between the lessor (owner)
and lessee (tenant)
Lease Terms can vary depending on property type:
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Apartment: monthly to annually
Office/retail: monthly up to five years
Hotel/motel: daily
Warehouse/industrial: much longer terms (20 years)
How Price of Rent is Determined
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Market Rates for Comparable Space
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Ask brokers, appraisers, other market participants
View additional rent relative to IRR and NPV
Negotiation between lessor and lessee
The Anatomy of a Lease
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Date
Parties to lease
Length of Lease
Approved use & legal description of property
Responsibility for maintenance and repair
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Determined by negotiating power of landlord and tenants
Any Limitations on expenses
Common area maintenance (CAM)
Base rent plus any escalations
Renewal options
Anatomy of a Lease Continued
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Rent
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Could be set over entire term of lease
Could rise with a certain index (CPI for example)
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Percentage/Overage Rent
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Index should not be something controlled by the landlord
For retail properties. Have a base rent and then additional rent
once tenant’s sales surpass a certain benchmark
For example: Tenant pays $20 per square foot annually, but
could also pay 1% annually for sales over $400,000 at the
Panera Bread located on Miller Street.
If rent is fixed over entire term of lease, who bears
the risk if rental rates rise over the period?
Types of Leases
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Type of lease: Gross, Modified Gross, or Net
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Gross/Full Service: owner pays all expenses
Modified Gross: tenant pays for some expenses (possibly
utilities for an office building)
Absolute Net: tenant pays all expenses
Triple Net: tenant pays for taxes, insurance, and
maintenance of property
Expense Stops: owner pays for expenses up to a certain
(stop) point. Above this level, the tenant pays
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Expenses are passed through to the tenant.
Types of Leases
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Index Lease
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Graduated Rental Lease
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Rent can move up or down during term of lease
Escalator Lease
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Rent and operating expenses tied to index (CPI)
Lessor pays first year operating expenses
Lessee pays overage for remaining years
Revaluation Lease
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Periodic rent adjustments based on revaluation of property
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Good for properties in flux (redevelopment)
CAM and NNN Leases
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Some leases provide for tenants reimbursing
owners for various expenses
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Typically for the maintenance of the common
areas of a property
Also could be for repairs, taxes, insurance, and
utilities as negotiated by the owner and tenants
Common Area Maintenance (CAM) must be paid
by the owner for any space in property that is
vacant.
Common Area Maintenance (CAM)
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CAM is typically for repairs, maintenance, and
utilities but can be for any expense depending on
how the lease is structured
Each tenant would typically reimburse the owner
for their proportionate share of the expense being
shared
Consider the following rent roll and expenses
Sq. Ft.
Tenant
2,500
Uncle Bobby's Toy &
Hobby
5,000
Marvelous Marvin's
1,000
Stop and Rob
1,500
The Eatery
Taxes
25,000
Insurance
12,500
Repair/Maint
24,000
Utilities
18,500
Common Area Maintenance (CAM)
Sq. Ft.
Taxes
Insur
2,500
Uncle Bobby's Toy &
Hobby
6,250
3,125
6,000
4,625
5,000
Marvelous Marvin's
12,500
6,250
12,000
9,250
1,000
Stop and Rob
2,500
1,250
2,400
1,850
1,500
The Eatery
3,750
1,875
3,600
2,775
25,000
12,500
24,000
18,500
10,000
Tenant
Totals
Who pays if there is a vacancy?
Repair/Main
Utilities
Another CAM Example
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You own a 20,000 sq. ft. retail strip center. There are currently
four tenants. The leases allow for the taxes, insurance, utilities,
repairs and maintenance to be paid by the tenants.
How much in $ per square foot would each tenant reimburse
the landlord for the current year if…
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Taxes are $20,000
Insurance is $4,500
Utilities are $7,500
Repairs & maintenance is $20,000
How much would each tenant pay annually if each tenant
occupied 5,000 square feet of space?
What if a tenant vacates? Who pays the expenses then?
Example of an expense stop
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A tenant has an expense stop of $5 per square foot
based on expenses during the first year of the lease
Expenses are currently $7 per square foot and the
tenant has 15,000 sq. ft. of rentable area.
How much does the owner and tenant pay in
expenses for this tenant’s space?
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Owner pays: $5 x 15,000= $75,000
Tenant pays: $2 x 15,000= $30,000
Other Lease Contents
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Concessions
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Lease will disclose amount of free rent, if tenant improvements will
be paid by the owner, and other discounts
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Non-compete clause
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Lease will specify if cannot lease adjacent space to a competitor
Non-dilution/radius clause
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When would these be more likely: Low or High Vacancy markets?
Or if tenant cannot lease another location within a certain radius
Common for retail leases.
Domino (or “Go Dark”) Clause
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If anchor tenant vacates, in-line (or supporting) tenants may have
the ability to break their leases for a specified fee
Lease Contents Continued
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Lender approval of major leases
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For both changes to existing tenant mix and for
any new tenants
Load Factor
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Used to pro-rate space
Rentable area per floor divided by useable area
per floor
Lease Addendums: SNDA
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Subordination: lease is subordinate to all
provisions of loan including renewals,
modifications and extensions.
Non-Disturbance: in event of foreclosure,
tenant can stay in property as long as they
are paying rent as agreed.
Attornment: tenant agrees to be tenant for
any subsequent landlord (bank or otherwise).
Lease Rollover Risk
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Evaluation of % of leases maturing in same
period
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Stated maturity vs. business risk issue
This is a concern for both investors and
lenders
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Specific property may be performing well but
others in portfolio could cause repayment issues
Effective Rent
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Present value of the expected income stream from
the lease minus any expenses.
Used to compare leasing alternatives
– Subtract out any expenses landlord must pay
Example: Panera Bread leases 2,000 sq. ft. in a
retail strip center in Winston-Salem. They are paying
$20 per square foot for the next five years, absolute
net. Each year, the rent will increase by 5%.
Determine the effective rent for this lease assuming
a 10% discount rate.
Panera Bread Effective Rent
Year 1
Annual Rent
Discount
Factor
$
40,000
Year 2
$
42,000
Year 3
$
44,100
Year 4
$
46,305
Year 5
$
48,620
1.10
1.21
1.331
1.464
1.61051
PV of Rent
$ 36,363.64
$34,710.74
$33,132.98
$31,629.10
$30,189.19
Total PV
$166,025.65
To then calculate effective rent:
N=5, I=10, PV= (166,025.65), FV=0
Solve for PMT= $43,797.15
Remember: Set your calculator to 1 P/Yr!!!
Ground Lease Decision
How many different owners could there be in a
ground lease?
Which portion of the property would you want to
own and why?
Ground Leases: Bank’s Perspective
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Sale and Lease Back of Land creates a ground
lease between the purchaser of the land, and the
owner of the building
Most banks will not want to loan against a property
that has a ground lease, unless that ground lease
has a substantial period of time left on the lease
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One Rule of Thumb is that lease should exceed the
amortization of the loan by at least 25 years.
Once the ground lease expires, the building
improvements may revert back to the owner of the
land…
End of Session
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Next Session
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Chapter 6
Market Research
Mini-Case