CHAPTER NINE

1. CHAPTER NINE INTRODUCTION TO INCOME- PRODUCING PROPERTIES: LEASES AND THE MARKET FOR SPACE

2. Chapter Objectives • Major property types • Economic forces • Supply and demand relationships • Location analysis • Competitive nature of real estate • Importance of leases

3. Classification of Real Estate Uses • Single family • Multi- family • Office • Retail • Industrial • Recreation • Institutional • Mixed use

4. Economic Base Analysis- Location Quotients • RE- Regional Employment • USE- U.S. Employment • j- Industry Classification • TOT- total • LQ= (R.E.j/RETOT) / (USEj/USETOT)

5. Economic Base Analysis- Location 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

6. Housing Demand and Supply 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.

7. Retail Demand and Supply 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.

8. Office Demand and Supply 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.

9. Location 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

10. Location and User- Tenants Continued • Locations with the greatest appeal to users will produce higher rents and also highest densities • Firms that are cost- sensitive are competitive for locations

11. Location and User- Tenants Continued • 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

12. Location and User- Tenants Continued • 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

13. The 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

14. The 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.

15. Leases- Features and Characteristics • Date • Term • Parties, lessee, and lessor • Legal description • Allowed uses • Restrictions on alterations • Responsibility for maintenance and repair

16. Leases- Features and Characteristics Continued • 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

17. Leases- Features and Characteristics Continued • TI allowance • Rent concessions • Lease renewal options

18. Lease Demand and Supply • Demand and supply model with vacancy Va= S-D • Natural vacancy • Rents • Equilibrium rent • Net contract rent • Effective contract rent

19. Lease Demand and Supply Continued • 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

20. Financial Content of Leases • Base rent • Step up provisions (CPI) • Percentage rent • Maximum rent • Overage rent • Gross lease • Net lease • Expense stop

21. Responsibility 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

22. Example 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

23. Financial Content of Leases Continued • Concessions- base rent, TI allowance, etc. • Signage • Non- compete clause • Lender approval of major leases • Load factor • Load factor for floor= Rental area per floor Usable area per floor • Effective rent