Office Acquisition Basics v0.1

8/14/2019 Office Acquisition Basics v0.1

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OFFICE ACQUISITION BASICS(www.howrealestateworks.com)

1Copyright @ 2010. Compress Reality LLC.


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OFFICE ACQUISITION BASICS

PROPERTY OF COMPRESS REALITY LLC

This publication is sold for educational purposes. It is understood that Compress Reality LLC is notengaged in rendering legal, accounting, or other professional services. If legal advice or otherprofessional assistance is required, the services of a competent professional should be sought.



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TABLE OF CONTENTS

1- THE MARKET 6 / Overview 7 / Supply 8 / Class defined 9 / The Investor 11 / Investment Categories 12 / Demand 14 /

Change in Population 15 / Change in Unemployment 20 / Employed working in office buildings 22 / Building area that each

office worker occupies 23 / Real Estate Cycle 24 / The Four Phases 25 / Recovery Period 27 / Building Cost 28 /

Capitalization 29 / Target Rent 34 / Future Target Rent Methodology 36 / Future Building Cost 37 / Future Target Rent

Calculated 38 / Market Rent Now Theory 39 / How the Current Market Rent is estimated 41 / Rent Growth Scenarios 46 /

Market Rent Recovery or Spike 51

2- THE BUILDING 55 / The Office Building 56 / Chronology of Tall Buildings 61 / Building Area 62 / The Survey 63 /

Foundation 67 / The Structure 69 / Classification of Structural Systems 70 / Floor Plan 72 / Vertical Systems 75 /

Electricity 76 / Security 82 / Curtain Walls 83 / HVAC 98 / The Elevator 120 / Roof 124 / Lighting 128 / Plumbing 134 /

Interior Finish 136

3- THE LEASE 146 / Lease Basics 14 7 / The Tenant 152 / Sole Proprietor 153 / Corporation 154 / Partnerships 156 /

Services Provided by the Landlord 157 / Lease Economics Use 163 / Lease Dates 165 / Lease Term 167 / continued ..



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TABLE OF CONTENTS (continued)

3- THE LEASE (continued) - Leased Area 168 / Base Rent 169 / Rent Abatement 171 / Operating Expense

Reimbursement 172 / Pass Through Expenses 174 / Pass Through Expenses Real Estate Tax 177 / Pass Through Expenses -

Gross Up Provision 178 / Tenant Improvements - Overview 179 / As Is Improvements 183 / Completion of Tenant

Improvements 184 / Amortization 186 / Alterations within the Lease Term 187 / Asbestos 189 / American Disabilities Act 190 /

Building Standard 191 / Appurtenances 192 / Hazardous Materials 193 / Abandoned Cable 194 / Future Factors Expansion 195

/ Termination 196 / Right of First Refusal 197 / Renewal 198 / Right to Purchase 200 / What If - Landlord Access 201 /

Holdover 202 / Default 203 / Other Fixtures and Trade Fixtures 204 / Security 205 / Guarantors 206 / Subordination 207 /

Estoppel 208 / Mechanic Lien 210 / Brokers 211 / Signage 212

4- THE INVESTMENT 213 / Why Invest 214 / The Investor 215 / The Cash Flow 216 / The Discounted Cash Flow 218 /

DCF Template 227 / Steps in the DCF 229 / Assumptions 230 / Market Rent 235 / How the Market Rent is Estimated 237 /

Growth Rates 242 / Lease Revenue 244 / Rent Roll 246 / Who is the Tenant / 248 / Financial Ratios 251 /

Rental Concessions 259 / Vacancy 261 / Lease up 264 / Vacancy Loss 266 / Recoverable Operating Expenses 267 / continued

.



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TABLE OF CONTENTS (continued)

4- THE INVESTMENT (continued) - Other Revenue 272 / Credit & Collection Loss 275 / Operating Expenses 276

/ Net Operating Income 280 / Capital Expenditures 281 / Calculate Cash Flow 283 / Reversion 284 / Discount Rate 289 /

Net Present Value 291

5- PURCHASE AND SALE AGREEMENT 294 / Calendar 295 / Letter of Intent 298 / The Purchase and Sale

Agreement 301 / The Purchase 302 / Purchase Price 304 / Sale Transaction 305 / Property Description 306 / Deposit 309 /

Seller Obligations before Closing 310 / Start Date and Closing Date 311 / Due Diligence Period 314 / Checklist 316 / Zoning

318 / Title and Title Objections 320 / Title Policy 32 2 / Estoppel Certificate 325 / Items to be Confirmed 329 / SNDA 332 /

Surbordination 333 / Nondisturbance 334 / Attornment 335 / SNDA Provisions 336 / Termination Rights 338 / Indemnification 339 / Default 340 / Brokers 341 / Assignment 341 / Extension 342 / Conditions to Closing 343 / Closing

Costs 346 / Representations and Warranties 349 / Various Legal 363 / Closing Documents 370



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Chapter 1THE MARKET


Table of Contents / Chapter 1 The Market / Chapter 2 The Building / Chapter 3 The Lease /

Chapter 4 The Investment / Chapter 5 Purchase and Sale Agreement


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OverviewThe Market analysis is used to forecast the current and future market rent and occupancy of the officebuilding.

Data is gathered, including supply and demand.

The market cycle is then incorporated using the data to derive a time estimate for recovery.

The final step forecasts how the current rent will change in response to the cyclical market.

The overall US market is examined; each submarket has its own unique circumstances, but the generalapproach can be applied to the smaller segments as well.


Chapter 1 The Market


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Supply

We start with the existing supply or inventory.

There are a multitude of resources to estimate the existing office stock in the US, including TortoWheaton (CBRE), Cushman & Wakefield, Jones Lang LaSalle (JLL) and Integra Realty Resources(IRR) among others.

The surveys differ in total inventory, based on the submarkets surveyed. Of the listed sources, JonesLang LaSalle reports the smallest office inventory; Integra Realty Resources the largest. For purpose of this discussion, the IRR estimate is used.

Top 10 markets based on existing inventory are as follows (again according to Integra) New York, NY, Washington DC, Northern New Jersey, Houston, Dallas, Chicago, Philadelphia, LosAngeles, Boston, and Atlanta.

Total Inventory (SF) Vacancy (%) As of

Integra Realty Resources 4,833,536,000 13.7% 4Q08




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Class Defined

Office buildings are categorized as Class A, Class B or Class C. The class is used to indicate thephysical condition and operating performance of the property. The properties are segregated based on

location, management, physical characteristics (age, construction type, renovation, if any, andamenities) and tenancy. As a baseline, the Class B and Class C properties are categorized in referenceto Class A buildings.

The Class A buildings include trophy properties. A trophy building is a landmark property (typicallyone-of-a-kind architectural designs, with the highest quality of materials and finish), well known by thepublic, highly sought by institutional investors and pension funds and insurance companies, moredesirable than Class A properties that command significantly higher price than non-trophy buildings.

Class B buildings are, as a general rule, older properties. If the buildings are well located and can berenovated with upgrades to the faade, common areas and operating systems, the Class B properties canbe returned to the Class A designation.

It is estimated that in the top office markets, over half of the buildings are categorized as Class A.




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Class Defined (continued)

Class A Class B Class C

Design Above average Not the latestpreferences orstandards

Dated, generally 15 to25 + years old

Construction Above average Not the latestpreferences orstandards

Dated construction

Location Excellent Above average Less desirable

Tenancy Strong credit Good to high quality Lower credit

Management Professional managed Good management Local management

Condition Well maintained Good to average;minor deterioration

Average, with deferredmaintenance

Rental Rates 90% to 95% of rentneeded to justify newconstruction

5% to 15% less thanClass A product

Below market average,5% to 15% less thanClass B




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Investment Categories

Office buildings are segregated by their return and the group of investors seeking those returns. Officebuildings are grouped as core, core plus, value add and opportunistic.

CoreBuyer profile longer holding U.S. and international institutional investors and some individualinvestorsMotivation - want a secure return from the property cash flowTarget - trophy office buildings in major urban markets, Class A multi -tenant buildings with limitedlease rollover exposure and properties with long term leases to strong credit tenants

Core Plus

Buyer profile core buyersMotivation - slightly higher overall return than core, often generated from the residual valueTarget - core investments with higher releasing risk




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Investment Categories (continued)

Value AddBuyer profile - knowledgeable institutional and individual investors

Motivation - some current cash flow but with focus on future appreciationTarget buildings in recovering primary, secondary or even tertiary markets; properties with theopportunity to increase cash flow as rental rates with current leases expire and roll to higher marketrents; offices repositioned due to a change in marketing, operating, or leasing strategy or with aphysical renovation

OpportunisticBuyer profile- sophisticated, capitalized investors with high risk tolerance for higher levels of leverageMotivation majority of the return is from the sale or refinancing

Target - growth and development oriented projects with significant "turn around" potential, oftenrequiring significant capital based on major market trends




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DemandForecast future office demand is a function of

the change in the population,

the change in unemployment,

the employed working in office buildings and

the building area that each office worker occupies.

Estimating future demand for office space is a subjective estimate, at best. Variables abound, and, with

the magnitude of the numbers, any small change can significantly impact the results. With this said, thedemand for office space will be estimated.




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Change in the PopulationThe U.S. Census Bureau forecasts the population through 2050.

For this analysis, the following classifications are used: a) the working group defined as ages 20through 69 years of age and b) retirees, age 70 and more.

The forecast effort for that many years in the future is an estimate only, but there are some trends to beexamined in regard to the impact on real estate and the office sector.

The population in total is estimated to be 310.2 million in 2010, growing to 439.0 million in 2050. Thisincrease equates to a change of 41.5%, or 1.04% per year over the 40 year period.

For the working age, identified in this analysis as the group 20 to 69 years old, the estimated 198.1million increases to 259.1 in 2050, a change of 30.8%, or 0.77% per year.

For the retired group, ages 70 plus, the number swells from 28 million to 67 million, a change of over130%, or almost 3.5% per year.




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Change in the Population (continued)The total population during the period through 2050 will increase an average 1.04% per year.

The working group numbers will increase .077% per year.

The retirees can be counted to grow at an annual rate of 3.5%.

The ratio of worker bees ages 20 to 69 divided by the retired ages 70+ in 2010 is 7.08 working age to 1retired age person. In 2050, the ratio drops to 3.8 to 1.

The ratio approaches near the 4.0 to 1 level in the early 2030s.

According to the Census forecast, the greatest change in number of retirees in one year will occur in2030, when 1.6 million Americans will join the 70 plus age group.

The trend is visually presented on the next page,




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Change in the Population (continued)According to the Census, in 2020, the ratio of workers to retirees is forecast to decline, as fewerworkers are available to financially support government programs (i.e, Social Security).

The acquisition analyst in 2010 will attempt to estimate the value of the property in 2020. The chancesare great that the analyst will view things as normal as he estimates this reversion in 2020, and theeffect on values in 2010 will be minimal.

The acquisition analyst in 2020 will attempt to estimate the value of the property in 2030. Forproperties purchased in 2020,however, the forecast future will be different. As the analyst seeks topurchase properties in 2020, he will using the 10 year hold and estimate the reversion in 2030.

From the graph, in 2020 the ratio of workers to retirees will be in decline. Government will then seek toaddress the social security issue, if not done so earlier. There is potential that a) the existing workingpopulation will need to pay a greater portion of their income as tax to support the social security

program, b) the countrys financial debt will increase to absorb the social security obligations, or c) thesocial security benefits will be reduced, potentially affecting the then retireds quality of living. Anychoice has the potential to affect the economy, the perceived 2030 reversion and the correspondingvalue for a purchase in 2020.




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Chapter 2THE BUILDING





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The Office BuildingWho benefits from an office building?

-the tenant or occupant, who uses the property

-the landlord, the owner who receives financial returns on his investment

-acquisitions personnel, who sought the investment, performed the analysis and due diligence,negotiated the contract, and closed the property

-property management company, the manager of the building

-engineers, who operate the property providing adequate services to the tenant or occupant

-accountants, who maintain the financial records of the property, including the billings to thetenant, and

-the lender, who provided financing for the acquisition of the property, along with providingadditional loans for tenant improvements and capital outlays


Chapter 2 The Building


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Building AreaThe most used method for determining usable and rentable areas in commercial office buildings is"BOMA Z65.1- 1996 Standard Method for Measuring Floor Area in Office Buildings. The property ismeasured on a building-wide basis. The floor area is classified by Gross Area, Major Vertical

Penetrations, Office Area, Store Area, Building Common Area, Floor Common Area and ApportionedArea. The standard provides for locations of the boundaries between and within each class of space, i.e.,dominant portion, finished surface, and wall centerline. The Standard also presents the mathematicsapplicable to allocate common areas to tenant suites.

Because of the addition of the Building Common Area, a building measured using BOMA 1996 almostalways yields higher Rentable Areas than the same building measured according to the older standard,BOMA 1980.

In its simplest terms, Net Rentable Area is the gross area of the full floor less the area of all verticalpenetrations, which include elevator and mechanical shafts, and stairwells. Net Rentable area can alsobe viewed as the area that includes the tenant's premises plus an allocation of the common area directlybenefiting the tenant, such as restrooms, common corridors, mechanical and janitor's rooms and theelevator lobby on the tenant's floor.




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The SurveyFormat - The most common survey format is the ALTA/ACSM survey, prepared per "MinimumStandard Detail Requirements" adopted by a) the American Land Title Association (ALTA), b)American Congress on Surveying and Mapping (ACSM) and c) the National Society of Professional

Surveyors.

Timing - The survey should be certified within 30 days (approximate) before closing.

Certification - The form of certification is based on client requirements. If the ALTA/ACSMcertification is required, then the surveyor's certification should state a) parties included incertification: owner, Buyer, lender, title insurance company, b) the actual on the ground survey wasperformed on the date the survey performed and c) the survey performed according to theALTA/ACSM standards.

"Same as Survey" provision - The "same as survey" endorsement to title policy may be available. Thisprovision insures that the land described in Schedule A of title policy is same as land shown on thesurvey.

Who pays for survey? - The party signing the contract with the surveyor is responsible for thesurveyors fee. The Purchase and Sale Agreement can include reimbursement provisions as to who isthe ultimate payor.




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The FoundationThe foundation is the lowest segment of the building, whose primary function is to support and anchorthe structure above and transmit the structure's loads safely to the earth. Principal loads are live anddead loads that act vertically and horizontally. Loads are derived from wind, uplift, ground movement

and pressure from surrounding soil and groundwater.

Foundation systems are classed as shallow or deep.

Shallow -also called spread foundations.

used with stable soil with adequate weight bearing capacity relatively near the ground surfacetransfers loads directly to the soil by vertical pressure.

lowest part is called the spread footing, which extends laterally distributing the load.

most common spread footing - strip and isolated. Strip footings are continuous spread footingson foundation walls or a reinforced concrete footing extended to support a row of columns.Isolated footings are individual spread footings, i.e., with supporting freestanding columns andpiers




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The StructureThe purpose of the structure is to carry vertical gravity loads. Vertical load resisting systems are thesame for high rise as low rise. In addition, the structure should withstand lateral wind and seismic loadsfrom any direction. In the current environment, structures should also be able to withstand blast loads.

Wind forces at the maximum 100 year interval will differ greatly depending on location. Forces in thecontinental interior are typically 20 pounds per square foot at ground level. In the coastal locales, themaximum force is greater, i.e. up to 50 pounds per square foot. Wind forces also increase with buildingheight to a constant or gradient value as a result of the effect of ground friction diminishing. Forexample, in hurricane areas, the maximum design wind force in tall buildings is about 170 pounds persquare foot.

The principal elements of the structure are the column, beams, slab, and loadbearing wall.

For office buildings the elements are horizontal spans crossed by reinforced concrete slabs, ahierarchical arrangement of girders, beams, and joists overlaid with decking.




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ElectricityThe office building is powered by alternating current or AC (voltage and current flips back and forth 60times per second) as opposed to direct current or DC.

In the building, electrical power enters through the primary service feeder then through transformers,switchboards, panels, before arriving at the load, i.e., the elevator, ceiling light, or computer. Theelectrical system has motor control centers (MCC) used to serve various equipment in the mechanicalroom, elevator machine rooms, and penthouse mechanical room.

Major pieces of electrical equipment have a typical useful life expectancy of 40 to 50 years.




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Electricity - Utility to TransformerPrimary transformers may be located either outside or inside the building. If space is available, anoutdoor transformer on a grade-level concrete pad is the first choice (less capital, better cooling,accessible and easy to service, less noise to occupants and increased fire safety). These are very heavy

and need a thicker pad support than the rest of the building.

There are dry-type and oil-filled transformers. With the former, the switchgear, i.e., disconnectswitches, secondary switches, fuses, and circuit breakers, can be located in the with the transformers ina unit substation. With the latter, in large buildings, the switch gear is typically located in a roomadjacent to the transformer vault.

For buildings greater than 25,000 SF, electric utilities deliver electricity at high voltages, typically13800 or 4160 volt. This primary service enters the building at 120/240 VAC (volts alternating current)if single phase, or if in 3 phase, 120/208 VAC, 277/480 VAC or higher (up to 2400/4160 VAC foundonly in largest buildings). Note the first number is voltage between any single phase and the groundand 2nd is voltage between any two phases.

With these higher voltages, the landlord receives a lower utility rate and also provides his own primarytransformers at the service entrance. The transformers take this high voltage and reduce it to lowervoltages that can be utilized directly to the building, typically 120/208 volts or 115/230 volts in walland floor receptacles, and up to 480/277 volts in some types of machinery and lighting fixtures.




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Curtain Walls - The Window Unit and GlazingThe office window assembly, known as an insulated glazing unit (IGU), contains the glazing (one ormore layers of glass with air spaces in between) in the window frame. The glazing has spacers aroundthe edge and, if more than one pane, with gases in the spaces between glazings.

The frame can be made of aluminum, steel or composite material. Aluminum frames are light, strong,durable, non-corrosive, formed to complex shapes, and fabricated to extremely close tolerances. Adisadvantage is the aluminum can conduct thermal heat. The thermal resistance is affected by thesurface area of the frame versus the frame thickness. In addition, in cold weather the simple aluminumframe (non-thermally broken frame) can condense moisture or frost on the inside surfaces of windowframes. One solution is to add a "thermal break. The frame components are separated into interior andexterior pieces joined by a less conductive material, which can decrease the heat loss rate by 50%.The edge spacer separates the glass units from the frame, absorbing stress from expansion and pressurechanges, preventing water / vapor from fogging the unit, sealing the interior gas in the air space andlowering the interior condensation at the edge. It has a thermal effect that extends 2 wide beyondthe spacer edge, reducing heat loss and condensation at the bottom edge of the window.




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Curtain Walls - Design Wall Construction - Energy efficiencyThere are various measurements to determine the energy efficiency for curtain walls.

The Solar Heat Gain Coefficient (SHGC) indicates the amount of solar energy striking the window that

is transmitted, absorbed and released inside the building, warming the buildings interior. It is reportedbetween 0 and 1. A lower SHGC means the less solar heat the window transmits and the greater itsability to shade.

The U-factor measures the rate of heat transfer through the window (from inside to outside when it iscold and vice versa when it is hot). It is the rate of heat loss of a window assembly and is the inverse of the R-value (the insulating factor). The lower the U-factor, the greater the resistance to heat flow andthe better its insulating value. The U-factor ranges from 0.3 to 1.2. The U-factor can range from 0.35 orless in the northern sections of the US to 0.75 or less in the southern sections. In general, the larger theheating bill, the more important a low U-factor becomes.

Visible transmittance (VT) is the measure of how much visible light passes through the assembly. Therating is from 0 (no light) to 1.0 (all light). Most values are between 0.3 and 0.8. The greater the VTindicates more daylight.




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Chapter 3THE LEASE





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Lease Basics

Overview

Most people are familiar with a lease, particularly the apartment lease. With that lease comes the rightto lease and occupy the apartment for a set period of time, provided rent is paid on a timely basis andthe tenant acts in an orderly manner. In the majority of cases, the prospective tenant does not retainlegal counsel.

The office lease is substantially different. Legal counsel is used by both the tenant and the landlord.Both parties seek to protect themselves and maximize their position. Everything is negotiable, but as inall commercial real estate, the market place dictates lease parameters. In general, the focus of the tenantis possession of the leased area, the premises. The landlord concentrates on the rent and reversion.


Chapter 3 The Lease


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Services Provided By The Landlord

The landlord furnishes the following services to the building tenants during their lease term. The costsof the standard services are included as operating expenses. The landlord can, at any time, makereasonable changes, as long as the changes are in line with the standard services offered in comparableoffice buildings in the submarket, taking into account age, size and other relevant operating factors(typical lease verbiage).

These services include (not all inclusive)hot and cold water to common area rest rooms and water fountains,

HVAC during normal business hours as the landlord deems appropriate based on competing properties operations or as required by government regulations

maintenance and repair,

janitorial service for x business days per week,


Chapter 3 The Lease


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Lease Economics - Lease Dates

Leases contain a variety of dates, some being apparent. All may be different or the same. Theseinclude:

date of the lease,date of the lease commencement,date the rental payments begin, anddate to determine the expense reimbursement base year.

Depending on the jurisdiction, a lease signed by both parties does not need to be delivered to beeffective. Execution generally means signing and delivering. This is compared to deeds for propertywhich do need to be delivered to be effective.

The lease is signed before the tenant has the right to occupy the premises.The interval between the contract signing and the time of an actual right to possess or occupy by thetenant is called the contract interval. During this period the tenant improvements can be constructed.


Chapter 3 The Lease


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Lease Economics - Lease Term

The lease term is the specified time that the tenant may occupy and use the lease space. Thecommencement date, the expiration (last day of lease) and duration must be defined in the lease.

In theory, the longer the lease term, the greater the tenant responsibilities. Repairing the roof is notexpected in a short term lease; but requiring replacement is reasonable with a 20 year lease. If the leaseterm exceeds a specified duration in some states, the lease must be recorded at the court house.

Note that a termination of the lease (ending the lease before the lease termination date) can affecttenant improvement expenditures,broker commissions (depends on the agreement with the broker, which can be a separatedocument), and

lease assignments.


Chapter 3 The Lease


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Lease Economics - Leased Area

The space the tenant leases can be called the leased premises, the premises, the demised premises, theleased space, or the space. The specific description should be insufficient detail to identify the location.The building location itself should be specifically defined.

The amount of leased area in square feet the premises contains should be presented, i.e., net rentablesquare feet. If the tenant should take the entire floor, the landlord will include lease language that allcorridors and restrooms located on each full floor will be considered part of the Leased Area.


Chapter 3 The Lease


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Lease Economics - Base Rent

The Base Rent is the leases most obvious provision. The term base rent is often used with officeleases. The term face rate is the full rental rate without abatement. In a typical scenario, the base rentis paid in equal consecutive monthly installments, on or before the first day of each month.

The rent can be stated in a variety of ways, i.e., $ per square foot of net rentable area, $ per square footof net usable area, $ per month, $ per year. One example for 10,000 SF net rentable area is:

Period $ PSF $ per Year

Commencement Date to 12th lease month $21.50 $21,500

13th Lease Month to 24th lease month $22.50 $22,500





Chapter 3 The Lease


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Lease Economics - Base Rent (continued)

If the rental rate structure increases over the term, the specified increases or steps can be date specificor begin a number of months from lease commencement or other begin date.

Effective rate includes the effects of the rental abatement and is less than the face rate if the face rateis $12 per square foot per year for a three year term and the abatement period is 3 months, the effectiverent is $11.00 per square foot per year.


Chapter 3 The Lease


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Lease Economics - Rent Abatement

Rent abatement is described in the lease, generally as the number of months of monthly rentalminimum rent, or in some cases as an amount that the tenant does not pay rent. It is also called free rentor rent incentive. Free rent can be a landlord tool to get space leased.

The abatement typically does not affect the reimbursement of operating expenses, which remainunaffected and are payable by the tenant. The free rent can include the abatement of other categories,i.e., parking, storage, or overtime expenses.

The free rent given is equivalent to the term needed to find, identify and negotiate a lease with aprospective tenant.


Chapter 3 The Lease


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Lease Economics - Operating Expense Reimbursement

The tenant pays its share of expenses in the form of an operating expense reimbursement.

As part of the negotiations, verbiage is agreed upon in the lease stating the share of increasing operatingexpenses the tenant is to pay to the landlord. This is negotiable but depends in large part on the marketconditions. Reimbursement methods vary by market.

The operating expenses typically are included by account - maintenance, repairs, management, utilities,tax and insurance.

Reimbursable operating expenses typically exclude administrative costs, advertising, franchise tax,leasing commissions, tenant alterations, income tax, and legal fees.

In some markets, real estate tax expense is separated from operating expenses and treated separately.Parking expense is generally segregated from the other building operations.


Chapter 3 The Lease


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Chapter 4THE INVESTMENT





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The InvestorThe buyer of an office building represents a diverse group, from the extremely large and sophisticatedinvestor to the single user needing a particular building for a particular purpose.

Institutional Banks, insurance companies, pension funds and retirement funds

Syndicators Groups of individuals or companies formed to transact some specific business, includingtenants in common (TICs) and private REITS

Funds Privately sponsored equity and opportunity funds

Private parties Investors seeking to operate, develop or invest in commercial real estate

Other Corporations, educational, governmental, non-profits and private parties


Chapter 4 The Investment


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The Cash Flow (continued)The following expands the basic formula and is the typical format for a commercial office building.

Revenue Base Rental Revenue(-) Absorption & Turnover Vacancy(-) Base Rent Abatements= Total Base Rental Revenue(+) Operating Expense Reimbursement(+) Other Income= Gross Potential Revenue(-) General Vacancy & Collection Loss= Effective Gross Revenue

(-) Operating Expenses (-) Reimbursable Operating Expense

(-) Nonreimbursable Operating Expense= Net Operating Income (NOI) = NOI

(-) Leasing and Capital Costs (-) Capital(-) Tenant Improvements(-) Lease Commissions(-) Reserves

= Cash Flow = Cash Flow




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The DCF Template

The template for the DCF is as follows. The cash flow for each succeeding twelve month period iscalculated. The number of years utilized is a function of the holding period. The general rule for thetime period for the investment analysis of office buildings is ten years. The details will be explained inthe following pages.

The overall general assumptions are

Discount rate 10.0%Reversion cap rate 9.0%Rental growth overall 2.3%Expense growth 3.0%




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Steps in the DCFThe sequence to arrive at the value using the discounted cash flow method is to estimate -

assumptions for the future Cash Flows over the holding periodthe market rent for the property,growth rates for future projections of market rent, tenant refit and operating expenses,lease revenue relative to contract rent levels, lease expiration dates, renewal options, expense recoveries, otherconditions that can impact collected rent from the tenant,rental concessions, including free rent,loss due to vacancy,lease up of vacant space,recoverable operating expense,other revenue,credit and collection loss,annual operating expenses, both recoverable (or reimbursable) and non recoverable,

the Net Operating Income (NOI),the timing and magnitude of capital expenditures,the forecast Cash Flow,the reversion capitalization rate to convert future NOI in the reversion year,the appropriate discount rate to convert future cash flows, andthe net present value of the discounted future cash flows and reversion.




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Assumptions for Future Cash Flow

The investor of an office building purchases the right to receive the revenue stream from leases in place.If he expects to own the property for a period of time, he must estimate the future revenue stream fromthe lease obligations.

Following are the assumptions used for the DCF. NOTE: for this example, there is one tenant in thebuilding; the building contains 1 SF NRA. Some assumptions are considered industry standard. Theseare

Start Date January 1 (the actual date the bui lding is closed is January 2; 1 day rent is immaterial

Fiscal Year End 12/31 (Calendar Year Analysis)

Analysis Period 11Years (10 year hold)Reversion Capitalization of Year 11 Net Operating Income

NRA 1 SF; 1 tenant (for illustration)

Expense Growth 3% per year




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Assumptions (continued)

Some assumptions are based on probability, particularly at the end of the tenant lease.

Excluding default and early termination, a tenant may

renew with no downtime, with monies spent by the landlord for space improvement and acommission to a leasing broker (if any), or

vacate at the end of the term.

If the tenant vacates, the buyer will forecast a period of downtime for lost revenue and costs while anew tenant is found, a lease is negotiated, and monies are spent to improve the space for the new tenantand to pay the broker a commission for securing that tenant and the attorneys for lease preparation.

Either scenario can be modeled in the future cash based on the best forecast of the tenant's future.




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Assumptions (continued)

Lease commissions represent payments tothe broker of the leasing company representing the landlord (the inside broker) andthe broker representing the tenant (the outside broker).

Both fees are typically agreed in the leasing agreement between the inside broker and the landlord,which has already been negotiated.

Probability of renewal 75%

Lag Vacancy 12 months

Vacancy based on probability 3 months = (1 75%) x 12 months

Tenant Improvements New leaseRenewalBlend (based on probability)

$25.00 PSF NRA$10.00 PSF NRA$13.75 (25% x $25.00 + 75% x $10.00)

Lease Commission New = Renew = Blend = 6%




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Chapter 5THE PURCHASE ANDSALE AGREEMENT





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Calendar - Major Dates

Date of the Purchase AgreementDate Purchase Agreement is signedEffective DateDate of final acceptance of Letter of IntentDate of full executionDate of acceptanceDate of deposit money due to be paid to Buyer or agentDate deposit is non refundableDate that begins the Review or Due Diligence PeriodDate that ends the Review or Due Diligence PeriodDate of Termination of the ContractDate for tenant interviewsDate for interviews with 3rd party contractorsDate of receipt of documents and materials requested during the Review PeriodDate of delivery of documents and materials requested during the Review PeriodDate of ClosingDate of Closing extension


Chapter 5 Purchase and Sale Agreement


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Calendar - Major Dates (continued)

Dates regarding title issues -Date Buyer causes title search to beginDate of delivery of Survey to BuyerDate of delivery of Title Commitment to BuyerDate of delivery of Title exception documents to BuyerDate of the Title CommitmentDate of receipt of the Title CommitmentDate of receipt of Buyers objections to titleDate Seller replies to Buyers objections to titleDate Buyer responds to Sellers reply to title objections

Other dates -Expiration date of letter of creditDate of default by SellerDate of Notice of Default by SellerDate of creation of the entity of the Buyer




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Calendar - Major Dates (continued)

Date of the Estoppel certificateDate Estoppel Certificates dueDate SNDAs dueDate of receipt of Notice of CasualtyDate of Notice to tenants notifying them beginning date rent is sent to BuyerDate for calculation of prorations after Closing DateDate of payment prorations to be paid after Closing DateDate of demand for tax proration after Closing DateDates of certificate of occupancyDates of 3 rd party contracts or agreementsDate of insurance contractsDate of flood hazard mapDate of knowledge in environmental issuesDate Seller learns Sellers reps/warranties are not correct as of Closing DateDate of any noticeDate of commission agreement with outside brokersDate of acceptance or contract will be null and void




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The Letter of Intent (LOI)

The Letter of Intent is also called the a) the LOI, b) Letter of Interest, c) Agreement to Agree, d)Memorandum of an Agreement or e) the Preliminary Binding Commitment. These all describe adocument that serves to outline an agreement between the Buyer and the Seller to purchase the propertybefore the purchase and sale agreement is finalized.

Major points the typical LOI contains are as follows.

Name of the Buyer The Buyer is ________(can be a General Partnership, Limited Partnership,Limited Liability Corporation, Corporation, individual, etc.)

Purchase price - dollar amount in number and written form, in total or on a per unit basis

Which party pays for the following transaction costs 1) broker's fee paid to a specified broker,2) survey, 3) title insurance and other costs, and 4) costs and expenses allocated between theBuyer and Seller at closing, known as prorations




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The Purchase

The most negotiated transaction item is price.

The purchase agreement isdated andbetween ____ (Seller) and ____ (Buyer). Both parties must have the legal ability to act.

For good and valuable consideration, the Buyer and the Seller agree to the terms of this Agreement.

Unless the Agreement states differently, the Buyer is entitled to the right to receive marketable title tothe property.




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The Purchase (continued)

The Seller wants the following:a qualified Buyer,receive a large, non-refundable, earnest money/deposit, ideally released to the Seller,certainty of close at a defined price, by a specific date, with good funds,sell the Property as is, i.e., no representations or warranties provided from the Seller,sell with no contingent liabilities,remove any items beyond the Sellers control, andafter the sale, the Buyer assumes all environmental responsibility.

Note the 2nd most negotiated item is the Representations and Warranties (i.e., reps/warranties) of theAgreement. From the viewpoint of the Seller, sell the property "as is" with no reps/warranties; theBuyer wishes to allocate some or all risks between the Buyer and the Seller.

The Buyer should verify the Seller actually owns the property. Resources from the Seller include an oldtitle policy and deed showing ownership transfer and organizational documents. These documents canalso be obtained from public records if the Seller is a limited partner or a corporation.




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The Property Description

Seller will sell/convey to Buyer the property, described with by plat or metes and bounds.

All items are collectively called "the Property.

From the viewpoint of the Buyer, the Buyer should include verbiage in the Agreement that if the landor building area is different from the initial representation, then the Buyer can choose to a) cancel theAgreement or b) change the Purchase Price.




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Start Date and Closing Date

All dates are negotiable.

The Start Date of the Agreement is also called the Reference date or Effective date.

The Reference date is the starting point for all important dates and specified time periods to bedetermined from this date. It can be

the date contract is executed,the Effective date of the contract, orsome other date.

The Effective Date is the starting reference point for dates and/or deadlines in the contract.and can bethe date the contract is last signed,the date of the contract,the date that the letter of intent (LOI) is signed ora specified number of days when monies are deposited.




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Start Date and Closing Date (continued)

The Closing Date can be -a specific date,a specific number of days (calendar or business) from end of the due diligence period, ora specific number of days (calendar or business) from the deposit of the Deposit or Earnestmoney.

The contract should specify the dates that the Seller must provide copies of the survey,the title commitment, andthe title exception documents.




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