CHAPTER NINECHAPTER NINE

INTRODUCTION TO INCOME- PRODUCING PROPERTIES:

LEASES AND THE MARKET FOR SPACE

Chapter ObjectivesChapter Objectives

• Major property types

• Economic forces

• Supply and demand relationships

• Location analysis

• Competitive nature of real estate

• Importance of leases

Classification of Real Estate Classification of Real Estate UsesUses

• Single family• Multi- family• Office• Retail• Industrial• Recreation• Institutional• Mixed use

Economic Base Analysis- Economic Base Analysis- Location QuotientsLocation Quotients

• RE- Regional Employment

• USE- U.S. Employment

• j- Industry Classification

• TOT- total

• LQ= (R.E.j/RETOT) / (USEj/USETOT)

Economic Base Analysis- Economic Base Analysis- Location Quotients ContinuedLocation Quotients Continued

• If LQ is greater than 1.0, then industry is base or driver industry

• If LQ is less than 1.0, then industry is usually referred to a supporting industry

Housing Demand and Housing Demand and Supply FactorsSupply Factors

• Housing factors of demand include:– New household formations, age

composition of new households, household income, and mortgage credit conditions.

• Housing factors of supply include:– Prices of factors of production,

productivity factors, number of builders in the market, and credit conditions.

Retail Demand and Retail Demand and Supply FactorsSupply Factors

• Retail factors of demand include:– Number of consumers, customer income,

consumer tastes and preferences, prices of substitute products, and credit conditions.

• Retail factors of supply include:– Prices and productivity of factors of production,

number of developers, developer expectations, and credit conditions.

Office Demand and Office Demand and Supply FactorsSupply Factors

• Office factors of demand include:– Number of local firms, types of business

of local firms, growth in local firms, and office space square feet per employee.

• Office factors of supply include:– Similar to retail market supply factors.

Location and User- TenantsLocation and User- Tenants

• Firms competing for space will result in the highest rents possible for the most profitable locations

• Locations will tend to be determined by clusters of users with similar financial structures that relate in similar ways to a given location

Location and User- Tenants Location and User- Tenants ContinuedContinued

• Locations with the greatest appeal to users will produce higher rents and also highest densities

• Firms that are cost- sensitive are competitive for locations

Location and User- Tenants Location and User- Tenants ContinuedContinued

• Location decision factors of household:– Users seek to avoid transportation costs,

thus having incentives to locate close to economic centers

– The price of land decreases with the distance from the economic activity centers within urban areas, and buyers substitute land quantity for location

Location and User- Tenants Location and User- Tenants ContinuedContinued

• Location decision factors of firms:– Transportation costs

• Proximity to customers

• Proximity to suppliers

• Proximity to work force

– Land requirements– Type of service or product

• High- density / low- density demand

• Weight- gaining / weight- losing production

The Business of Real EstateThe Business of Real Estate

• Lease v.s. purchase• Most tenants find leasing to be more cost-

effective than owning• Owning requires capital commitment and

risks of ownership• Owning reduces operating flexibility• Maintenance• An economic market for real estate services

has emerged

The Asset MarketThe Asset Market

• Real estate values vary according to their physical characteristics, their locations, and the economic conditions of the market.

• Real estate values depend on income expectations and its relative riskiness.

Leases- Leases- Features and CharacteristicsFeatures and Characteristics

• Date• Term• Parties, lessee, and lessor• Legal description• Allowed uses• Restrictions on alterations• Responsibility for maintenance and

repair

Leases- Leases- Features and Characteristics Features and Characteristics

ContinuedContinued• Any restrictions on operations of

tenants business• Assignment or subletting• Use of common areas• Adequate insurance• Default• Base rent and any increases• Gross lease v.s. net lease

Leases- Leases- Features and Characteristics Features and Characteristics

ContinuedContinued

• TI allowance

• Rent concessions

• Lease renewal options

Lease Demand and SupplyLease Demand and Supply

• Demand and supply model with vacancy Va= S-D

• Natural vacancy

• Rents– Equilibrium rent– Net contract rent– Effective contract rent

Lease Demand and Supply Lease Demand and Supply ContinuedContinued

• Physical and financial asset markets• Functions of space markets:

– To allocate existing space– To expand or contract space to meet

conditions– To determine new uses for land

• Demand and supply model with vacancy Va= S-D– Natural vacancy

Financial Content of LeasesFinancial Content of Leases

• Base rent• Step up provisions (CPI)• Percentage rent• Maximum rent• Overage rent• Gross lease• Net lease• Expense stop

Responsibility for ExpensesResponsibility for Expenses

• Gross or full service- owner pays all expenses

• Net- tenant pays all expenses• Expenses stop- owner pays up to the “stop”

expenses in excess of the stop are “passes through” to tenants– The stop is typically the expenses per s.f.

during the first year of the lease– There can be a “cap” on the amount passed

through

Example of Expense StopExample of Expense Stop

• A tenant has an expenses stop of $5 per s.f. based on expenses the first year of the lease

• Expenses per s.f. are currently $7 per s.f. and the tenant has 15,000 s.f. of leaseable area

• How much does the owner and tenant pay in expenses for this tenant’s space?– The owner pays $5 x 15,000= $75,000– The tenant pays ($7-$5) x 15,000= $30,000

Financial Content of Leases Financial Content of Leases ContinuedContinued

• Concessions- base rent, TI allowance, etc.• Signage• Non- compete clause• Lender approval of major leases• Load factor• Load factor for floor=

Rental area per floorUsable area per floor

• Effective rent