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McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved C H A P T E R 9 Introduction to Income-Producing Properties: Leases, Rents, and the Market for Space

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Page 1: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

McGraw-Hill/Irwin©2008 The McGraw-Hill Companies, All Rights Reserved

CHAPTER

9

CHAPTER

9

Introduction to Income-Producing Properties: Leases, Rents, and the

Market for Space

Page 2: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-2

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Property TypesProperty Types

• Residential Single Family Multifamily

• Nonresidential Commercial

• Office Buildings

• Retail

Industrial• Warehouse Space

• Manufacturing

Page 3: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-3

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Property TypesProperty Types

• Nonresidential Hotel/Motel

• One-night stays

• Destination resorts

Recreational Institutional

• Government

• Hospital

• University

Page 4: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-4

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Supply & DemandSupply & Demand

• Equilibrium Rent

• Equilibrium Vacancy Rate

• Short-Run Supply

• Long-Run Supply

• Demand Factors

Page 5: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-5

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Location & User-TenantsLocation & 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

Page 6: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-6

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Popular Business Choice: LeasingPopular 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.

Page 7: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-7

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Real Estate IncomeReal Estate Income

• Market Rent Supply & demand for specific property type Population demographics & income level Economic base of the area Economic forecasts

• Vacancy

Page 8: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-8

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

LeasesLeases

• 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

Page 9: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-9

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Lease IncomeLease 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

Page 10: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-10

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Leases & ExpensesLeases & Expenses

• Gross Lease Tenant pays rent only Property owner pays all operating expenses

• Modified Full Service Lease Tenant pays rent & specified expenses

Page 11: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-11

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Leases & ExpensesLeases & 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

Page 12: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-12

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Effective RentEffective 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%...

Page 13: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-13

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Effective RentEffective Rent

• Step 1: Compute the present value

= 0

= 12

= 14

= 15

= 12

= $32.55

C0

CPT

C1

C2

C3

i

NPV

Page 14: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-14

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Effective RentEffective Rent

• Step 2:

= $32.55

= 3

= 12

= $13.55

This is the effective rent for this rent schedule.

n

i

CPT PMT

PV

Page 15: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-15

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Effective RentEffective Rent

• Use the same procedure to evaluate all potential lease alternatives.

• This measures the return to the lessor and cost to the lessee.

Page 16: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-16

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Pro-Forma Cash Flow StatementPro-Forma Cash Flow Statement

Rental Income

+ Other Income

+ Recovery of Expenses

- Vacancy & Collections

- Concessions

______________________

Effective Gross Income (EGI)

Page 17: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-17

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Pro-Forma Cash Flow StatementPro-Forma Cash Flow Statement

EGI

- Operating Expenses

______________________

Cash Flow from Operations (NOI)

- Lease Commissions

- Recurring Capital Outlays

- Nonrecurring Capital Outlays

______________________

Net Cash Flow

Page 18: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-18

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Office LeasesOffice Leases

• Normally 3-7 Year Terms

• Renewal option

• Premium Rents

• Rent Discounts

• Right of first refusal

• Right to put back space

• Purchase option

Page 19: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-19

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Industrial Property LeasesIndustrial Property Leases

• Similar to office leases

• Individualized and longer

• Tend to be pass-through

• Premiums & Discounts

Page 20: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-20

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Retail LeasesRetail 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

Page 21: McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER9CHAPTER9 CHAPTER9CHAPTER9 Introduction to Income- Producing Properties:

9-21

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Apartment LeasesApartment Leases

• Shorter Term

• Consumer protection laws

• Gross Potential Rental Income Full occupancy

• Loss to Lease


Chapter 10 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 $ Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

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© McGraw-Hill Companies, Inc., McGraw-Hill/Irwin

Chapter McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill

McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, All Rights Reserved

Local Marketing in Mature Markets Chapter Eight. Irwin/McGraw-Hill ©The McGraw-Hill Companies,, Inc., 2000 Irwin/McGraw-Hill ©The McGraw-Hill Companies,,

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill

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Chapter 11 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Chapter 11 Reporting and Interpreting Owners’ Equity. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc.,

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