Session Plan

1. Session Plan • Chapter Five: • Importance of Market Research • The Anatomy of a Lease • Mini-case on reading a lease

2. Location & Tenants • Individual Households • Seek to avoid transportation costs, want to locate close to economic centers • Firms • Seek proximity to customers, suppliers, and work force • Land Prices • Price of land decreases with further distance from economic activity centers.

3. Local Market Studies • Real Estate Brokers typically have regional or sub-market related information available for their customers (for a fee). • Local appraisers can also be hired to conduct market studies for an investor • Study vacancy, rental, and expense rates in area • Determine level of new construction approved or underway • Provide analysis of demographic information • This is similar to your WFU Off-Campus Student Housing Occupancy Studies

4. Kick the Tires Yourself • Nothing beats visiting the property yourself, obtaining pictures of the property, and assessing the neighborhood and overall location of the property being considered as an investment. • Pictures in broker packages often represent the “best case” view of a property, so as an investor, seeing is believing!

5. Importance of Leases • Lease represents the “duration” of the income stream for an investment property • Lease is an agreement between the lessor (owner) and lessee (tenant) • Lease Terms can vary depending on property type: • Apartment: monthly to annually • Office/retail: monthly up to five years • Hotel/motel: daily • Warehouse/industrial: much longer terms (20 years)

6. How Price of Rent is Determined • Market Rates for Comparable Space • Ask brokers, appraisers, other market participants • View additional rent relative to IRR and NPV • Negotiation between lessor and lessee

7. The Anatomy of a Lease • Date • Parties to lease • Length of Lease • Approved use & legal description of property • Responsibility for maintenance and repair • Determined by negotiating power of landlord and tenants • Any Limitations on expenses • Common area maintenance (CAM) • Base rent plus any escalations • Renewal options

8. Anatomy of a Lease Continued • Rent • Could be set over entire term of lease • Could rise with a certain index (CPI for example) • Index should not be something controlled by the landlord • Percentage/Overage Rent • For retail properties. Have a base rent and then additional rent once tenant’s sales surpass a certain benchmark • For example: Tenant pays $20 per square foot annually, but could also pay 1% annually for sales over $400,000 at the Panera Bread located on Miller Street. • If rent is fixed over entire term of lease, who bears the risk if rental rates rise over the period?

9. Types of Leases • Type of lease: Gross, Modified Gross, or Net • Gross/Full Service: owner pays all expenses • Modified Gross: tenant pays for some expenses (possibly utilities for an office building) • Absolute Net: tenant pays all expenses • Triple Net: tenant pays for taxes, insurance, and maintenance of property • Expense Stops: owner pays for expenses up to a certain (stop) point. Above this level, the tenant pays • Expenses are passed through to the tenant.

10. Types of Leases • Index Lease • Rent and operating expenses tied to index (CPI) • Graduated Rental Lease • Rent can move up or down during term of lease • Escalator Lease • Lessor pays first year operating expenses • Lessee pays overage for remaining years • Revaluation Lease • Periodic rent adjustments based on revaluation of property • Good for properties in flux (redevelopment)

11. CAM and NNN Leases • Some leases provide for tenants reimbursing owners for various expenses • Typically for the maintenance of the common areas of a property • Also could be for repairs, taxes, insurance, and utilities as negotiated by the owner and tenants • Common Area Maintenance (CAM) must be paid by the owner for any space in property that is vacant.

12. Common Area Maintenance (CAM) • CAM is typically for repairs, maintenance, and utilities but can be for any expense depending on how the lease is structured • Each tenant would typically reimburse the owner for their proportionate share of the expense being shared • Consider the following rent roll and expenses

13. Common Area Maintenance (CAM) Who pays if there is a vacancy?

14. Another CAM Example • You own a 20,000 sq. ft. retail strip center. There are currently four tenants. The leases allow for the taxes, insurance, utilities, repairs and maintenance to be paid by the tenants. • How much in $ per square foot would each tenant reimburse the landlord for the current year if… • Taxes are $20,000 • Insurance is $4,500 • Utilities are $7,500 • Repairs & maintenance is $20,000 • How much would each tenant pay annually if each tenant occupied 5,000 square feet of space? • What if a tenant vacates? Who pays the expenses then?

15. Example of an expense stop • A tenant has an expense stop of $5 per square foot based on expenses during the first year of the lease • Expenses are currently $7 per square foot and the tenant has 15,000 sq. ft. of rentable area. • How much does the owner and tenant pay in expenses for this tenant’s space? • Owner pays: $5 x 15,000= $75,000 • Tenant pays: $2 x 15,000= $30,000

16. Other Lease Contents • Concessions • Lease will disclose amount of free rent, if tenant improvements will be paid by the owner, and other discounts • When would these be more likely: Low or High Vacancy markets? • Non-compete clause • Lease will specify if cannot lease adjacent space to a competitor • Non-dilution/radius clause • Or if tenant cannot lease another location within a certain radius • Common for retail leases. • Domino (or “Go Dark”) Clause • If anchor tenant vacates, in-line (or supporting) tenants may have the ability to break their leases for a specified fee

17. Lease Contents Continued • Lender approval of major leases • For both changes to existing tenant mix and for any new tenants • Load Factor • Used to pro-rate space • Rentable area per floor divided by useable area per floor

18. Lease Addendums: SNDA • Subordination: lease is subordinate to all provisions of loan including renewals, modifications and extensions. • Non-Disturbance: in event of foreclosure, tenant can stay in property as long as they are paying rent as agreed. • Attornment: tenant agrees to be tenant for any subsequent landlord (bank or otherwise).

19. Lease Rollover Risk • Evaluation of % of leases maturing in same period • Stated maturity vs. business risk issue • This is a concern for both investors and lenders • Specific property may be performing well but others in portfolio could cause repayment issues

20. Effective Rent • Present value of the expected income stream from the lease minus any expenses. • Used to compare leasing alternatives • Subtract out any expenses landlord must pay • Example: Panera Bread leases 2,000 sq. ft. in a retail strip center in Winston-Salem. They are paying $20 per square foot for the next five years, absolute net. Each year, the rent will increase by 5%. • Determine the effective rent for this lease assuming a 10% discount rate.

21. Panera Bread Effective Rent To then calculate effective rent: N=5, I=10, PV= (166,025.65), FV=0 Solve for PMT= $43,797.15 Remember: Set your calculator to 1 P/Yr!!!

22. Ground Lease Decision • How many different owners could there be in a ground lease? • Which portion of the property would you want to own and why?

23. Ground Leases: Bank’s Perspective • Sale and Lease Back of Land creates a ground lease between the purchaser of the land, and the owner of the building • Most banks will not want to loan against a property that has a ground lease, unless that ground lease has a substantial period of time left on the lease • One Rule of Thumb is that lease should exceed the amortization of the loan by at least 25 years. • Once the ground lease expires, the building improvements may revert back to the owner of the land…

24. End of Session • Next Session • Chapter 6 • Market Research Mini-Case