Real Estate Finance and Investments: Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]

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Concept Box 9.5: Lease and Selected Operating Characteristics of Apartments

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Apartment Properties*... *_____* (Concept Box 9.5: Lease and Selected Operating Characteristics of Apartments) 1. Leases. a. Multiple occupants - all occupants are jointly and severely liable for rent. No subletting or substitution of tenants is allowed without approval of lessor. A fee may be charged for substitution of any tenants on the lease. b. Lease termination - failure to pay rent, delay in taking occupancy, breach of lease agreement, break of community rules. In some situations, the lessee may be able to terminate the lease and/or temporarily stop rent payments because of military duty or loss of employment. 2. Collection losses are usually due to nonpayment of rent, bankruptcy, abandonment of units, and so on. 3. Concessions and adjustments. Free rents, reduced rents for affordable housing requirements, discounts for corporate accounts, and so on. 4. When leases expire and the tenant does not give notice to vacate or renew, some states require that the lease automatically becomes "month to month," whereas other states may require that the lease be extended for a term equivalent to the original term of the lease. In some cases, if leases are not renewed on the lease expiration date, an additional "fee" may be added to the rent if the tenant renews at a later date. a. Fees are usually charged for late rent payments and for NSF checks. b. Deposits: security, damage, pets - specified dollar amounts usually collected upon execution of the lease and the conditions under which all or part of amounts collected will be returned to the lessee (tenant). c. Move out notice by tenants - usually 30 days prior to move out date. Failure to provide notice results in an additional fee. d. Additional income may come from the following sources: lease cancellation fees, application fees, forfeited deposits, cable TV contract, laundry room, vending machines, garage rentals, club room rents, damage charges, and so on. 5. Recoveries. Heating/cooling, water and special services provided to tenant by property owner. 6. Repairs. Owner takes responsibility for repairs of appliances, roof sprinklers, parking lot, equipment, glass windows, pool, HVAC, and all supplies. Turnover costs: all make-ready expenses (carpet and other cleaning, paint, counter tops, tile/bath, etc.), property maintenance, security, administrative costs, and benefits.

Pro Forma Statement of Cash Flow - Industrial/Warehouse Properties

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Industrial and Warehouse Properties*... *_____* (Pro Forma Statement of Cash Flow - Industrial/Warehouse Properties) In Exhibit 9-10, we provide a brief illustration of the pro forma cash flow for a distribution/warehouse with a total of 100,000 square feet of rentable area, 10 percent of which is office and showroom space... ...property taxes and insurance will be billed, or passed through, to the tenant. These expenses must be paid by the owner. Other outlays shown in Exhibit 9-10 include CAPEX/Improve allowance outlays for recurring expenses prior to occupancy of the warehouse... As was the case for office properties (see Exhibit 9-9), this pro forma is for the base year only. A more thorough investment analysis would include multiyear pro forma statements reflecting changes in revenue and expenses based on the lease agreement and any expected capital outlays for repairs of exterior, structural items such as roofing, parking area, driveways, and the like for the years in which such outlays are expected.

signage clause

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Office Properties* *Rent Premiums and Discounts for Office Space*... *Concept Box 9.3: Lease and Selected Operating Characteristics - Office Properties*... -Signage. The purpose of a _____ is to grant one or more tenants the right to display a name inside and/or outside of the building.

anchor tenants

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Office Properties* *Rent Premiums and Discounts for Office Space*... *Concept Box 9.3: Lease and Selected Operating Characteristics - Office Properties*... -Signage... (For tenants that lease very large amounts of space, sometimes referred to as _____, signage may be offered as an inducement to lease space.)

right of first refusal

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Office Properties* *Rent Premiums and Discounts for Office Space*... *Concept Box 9.3: Lease and Selected Operating Characteristics - Office Properties*... -Tenant _____. According to the _____, tenants may have the right to rent contiguous space and/or any space in the building when it becomes available.

usable area

Load Factor

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Office Properties* *Rent Premiums and Discounts for Office Space*... *Multiple Tenants - Rentable Area per Floor - _____s* In cases where tenants share a building, each tenant will occupy its usable area on a floor. For example, if four tenants share one floor equally and that floor has a total of 20,000 square feet of rentable area that is partitioned off into equal interior office spaces of 4,500 square feet each, then the total usable space on the floor is 18,000 square feet. However, there would have been 20,000 square feet of usable area if only one tenant leased the entire floor... In this instance, the owner will prorate the 2,000 square feet of common area among the four tenant users to determine the rentable area for each tenant by using a _____, which is calculated as follows: _____ per floor = Rentable area per floor / Usable area per floor 1.111 = 20,000 / 18,000 Therefore, for a tenant with usable area of 4,500 square feet, rentable area for that tenant would be caluclated as 4,500 X 1.111 = 5,000 square feet... However, it should be pointed out that loads may vary by tenant and by floor... In many cases, the _____ per floor may be further adjusted for additional area in the building... In our example, if we assume that the 200,000 rentable square feet is distributed evenly over 10 floors (square building), and the first floor is a lobby and common area containing 10,000 square feet, then an owner may also attempt to prorate this lobby common area among all tenants in the building... Therefore, when tenants shop for office space in a multitenanted office building, they will not only be interested in the base rent per square foot. They will also be interested in how the rentable area is determined, including the _____s that will be applied to the usable area they occupy to determine the total rentable area... High _____s generally indicate a large amount of common area, and therefore lower "building efficiency."

Concept Box 9.3: Lease and Selected Operating Characteristics - Office Properties

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Office Properties* *Rent Premiums and Discounts for Office Space*... *_____* (Concept Box 9.3: Lease and Selected Operating Characteristics - Office Properties) Because of the cost and importance of space firms use in their operations, many options and other features are considered by owners and tenants when negotiating leases. In addition to the basic provisions discussed earlier (see Concept Boxes 9.1 and 9.2), what follows is a sample of some features found frequently in office leases: -Tenant right of first refusal... -Tenant right to "put back" space to property owner. Tenant may have the right to decrease space rented in the event that tenant desires to reduce space needs. -Sale or merger by a landlord shall give tenant the option to terminate the lease. -Access/egress. Material modification in access/egress or parking on the site by the owner requires approval of tenant. -Purchase option. The tenant has the first right to purchase the property should the property owner desire to sell at some future date. -Signage... New lease approval. Anchor tenants may want the right to approve any major lease agreements being negotiated by the property owner with new tenants so as to protect their image/identification with the building. -Overloading - use of space. Tenant must keep the current and future number of employees per square foot at an agreed level (e.g., 250 sq. ft. of rentable space per employee). -Parking. Property owner must reserve and/or keep a specified minimum number of spaces relative to rentable square feet currently in the building and relative to leasable space to be constructed in the future.

Determining Lease Revenue

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Office Properties* *Rent Premiums and Discounts for Office Space*... *_____* (Determining Lease Revenue) In order to determine revenue, the base rent per square foot of rentable area must be multiplied by the quantity leased to tenants.

Rentable Area in a Building

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Office Properties* *Rent Premiums and Discounts for Office Space*... *_____* (Rentable Area in a Building) It is useful to think about the rentable area in a building as the total area that could be rented to a single-tenant user. This would usually equal the total area on all floors and the lobby but exclude the nonrentable area, which usually includes the thickness of exterior walls, any columns or protrusions through the floors such as elevator shafts or structural supports, mechanical equipment closets, basements, and so on, needed by the owner to maintain or operate the building. It would include areas such as elevator landings, lobbies, or reception areas, restrooms, or any areas that could be used by a tenant and their visitors/clients (these latter areas are also referred to as common areas).

Rent Premiums and Discounts for Office Space

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Office Properties* *_____* (Rent Premiums and Discounts for Office Space) Office space tends to be leased for three- to seven-year terms with tenants often having the option to renew leases for additional terms. Rents vary by location within office properties, and owners may charge premium rents for space with the following features and locations: -Ground floor, transfer points, and space contiguous to elevator banks. -Higher floors with unobstructed views. -Building corners. Rent discounts may apply to office space in the following locations: -Middle floor and locations not adjacent to the elevator bank. -Offices with obstructed or less desirable views. -Noncontiguous space occupied by one tenant (e.g., space on the second floor and space on the sixth floor). See Concept Box 9.3 for a listing of the typical provisions in office property leases.

Pro Forma Statement of Cash Flow - Office Properties

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Office Properties*... *_____* (Pro Forma Statement of Cash Flow - Office Properties) In Exhibit 9-9, we provide an example of a pro forma statement of cash flow for Webster Office Plaza, a 17-story office property with 459,295 square feet of rentable area... It should be noted that in the revenue section of the statement, an expected expense recoveries from tenants amount equaling $1,139,051 has been included. This amount was estimated by reviewing expense provisions in each of the 65 leases. Such a review should determine leases that (1) are "full service," and therefore do not provide for any operating expense recovery from tenants, (2) are modified full service, (3) provide for pass throughs for taxes and insurance, or (4) provide for operating expense recoveries, and if so, whether "stops" are applicable... It should be stressed that this pro forma statement is intended to provide the reader with guidance as to how to construct a pro forma statement for the base year only. In order to perform a more comprehensive investment analysis of this property, a multiyear forecast for Webster must be made.

termination clause, Cotenancy clause, Exclusivity clause, radius clause

termination clause

radius clause

Exclusivity clause

Contenancy clause

Concept Box 9.4: Leases and Selected Operating Characteristics of Retail Properties

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Retail Properties*... *CAM Charges - Recoveries*... *_____* (Concept Box 9.4: Leases and Selected Operating Characteristics of Retail Properties) Because of the nature of retail properties and the interaction of many vastly different businesses ranging from high fashion to restaurants, many features are unique to leases on retail properties. What follows is a list of some of the more important features that may affect risk and return. -Lease termination or "kick out" clause... -Contenancy clause... -Anchor tenant and lender approval of major leases. In retail situations, large anchor tenants are usually very concerned about the quality, image, and visibility of potential in-line tenants, and they may demand the right to approve all major leases (e.g., 5,000 sq. ft or more) being negotiated between property owners and (1) new in-line tenants and (2) other anchor tenants... -Signage. A signage clause confers the right to display a name inside and/or outside of the building or in the mall ways... -Exclusivity clause... -Nondilution, or radius, clause... -Excluded uses. Many anchor tenants require that some uses be excluded within a specified number of feet from their leased space... -Operating times. All tenants must generally operate during specified times each day and on holidays. This precludes problems that may affect customer traffic due to nonuniformity in times of operation of the many tenants in a retail property.

Anchor Tenants versus In-line Tenants

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Retail Properties*... *The Retail Leasing Environment* *_____* (Anchor Tenants versus In-line Tenants) When an investment in large retail properties is considered, understanding the nature of the business and importance of various tenants is important. A common distinction is made between anchor tenants and in-line, or shop, tenants, Anchor tenants usually include very large department stores or other retailers that achieve very high sales volumes and generate a considerable amount of customer traffic. In many cases, because they lease a very large amount of space, anchors receive large rent discounts and demand many special lease features. In-line tenants, on the other hand, tend to be smaller retailers that hope to generate retail sales as a result of participating in the high shopping traffic, part of which is produced by the anchor tenants.

percentage rent clause

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Retail Properties*... *The Retail Leasing Environment*... *Rents*... For some in-line tenants, an additional component of retail leases combines base rent with a so-called _____. The rationale for this usually occurs when, in spite of high traffic counts and sales volumes, in-line tenants believe that the base rents being asked by the property owner are relatively high. In these cases, tenants may prefer to negotiate a lower base rent and agree to pay additional rents (referred to as overage rents) if their business in the retail property is successful.

breakpoint sales level

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Retail Properties*... *The Retail Leasing Environment*... *Rents*... For some in-line tenants, an additional component of retail leases combines base rent with a so-called percentage rent clause... The additional rent is based on a percentage of the retail sales above some _____.

Rents

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Retail Properties*... *The Retail Leasing Environment*... *_____* (Rents) Another very important distinction between anchor and in-line tenants is the determination of rent. In general, when negotiating with property owners, anchor tenants can usually bargain more effectively than in-line tenants. In many cases, anchor tenants will pay very low rents, or no rent at all. In fact, if a particular anchor tenant is highly desirable, the property owner may be willing to lease space at very favorable rents and provide other incentives such as contributing funds to construct and finish out the space being leased by the anchor... In contrast to the low rents and very long-term leases made with anchor tenants, rents for in-line tenants tend to be driven by current market conditions. Rent typically consists of a base rent per square foot of rentable space for relatively short terms - say, three to five years (with renewal options)... For some in-line tenants, an additional component of retail leases combines base rent with a so-called percentage rent clause.

CAM Charges - Recoveries

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Retail Properties*... *_____* (CAM Charges - Recoveries) As indicated above, another very important component of retail leases is an expense recovery for common area maintenance (CAM)... CAM charges are usually charged to in-line tenants as follows: CAM charges per square foot of rentable in-line space: (Total CAM expenses for the property - Contribution to CAM expenses paid by anchor tenants) / (Total rentable area occupied by in-line tenants) It should be clear that when negotiating CAM charges with anchor tenants, the property owner may be taking on considerable risk... ...in order to justify these favorable terms to anchor tenants, higher rents and CAM expenses may have to be negotiated with in-line tenants... In addition to CAM charges, in some cases, retail property owners may pass through insurance and property taxes directly to all tenants based on the share of the rentable area that they occupy... See Concept Box 9.4 for a discussion of retail property leases and operating characteristics.

Pro Forma Statement of Cash Flow - Retail Properties

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Retail Properties*... *_____* (Pro Forma Statement of Cash Flow - Retail Properties) Exhibit 9-11 provides an illustration for Shady Elm Community Shopping Center, a community center with 245,000 square feet of rentable space... In order to accomplish a more complete investment analysis of Shady Elm, a multiyear pro forma statement of cash flow based on a review of rents and expenses for all 32 leases, plus any expected capital expenditures (CAPEX) in years when outlays are expected to occur, would have to be made. We will provide a discussion of multiperiod pro forma cash flows in Chapter 10.

CAM charges

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Case Example: Retail Properties*... One very important item regarding retail properties is the recovery of expenses related to maintaining common areas, or _____. These expenses tend to be very significant and are very important to tenants in retail properties.

concessions

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Developing Statements of Operating Cash Flow*... After other sources of income and expense recoveries are determined, cash inflow is then reduced by loss of rents because of vacancies and nonpayment of rents (because of tenant bankruptcy, etc.). In addition to these reductions, property owners may have provided tenants with _____, such as move-in allowances or rent reductions for a specified period of time. These are inducements for new tenants to lease space or to keep old tenants who are renewing leases. After these allowances are deduced, the resultant effective gross income is the amount of cash flow available to the owner to pay operating expenses.

effective net rent, net leases

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Comparing Leases: Effective Rent*... Based on the examples shown in Exhibit 9-7(A), property owners can now use ___1___, to compare leases with major differences in rents and responsibility for operating expenses. We should point out that results for ___2___ or those leases with a total operating expense pass through to tenants can now also be considered.

effective net rent

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Comparing Leases: Effective Rent*... Based on the examples shown in Exhibit 9-7(A), property owners can now use _____, to compare leases with major differences in rents and responsibility for operating expenses. We should point out that results for net leases or those leases with a total operating expense pass through to tenants can now also be considered.

net leases

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Comparing Leases: Effective Rent*... Based on the examples shown in Exhibit 9-7(A), property owners can now use effective net rent, to compare leases with major differences in rents and responsibility for operating expenses. We should point out that results for _____ or those leases with a total operating expense pass through to tenants can now also be considered.

Effective Rent

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Comparing Leases: _____* From the above discussion, we know that a number of provisions may affect how rents are determined and various expense recovery options that may be included in a lease... Because of the large number of possible combinations of lease terms, cash flows may vary considerably from lease to lease, making it difficult to establish what the lease cost is, as well as making comparisons between leases difficult. Therefore, it is useful to calculate a single measure or _____ that can be used for comparison of individual leasing alternatives... In order to compare the various possibilities, it is useful to calculate the _____ for every lease at the time that it is being negotiated or renewed. To calculate the _____ we will use the following procedure: 1. Calculate the present value of the expected net rental stream. The net rental stream is the amount of rent received minus operating expenses that the owner must pay after deducting any expense recoveries from the tenant. Note that the focus here is on the income to the owner of the property. 2. Calculate an equivalent level annuity over the term of the lease. An equivalent level annuity has the same present value as the original cash flow stream... Because of rent adjustments, the responsibility for payment of operating expenses can vary considerably for different lease structures, so the _____ must be calculated net of any operating expenses that must be paid by the lessor. That is, any operating expenses that must be paid by the lessor will be subtracted from the rental income. A similar procedure would be used to calculate the _____ paid by the lessee. In this case, the amount of operating expenses that the lessee is responsible for paying would be added to the rent each year.

Occupancy dates, free rent, letter of credit, tenant improvements, work letter, allowable uses, Subletting, Business conduct, nondisturbance clauses, eminent domain, responsibility for expenses, Estoppel certificates

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 1. Parties to the lease... ___1___ may be important in leases on newly constructed property which the owner may not have finished by the move-in date... 2. Rents... ...the owner may provide a ___2___ period during which no rent is paid... 3. Other guarantees. Depending on the outcome of the underwriting, if the risk of default is considered to be a possibility, a prospective tenant may be required to find a third party to indemnify the lease payments (a co-signer) or obtain a ___3___ (LOC) for a fee from a bank... 4. The condition of the space on the move-in date may be "as is," or the lease may require it to be "finished out" or renovated before the move-in date. In such cases, the lease may call for ___4___ (TIs)... The dollar amount and the description of TIs that the owner will provide are described in a ___5___... 5. ___6___ and prohibited uses are enumerated in all leases... 6. ___7___... 7. ___8___... 8. Owner services to be provided... 9. If the property owner wants to expand and construct new rental space, many leases contain ___9___... 10. Should the state or other government entity use ___10___ to condemn all or part of the owner's property... the lease may provide that the tenant receive a reduction in rent or other consideration... 11. Leases vary considerably regarding ___11___... 12. Many leases require the building owner to provide comprehensive insurance in common areas of the property... 13. As the lease expiration date approaches, tenants must give a termination notice to the owner as to whether the lease will be renewed or terminated... 14. ___12___... 15. Change in property ownership/bankruptcy.

Occupancy dates

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 1. Parties to the lease... _____ may be important in leases on newly constructed property which the owner may not have finished by the move-in date. In these situations, tenants may want the option to terminate the lease. Similarly with retail leases, should the tenant delay occupancy for an unreasonably long period of time, the property owner may want to terminate the lease, particularly if the retail sales of other tenants appear to be adversely affected by the vacant space.

eminent domain

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 10. Should the state or other government entity use _____ to condemn all or part of the owner's property (to acquire right-of-way, etc.), the lease may provide that the tenant receive a reduction in rent or other consideration, should parking or other factors affecting the tenant's business occur.

responsibility for expenses

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 11. Leases vary considerably regarding _____. In some cases, the property owner agrees to provide and pay for some or all of the operating expenses. In other cases, property owners do not wish to take responsibility for many of those expenses because (1) they may be directly related to the tenant's business and should be paid by the tenant and (2) there is a risk that such expenses may suddenly rise.

Estoppel certificates

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 14. _____. This provision allows a questionnaire to be sent to existing tenants seeking verification of (1) rents/expenses that the tenant is obligated to pay under lease terms, (2) any past-due amounts, and (3) any rents being withheld by the tenant because of disagreements with the owner. This clause is important because investors may want verification (1) that all rents and recoveries are, in fact, being collected from tenants and (2) that there are no disputes, lawsuits, and the like between the current owner and tenants.

free rent

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 2. Rents. As will be explained in the chapter, there are many ways to determine rents, ranging from rents that are flat, stepped-up, indexed, and so forth. Concessions also may be included that effectively lower rents. For example, the owner may provide a _____ period during which no rent is paid. These concessions or discounts tend to be used (1) when vacancy rates are high because the market is oversupplied with rentable space or (2) when demand for space is weak because of slow economic growth.

letter of credit

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 3. Other guarantees. Depending on the outcome of the underwriting, if the risk of default is considered to be a possibility, a prospective tenant may be required to find a third party to indemnify the lease payments (a co-signer) or obtain a _____ (LOC) for a fee from a bank. In an LOC, the bank guarantees that any rents in arrears will be paid to the property owner.

tenant improvements

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 4. The condition of the space on the move-in date may be "as is," or the lease may require it to be "finished out" or renovated before the move-in date. In such cases, the lease may call for _____ (TIs), which could include paint, lighting, carpets, wall coverings, and so on.

work letter

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 4... The dollar amount and the description of TIs that the owner will provide are described in a _____ which is prepared by the property owner.

Allowable uses

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 5. _____ and prohibited uses are enumerated in all leases. These provisions usually prohibit tenants from making major changes in their use of the leased space.

Subletting

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 6. _____. In the event that a tenant needs less space than originally leased, leases may allow the tenant to sublet to third parties with approval of the property owner.

Business conduct

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 7. _____. All tenants are usually required to "obey the rules" regarding the use of common areas as indicated in the lease.

nondisturbance clauses

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Concept Box 9.1: Detailed Discussion of General Lease Terms*... 9. If the property owner wants to expand and construct new rental space, many leases contain _____, which require the owner not to interfere with the tenant's business operations during an expansion or as any existing space is being renovated.

minimum rent, base rent

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Rental Income* The initial rent that must be paid under the lease contract is usually a specified dollar amount, which we refer to as the ___1___, or ___2___. However, the base amount may stay the same or change during the term of the lease.

minimum rent

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Rental Income* The initial rent that must be paid under the lease contract is usually a specified dollar amount, which we refer to as the _____, or base rent.

base rent

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Rental Income* The initial rent that must be paid under the lease contract is usually a specified dollar amount, which we refer to as the minimum rent, or _____.

CPI adjustment

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Rental Income*... There are many ways that rents can adjusted over the term of a lease... 3. Indexed rents... Using price indexes like the CPI to adjust rents differs from step-up leases because the change in rents is not known until the date of the _____.

percentage rent lease

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Rental Income*... There are many ways that rents can adjusted over the term of a lease... 4. Rents adjusted based on revenue/sales performance. In some retail leases, rents also may be fully or partially determined by an indicator of retail sales performance. For example, some leases in shopping centers may include a provision for rents to be partially based on the tenant's sales volume. This is referred to as a _____.

overage rent

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Rental Income*... There are many ways that rents can adjusted over the term of a lease... 4. Rents adjusted based on revenue/sales performance... The dollar amount by which the total rent exceeds the base rent is referred to as _____.

CPI adjustment, percentage rent lease, overage rent

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Rental Income*... There are many ways that rents can adjusted over the term of a lease... The reader also should keep in mind that a combination of the methods discussed below may be used to adjust rents. 1. Flat rents... 2. Step-up rents... 3. Indexed rents... Using price indexes like the CPI to adjust rents differs from step-up leases because the change in rents is not known until the date of the ___1___... 4. Rents adjusted based on revenue/sales performance. In some retail leases, rents also may be fully or partially determined by an indicator of retail sales performance. For example, some leases in shopping centers may include a provision for rents to be partially based on the tenant's sales volume. This is referred to as a ___2___... The dollar amount by which the total rent exceeds the base rent is referred to as ___3___.

expense stop, rentable area

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Responsibility for Expenses (Recoveries)*... *Concept Box 9.2: Common Classification of Expenses Related to Owning and Operating Income Properties*... In order to establish a base line of recoverable expenses at the time the tenant takes occupancy, the lease will generally specify that tenants will pay only a share of increases in recoverable expenses in excess of what is referred to as an ___1___. This "stop" is usually calculated based on the total recoverable operating expenses per square foot of ___2___ in the building that is incurred by the property owner during a specified base year... The tenant agrees to pay only for increases in recoverable operating expenses per square foot in excess of this stop.

expense stop

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Responsibility for Expenses (Recoveries)*... *Concept Box 9.2: Common Classification of Expenses Related to Owning and Operating Income Properties*... In order to establish a base line of recoverable expenses at the time the tenant takes occupancy, the lease will generally specify that tenants will pay only a share of increases in recoverable expenses in excess of what is referred to as an _____. This "stop" is usually calculated based on the total recoverable operating expenses per square foot of rentable area in the building that is incurred by the property owner during a specified base year.

rentable area

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Responsibility for Expenses (Recoveries)*... *Concept Box 9.2: Common Classification of Expenses Related to Owning and Operating Income Properties*... In order to establish a base line of recoverable expenses at the time the tenant takes occupancy, the lease will generally specify that tenants will pay only a share of increases in recoverable expenses in excess of what is referred to as an expense stop. This "stop" is usually calculated based on the total recoverable operating expenses per square foot of _____ in the building that is incurred by the property owner during a specified base year.

Common area maintenance (CAM)

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Responsibility for Expenses (Recoveries)*... *Large Users of Leased Space*... 4. _____. In cases where a building is a part of a larger property development (e.g., a corporate campus or industrial/warehouse park), tenants may pay a pro rata share of expenses required to maintain "common areas" in the campus... In retail leases, _____ charges for maintaining, heating, and cooling mallways, as well as maintaining parking lots, providing security, and the like, are very important.

Concept Box 9.2: Common Classification of Expenses Related to Owning and Operating Income Properties

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Responsibility for Expenses (Recoveries)*... *_____* (Concept Box 9.2: Common Classification of Expenses Related to Owning and Operating Income Properties) In order to better understand what expenses are identified as recoverable expenses in leases, it may be useful to review the greater range of expenses usually associated with owning and operating a property... As shown above, not all expenses incurred by a property owner are recoverable. Expenses incurred relative to marketing, leasing, advertising, concessions, capital expenditures/depreciation, are viewed as operating expenses and therefore the responsibility of the property owner... After owners and tenants negotiate what expenses will be recoverable, tenants usually also agree to pay for increases in recoverable operating expenses after they take occupancy of the space.

Large Users of Leased Space

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Responsibility for Expenses (Recoveries)*... *_____* (Large Users of Leased Space) Typically, as individual tenants lease very large amounts of the total space available in a property, a greater share of operating expenses will be directly related and identifiable to the operation of that tenant... In many of these cases, the owner provides a reduced level of services or no services (cleaning, etc.) that would be provided under a full-service or modified full-service lease. Examples include 1. Single net leases. The tenant pays rent and pays for all operating expenses identified in the lease. 2. Double net or net, net leases. As in the single net lease, the tenant pays rent and pays all operating expenses directly. In addition, the owner "passes through" nonoperating expenses such as property taxes and insurance costs to the tenant. 3. Triple net or net, net, net leases. As in the single and double net lease, in addition to paying operating expenses, taxes, and insurance, the tenant also agrees to pay certain recurring capital outlays for repairs, alterations, and modifications to the interior of the leased building space... Property owners are usually responsible for the cost of certain exterior repairs (roof, walls, and other equipment) to the property. 4. Common area maintenance (CAM).

expense pass throughs

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *Leases and Responsibility for Expenses (Recoveries)*... b. Nonoperating _____. Lease modifications are sometimes made when a property owner negotiates a pro rate "pass through" of certain, specific, nonoperating expenses to tenants... Examples of such _____ are property taxes and insurance.

Concept Box 9.1: Detailed Discussion of General Lease Terms

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *_____* (Concept Box 9.1: Detailed Discussion of General Lease Terms) The goal of this concept box is to expand the discussion of leases and how various clauses and options may affect the risk and/or cash flow to the investor... 1. Parties to the lease. If a corporation is a party to the lease, assurance that the person signing the lease is a corporate officer with the proper responsibility is important... 2. Rents... 3. Other guarantees... 4. The condition of the space... ...may call for tenant improvements (TIs)... 5. Allowable uses... 6. Subletting... 7. Business conduct... 8. Owner services to be provided. In most office leases, the property owner will agree to provide services such as cleaning, maintenance, and repairs... However, the property owner usually retains the right to approve (1) alterations and (2) the selection of architects, contractors, materials, and the like. 9. If the property owner wants to expand and construct new rental space, many leases contain nondisturbance clauses,... 10. Should the state or other government entity use eminent domain to condemn all or part of the owner's property..., the lease may provide that the tenant receive a reduction in rent or other consideration... 11. Leases vary considerably regarding responsibility for expenses... 12. Many leases require the building owner to provide comprehensive insurance in common area of the property (lobby, parking, etc.). Tenants must also provide evidence of insurance covering the tenant's space. 13. As the lease expiration date approaches, tenants must give a termination notice to the owner as to whether the lease will be renewed or terminated... 14. Estoppel certificates... 15. Change in property ownership/bankruptcy. This provision may give the tenant the right to terminate the lease in the event that the property is sold or the property owner enters bankruptcy.

Leases and Rental Income

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *_____* (Leases and Rental Income)... There are many ways that rents can be adjusted over the term of a lease... The reader also should keep in mind that a combination of the methods discussed below may be used to adjust rents. 1. Flat rents. In some cases, rents may remain the same (or flat) for the term of the lease... 2. Step-up rents. Some leases include step-up clauses. These provide that rent will increase at the end of specified time intervals and in specific amounts during the term of the lease... 3. Indexed rents. Another way of adjusting rents is to use a specified index as a basis for the adjustment... The lease also may address adjustments when a decline in the index occurs (deflation). In such cases, a floor, or maximum reduction in rent, may be included... 4. Rents adjusted based on revenue/sales performance.

Leases and Responsibility for Expenses (Recoveries)

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *_____* (Leases and Responsibility for Expenses (Recoveries)) There are many ways in which property owners can structure leases in order to recover operating expenses... However, it should always be kept in mind that competitive market conditions prevailing at the time that a lease is being negotiated will play a major part in determining (1) rents and (2) who will bear the risk of paying some, or all, operating expenses. Common patterns used to treat operating expenses in leases are described as follows: 1. Gross (full-service) leases. The tenant pays rent only, and the property owner provides all services and pays all operating expenses. 2. Modified (full-service) leases. The tenant pays rent that is lower than rent payable under a full-service lease. The owner provides all services but recovers from the tenant specific expenses identified in the lease (e.g., electricity)... a. Direct pass throughs. When some tenants, because of the nature of their business, use a greater amount of a service than other tenants occupying a property, owners usually attempt to link and "pass through" related expenses directly to those tenants... b. Nonoperating expense pass throughs... 3. Leases with operating expense recoveries. In many situations, particularly for leases involving large amounts of space, property owners may not want to execute either a full-service or modified full-service lease because they would continue to bear the risk of paying a substantial amount of the expenses required to operate the property. In these cases, tenants usually agree to pay lower rents than would be the case for a full-service or modified full-service lease, in exchange for agreeing to pay a greater range of operating expenses. Typically, in such leases, certain operating expenses will be identified as "recoverable." (See Concept Box 9.2).

Other Financial Considerations

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *General Contents of Leases*... *_____* (Other Financial Considerations) In addition to rents and operating expenses, there are several _____ that may be negotiated as part of lease agreements. Depending on how competitive market conditions are when leases are being negotiated, owners and potential lessees may negotiate one or more concessions and/or tenant improvement allowances (TIs) including: moving allowances, free or discounted rent, buyouts of existing leases or lease termination fees, and other inducements that a property owner may use to lease space to a desirable tenant... In some cases, free rent may also be used as an inducement... From the preceding examples, it should be clear that the effective rent is a measure of the expected present value of cash flows to the lessor (cost to the lessee). However, it should be stressed that effective rents cannot be compared without considering differences in risk. The effective rent is useful, however, when it is desirable to compare the expected returns from different lease alternatives with a single measure.

lessor

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Income Potential - Real Estate Assets*... *Underwriting Tenants* Typically, income properties are leased to tenants for a specific period of time. The lease document assigns rights, duties, and responsibilities between the _____ (owner) and lessee (tenant) for the duration of the lease. The terms of the lease include legal considerations that are designed to protect the interests of both the _____ and the lessee and specify how rents and expenses are to be paid.

lessee

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Income Potential - Real Estate Assets*... *Underwriting Tenants* Typically, income properties are leased to tenants for a specific period of time. The lease document assigns rights, duties, and responsibilities between the lessor (owner) and _____ (tenant) for the duration of the lease. The terms of the lease include legal considerations that are designed to protect the interests of both the lessor and the _____ and specify how rents and expenses are to be paid.

Underwriting Tenants

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Income Potential - Real Estate Assets*... *_____* (Underwriting Tenants)... When negotiating for the use of space, the property owner will evaluate the financial capacity of the tenant... Typically, when evaluating a tenant and a lease proposal, the owner considers the following information: -Financial statements/income statement-balance sheet. -Credit ratings. -Any analyst reports on the firm/industry. -Bank relationships. -Existing obligations (debt, other leases). Underwriting leases is a very important component of risk assessment, which ultimately affects cash flow produced by property and hence its value.

Vacancy

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Income Potential - Real Estate Assets*... *_____* (Vacancy) As indicated previously, all space available in a building may not be leased at a particular time... It is more difficult to project _____ for newly constructed properties. While some leases may be signed before a project is completed, it is possible that less than full occupancy will be achieved immediately after construction is completed. In these cases, projections must be made as to how long it will take for remaining space to be "absorbed" by the market... At this point it is useful to make a few additional observations. First, when dealing with an acquisition of a property and developing a pro forma statement that will be used in an investment analysis, it is important to stress that such a forecast should contain a summary of cash flow only... Second, the term net operating income (NOI) was discussed in the previous chapter and is used extensively in the real estate investment business. In this chapter, we also focus on operating cash flow, that is, a summary of all cash inflows and outflows... In Exhibit 9-6, we list data sources that may be used to help compile appropriate benchmarks for operating expenses and other data that may be relevant when developing financial projections for various properties. In summary, when analyzing financial statements, the reader should pay particular attention to how treatments of outlays for tenant improvements, repairs, and replacements are included in statements of cash flows.

market rent

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Income Potential - Real Estate Assets*... In this section, we consider four major property types: apartment, office, retail buildings, and industrial/warehouses... The term _____ refers to the price that must be paid by a potential tenant to use (lease) a particular type of space under then current market conditions. The rent depends on many factors, including (1) the outlook for the national economy, (2) the economic base of the area in which the property is located, (3) the demand for the type of space provided by the property in the location being analyzed, and (4) the supply of similar competitive space. For example, the _____ on office buildings depends on the number of firms doing business in the area as well as the likelihood of new firms locating in the area, the number of employees these firms currently employ and are expected to employ in the near future, and the amount of space that the firm needs for its employees to do their job... Similarly, the _____ on apartments depends on the demographic makeup of the population and median income of families in the area in which the property is located, the cost and availability of homes or condominiums to purchase as an alternative to renting an apartment, and other factors... Real estate investors must also be very concerned with the credit quality of tenants... Real estate is a durable asset that has a relatively long economic life. The _____ at a given point in time is the price that users must pay for the use of a particular unit of space, for example, the rent per square foot of leasable area in a building.

residential, nonresidential

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types* We begin with Exhibit 9-1, which outlines the major classifications used to identify and group different types of real estate. The two major categories used to classify property are ___1___ and ___2___.

office, retail, industrial, hotel/motel, recreational, institutional, mixed use development

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... *Nonresidential properties* are typically broken down into six major subcategories: ___1___, ___2___, ___3___, ___4___, ___5___, and ___6___. As is the case for many of the categories, the same building can contain both office and retail space... A combination of end uses in one property is usually referred to as a ___7___.

office

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... *Nonresidential properties* are typically broken down into six major subcategories: _____, retail, industrial, hotel/motel, recreational, and institutional... _____ buildings range from major multitenant buildings found in the central business districts of most large cities to single tenant buildings, often built with the needs of a specific tenant or tenants in mind.

retail

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... *Nonresidential properties* are typically broken down into six major subcategories: office, _____, industrial, hotel/motel, recreational, and institutional... _____ properties vary from large regional shopping centers containing over a million square feet of space to small stores occupied by individual tenants found in almost every town.

industrial

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... *Nonresidential properties* are typically broken down into six major subcategories: office, retail, _____, hotel/motel, recreational, and institutional... *_____ and warehouse properties* include property used for light or heavy manufacturing as well as associated warehouse space.

hotel/motel

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... *Nonresidential properties* are typically broken down into six major subcategories: office, retail, industrial, _____, recreational, and institutional... Hotels and motels vary considerably in size and facilities available.

recreational

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... *Nonresidential properties* are typically broken down into six major subcategories: office, retail, industrial, hotel/motel, _____, and institutional... *_____ real estate* includes uses such as country clubs, marinas, sports complexes, and so on.

institutional

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... *Nonresidential properties* are typically broken down into six major subcategories: office, retail, industrial, hotel/motel, recreational, and _____... *_____ real estate* is a general category for property that is used by a special institution such as a government agency, a hospital, or a university.

mixed use development

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... A combination of end uses in one property is usually referred to as a _____.

single-family, multifamily

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... Residential properties include ___1___ houses and ___2___ properties such as apartments. Condominiums and co-ops are also included as residential properties.

single-family

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... Residential properties include _____ houses and multifamily properties such as apartments... _____ dwellings are usually thought of as individual, detached units developed in subdivision tracts.

multifamily

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... Residential properties include single-family houses and _____ properties such as apartments... The second major category of residential housing is _____ housing. It is usually differentiated by location (urban or suburban) and size of structure (high rise, low rise, or garden apartments).

residential

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Property Types*... The two major categories used to classify property are _____ and nonresidential... In general, _____ properties are properties that provide residences for individuals or families.

nonresidential

Equilibrium Market Rental Rate

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Supply and Demand Analysis*... *_____* At any point in time, a fixed stock of space exists in the market in previously constructed buildings... The amount of existing space that building owners are willing to lease at different rental rates is expressed by a supply curve as illustrated in Exhibit 9-2. As the market rental rate rises, more space is supplied by the building owners... At lower market rental rates, some of the existing space may not be made available for lease... Exhibit 9-2 also shows the demand for space from users. As the rental rate falls, firms are more willing to use additional space in their operations rather than other factor inputs such as labor and capital... The supply curve illustrated in Exhibit 9-2 depicts a short-run equilibrium for a period of time during which the total supply of existing space is fixed and does not increase due to new construction or decrease due to demolition... Changes in the market for space after an additional building is constructed can result in a change in the market rental rate. For example, suppose that the demand for office space increases because new firms are locating in the area and office employment is increasing. This is indicated by a shift in the demand curve from D to D' in Exhibit 9-3. Based on the supply curve for existing space offered for lease, the market rent would rise from R to R'... As new space is developed and the stock of space increases, the maximum amount of space that can be offered for lease increases from S_sub_max to S'_sub_max and shifts the entire supply curve from S to S' as shown in Exhibit 9-3. Based on the new supply curve (After new space is constructed) equilibrium rents decrease from R' to R"... This analysis considered an increase in the demand for space, which was followed by an increase in the supply of space. A decrease in the demand for space causes an opposite movement in the demand curve and a reduction in the _____. This results in an increase in the vacancy rate.

Implications for Risk

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Supply and Demand Analysis*... *_____* (Implications for Risk) In general, market rent depends on changes in the demand for space as well as expected changes in the supply of space as we discussed. Expected and unexpected changes in market rental rates over the entire economic life of a property affect the return and risk associated with investing in that property... As we will see later in this chapter, leases can be structured to shift some of the risk from the owner/lessor to the user/lessee.

Local Market Studies of Supply and Demand

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Supply and Demand Analysis*... *_____* (Local Market Studies of Supply and Demand) While it is useful to think of supply and demand relationships in the abstract, when real estate investments are made, a market analysis must usually be undertaken to determine the level of vacancies, rents, the amount of new construction under way, and the time the property will be ready for occupancy... Exhibit 9-4 contains a summary of many of the variables that must be considered when undertaking a market study... Similarly, when considering investments in warehouses and office properties, a deeper understanding of the nature and kinds of employment produced by growth in the economic base will help in investment analysis... Exhibit 9-4 provides some idea of the variables that influence the demand for various property types. For the supply side of each market, developers of each property type also carefully consider each of the same variables in Exhibit 9-4. However, they must also weight the costs of financing and the economic benefits of acquiring land and undertaking development in other locations.

Location and User-Tenants

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *Supply and Demand Analysis*... *_____* (Location and User-Tenants) After briefly examining a method for identifying the economic drivers affecting cities and regions, we now turn to a conceptual framework for determining how locations within a city are evaluated by businesses. It goes without saying that location is an important attribute in real estate. Successful real estate investors and developers must also realize that location as viewed by user-tenants is also important to recognize. We mean that successful real estate investors and developers should understand the business operations of potential tenant-users and how certain locations will appeal to those users. Consequently, most real estate decisions made by these users are considered in terms of how leasing space in alternative locations will generate more profit by (1) increasing sales revenue, (2) reducing the cost of operations, or (3) some combination of both. A very basic illustration of the relationship between user profits and locations is shown in Exhibit 9-5... As Exhibit 9-5 shows, if we evaluate three locations in Big City, it is clear that User A will realize more profit in location (1) because revenues are greater and its operating expenses are invariant to location... Because profitability will vary by location, the above analysis also implies that User A and other users, either who are in competition with User A or who operate businesses in which location significantly affects sales revenue (examples could be retailers, restaurants, or certain service providers), will tend to cluster near location (1) as they anticipate earning higher profits there... The location will take on the characteristics of a submarket containing those tenant-users selling goods and services to consumers who are sensitive to the location. On the other hand, User B, whose expenses are very sensitive to location, will choose location (3) because it will tend to lower costs and thus produce higher profits. Competitors of User B and firms that are not necessarily in the same business as User B but that have similar operating cost structures will compete for space in and around location (3)... This process of profit analysis and competition by many different firms for space in locations that tend to maximize profits produces certain general land-use results in real estate markets: 1. The process of firms competing for space will result in the highest rents possible for the most profitable locations and, ultimately, the highest land value and best development for a site (e.g., office, retail, warehouse, apartment, or hotel). 2. Locations will tend to be dominated by clusters of users with revenue or operating expense structures that relate in similar ways to a given location. 3. Locations with the greatest appeal to users will tend to produce higher rents and also to exhibit highest spatial densities. Developers will attempt to build multistory projects or cluster buildings on very desirable sites so that they may earn the highest rents per square foot... 4. Some locations are competed for by firms that are most cost-sensitive. These firms tend to require large amounts of land and large facilities on which to conduct larger scales of operations at lower rents per square foot. When viewing location in this way, we can begin to understand how and why land-use patterns and submarkets develop within urban areas... In summary, a key concept to understand is that for most business users, real estate is considered to be an operating input that is used with labor to produce output. In other words, business firms in their operations combine labor and materials with real estate at a location to produce goods and services.

Case Example: Apartment Properties

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *_____* (Case Example: Apartment Properties) Using the same general format shown in Exhibit 9-8, we consider an example of cash flows for apartment investments. For a number of reasons, investments in apartment properties are considerably different from office, retail, and warehouse investments. Leases are made for relatively short periods of time, the turnover of units may be very significant, and many state and federal consumer protection laws may apply. Exhibit 9-12 shows a pro forma statement of cash flow for apartment properties... It should be noted that the gross potential rental income is calculated based on full occupancy of the mix of one- and two-bedroom units at an average current rent of $885.65 per month, producing $2,465,649 for the coming year. The "loss to lease" term is somewhat unique to estimating cash flows for apartments. It reflects the fact that leases on a number of units may have been made in previous periods and are different from current market rents being negotiated on new leases... Many other contents in apartment leases and other operating features affecting cash flows are detailed in Concept Box 9.5.

Case Example: Industrial and Warehouse Properties

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *_____* (Case Example: Industrial and Warehouse Properties) Many of the same features in office leases apply to industrial properties and warehouses... However, there are a few areas where these properties differ. Leases for warehouse property tend to be highly individualized due to the special-purpose nature of the buildings. Tenants generally prefer longer-term leases ranging from 10 to 20 years... Leases tend to contain significant pass-through clauses, or will usually be (1) net, (2) net, net, or (3) net, net, net leases. Rent premiums for industrial/warehouse properties might be added for properties with the following features: -Located near entrances to industrial parks. -Located near freeways, interstate highways, or rail access. -Wide turning radius and access to loading docks. Rent discounts for industrial/warehouse properties might be added for properties with the following features: -Poor ingress/egress. -Poor traffic circulation on the site. When industrial and warehouse buildings are located in a large, campus-like development, common area charges may be included in leases... Leases may provide that tenants can make outlays for leasehold improvements in order to improve efficiency. Such outlays are usually the responsibility of the tenant. Property owners usually retain the right to approve both the design and the contractor installing such improvements.

Case Example: Retail Properties

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *_____* (Case Example: Retail Properties) Retail properties derive much of their value from the landlord's ability to lease to a mix of tenants that attract shoppers. Key indicators of the success of a retail property include sales per square foot of rentable space and customer traffic counts... When developing retail properties, owners usually complete a trade area analysis. This study uses the population, age, and income of potential customers in the trade area as an indicator of demand for goods and services. Retail properties are subject to many changing trends, new concepts in retailing, fashions, and the like. In addition to rents and expenses, retail leases contain many provisions that affect how tenants may, and may not, operate their businesses. This is because most retailers will be operating their businesses adjacent, or in proximity, to other retailers. Furthermore, some tenants may have the right to approve leases being negotiated with competing retailers... Cash flow from retail leases may vary greatly.

Conclusion

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *_____* (Conclusion) The purpose of this chapter has been to familiarize the reader with lease provisions and operating characteristics generally representative of major property types. The illustrations have shown that regional economic conditions, market supply and demand, lease terms, tenant credit, investment risk, and the ability of property owners to pass through operating costs are all important considerations in income property analysis. Furthermore, the ability to modify and develop pro forma cash flow statements and to undertake a competitive market analysis serve as foundations for analysis and for estimating an investment value for properties being sought for acquisition. These latter topics will be the focus in the chapters that follow.

Developing Statements of Operating Cash Flow

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *_____* (Developing Statements of Operating Cash Flow) What follows is a general discussion of the link between lease provisions and how investors in income-producing real estate develop statements of cash flow... These statements reflect (1) lease terms, (2) market supply and demand conditions affecting rents, (3) the tenant's credit risk, and (4) how responsibility for certain expenses associated with operating a property will be divided between the property owners and the tenants... It is useful to think of net cash flow realized from an investment in an income property as a combination of the relationships shown in Exhibit 9-8. Rental income for a property is calculated based on rents specified in every lease made with individual tenants... As Exhibit 9-8 shows, in addition to rent, many properties produce other income from other services provided (such as laundry facilities in apartments, cell towers atop office buildings, covered parking, etc.)... The statement shown in Exhibit 9-8 also shows that expense recoveries are usually added to the rent and other income to produce gross cash inflow for the property. As we have explained, depending on the lease terms, some operating expenses may be recovered from tenants. Depending on the types of leases negotiated, such as full-service leases, modified full-service leases, net leases, and so on, some tenants may pay a pro rata share of operating expenses, while other tenants may pay a higher base rent but not make any contribution to operating expenses. Expense recoveries also must be determined on a lease-by-lease basis... In addition to operating expenses, additional items requiring cash outlays include "make ready" expenses for new tenants and other expenditures... Exhibit 9-8 includes such an allowance (see: CAPEX/Improve allowance)... From effective gross income, operating expenses and the CAPEX allowance are deducted, and the net result is the net cash flow, also referred to as net operating income (NOI). This concept represents the net cash inflow from operating the property over a normal operating cycle (usually one year). NOI is a very important concept in real estate investment analysis. As we explained, the pro forma statement of cash flow shown in Exhibit 9-8 is very basic... We should also note that our explanation in this chapter is limited to basic pro forma statements for only a one-year period. As will be seen in later chapters, when doing an investment analysis, pro forma statements must be developed annually for longer periods of time.

General Contents of Leases

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *_____* (General Contents of Leases) As discussed earlier, the contents of the lease include the term "lessor," which usually refers to the owner of the property. Thus, we tend to use lessor and owner interchangeably. Similarly, the "lessee" is typically the tenant who occupies and uses the space and pays rent. Hence, the terms lessee and user-tenant are used interchangeably. While many terms may be included in lease agreements, elements that are commonly included in many leases are shown below: 1. Parties to lease, namely, lessor and lessee. The date of the lease agreement, occupancy date, identification of area to be leased, and the length of the lease term. 2. The base or minimum rent and any methods that will be used to calculate and adjust future rent. Description of any concessions and other inducements to be provided to the tenant by the landlord. 3. Deposits and any indemnities and guarantees from third parties or co-signers. 4. Condition of the leased premises to be provided to the occupant on the move-in date, including any tenant improvements. 5. Allowable uses of the property, restrictions on occupancy, and prohibitions regarding future changes in the use of the property. 6. Any restrictions on assignment or subletting of any of the leased space by the tenant. 7. The use of common areas and facilities, such as lobbies, restrooms, and parking lots. 8. Responsibility for maintenance and repair of the tenant's space and of the general premises. 9. Any restrictions on alteration or improvements to the property by the tenant. 10. Construction of any expansion in the future by the owner and provisions for affected tenants. 11. Eminent domain and any consideration to be given to the tenant should it affect the space rented, business operation, availability of parking, and so forth. 12. The responsibility for payment of specific expenses by the lessee and/or the lessor. 13. The extent to which the owner and/or the tenant must provide for fire and casualty insurance. 14. Any lease renewal options. 15. Estoppels. Depending on the amount of space, length of the term, and financial implications for both owners and tenants, leases may range from very complex to relatively simple agreements... While we do not exhaust all possible features that may be included in leases, Concept Box 9.1 provides the reader with more detail on the general contents of leases listed above.

Supply and Demand Analysis

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *_____* (Supply and Demand Analysis)... Market rents for properties depend on the economic base, as well as on the supply and demand for space by tenants.

The "Market" for Income-Producing Real Estate

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *_____* (The "Market" for Income-Producing Real Estate) Given the preceding discussion about (1) the general relationships between users seeking a location to maximize profits, (2) the general desirability among users to lease rather than own the space they need in their operations, and (3) the advantages in terms of cost-effectiveness of depending upon the real estate business/industry to perform the functions and risks associated with developing, owning, leasing, and maintaining land and buildings (as opposed to the tenant-user undertaking these responsibilities), it is clear that an enormous market for real estate services has emerged. When we approach the subject of making real estate investments, we must understand how this competitive market operates and the nature of the negotiations between owners of real estate and tenant-users... It can best be summarized by saying that in this market for real estate services, tenants are searching for locations that provide the highest profit (through either greater revenues or lower costs), and real estate investor-owners stand ready to take the risks of developing and/or leasing and operating real estate for tenant-users. Real estate owners engage in providing these services in exchange for rent. However, as will be seen below, the term rent is a very general term and, though important, is not adequate to explain how expenses are allocated between owners and renters. In order to estimate total occupancy costs for tenants and profits for owners, there are many other areas of negotiation between real estate owners and business-users of real estate or tenants in addition to rent. These may include additional rights and responsibilities of both parties that are usually contained in leases.

The Business of Real Estate

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]*... *_____* (The Business of Real Estate) Contrary to popular belief, the vast majority of real estate used by business firms is leased and not owned... Why is this the case? There are many important reasons: 1. Most tenants find leasing to be more cost-effective than owning. This is particularly true when their space requirements are less than the quantity of space they would have to purchase in order to satisfy their needs in a desired location. For example, assume that a user needs 20,000 square feet of space to operate profitably, and it must have such space in a specific location. However, only buildings with a minimum size of 100,000 square feet are available for purchase in that location. In this case, the user will usually opt to lease the 20,000 square feet of space as opposed to purchasing a 100,000 square-foot building... a. Owning would require a large commitment of capital to purchase the 100,000 square-foot facility... b. A purchase would "put the user in the real estate business." That is, the tenant would have to take the risk of owning and also have the real estate business "know how" to lease, collect rents, maintain, and insure the additional 80,000 square feet of space that it does not use. 2. Even if a tenant could occupy the entire 100,000 square feet in a building, it might still choose to lease because a. Owning would reduce operating flexibility... b. If it owns the property, the firm must operate, maintain, and repair the facility. These activities may result in the loss of focus on its core business activities... c. If the firm decided to size down from using 100,000 square feet, as the owner of the building it would have to engage a broker to find an additional user or buyer for the excess space. Furthermore, it might have to renovate the space to suit the requirements of the new tenant... In summary, the primary point is that history is replete with evidence of corporations that ventured away from their core businesses and engaged in real estate investment and development. Results have been mixed at best. The real estate industry includes economic functions that are specialized in nature and are separate and distinct from the operations of the many different business activities conducted by tenant-users. These noncore real estate business activities include the risks of (1) selecting the "right tract" of land and developing the "right amount" of space; (2) leasing that space to many different tenants; (3) hiring personnel, collecting rents, and maintaining the facility; (4) finding financing for the investment or development; and (5) doing continuous research about real estate markets in order to decide when to sell, raise or lower rents, renovate, and so on... It has been estimated that over 80 percent of all office buildings and retail properties is leased to tenants... One general exception to the above observations may occur if a single tenant-user requires its own facilities for its corporate headquarters or must have unique features such as high-tech labs, specialized computer installations, security, or other features that are unique. In these very special cases, ownership may be preferred to leasing.

Lease, lessor, lessee

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: ___1___s, Rents, and the Market for Space [Due 1/15/20]*... *Income Potential - Real Estate Assets*... *Underwriting Tenants* Typically, income properties are ___1___d to tenants for a specific period of time. The ___1___ document assigns rights, duties, and responsibilities between the ___2___ (owner) and ___3___ (tenant) for the duration of the ___1___. The terms of the ___1___ include legal considerations that are designed to protect the interests of both the ___2___ and the ___3___ and specify how rents and expenses are to be paid.

Lease

*Real Estate Finance and Investments*... *Chapter 9: Income-Producing Properties: _____s, Rents, and the Market for Space [Due 1/15/20]*... *Income Potential - Real Estate Assets*... *Underwriting Tenants* Typically, income properties are _____d to tenants for a specific period of time. The _____ document assigns rights, duties, and responsibilities between the lessor (owner) and lessee (tenant) for the duration of the _____. The terms of the _____ include legal considerations that are designed to protect the interests of both the lessor and the lessee and specify how rents and expenses are to be paid.

Real Estate Finance and Investments: Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space [Due 1/15/20]

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