Real Estate Finance and Investments_ Lecture 7

Real Estate Finance and Investments: Lecture 7 Industrial, Office, and Shopping Center Real Estate Real Estate Finance and Investments: Lecture 7 Primer on Commercial Leases Characteristics of Commercial Leases  Agreement and Consideration – – – ―Meeting of the Minds‖ Owner sets asking price, and makes proposal to tenant Tenant accepts, and lease is commenced  Common Lease Clauses – – – – – – Fixtures Clause Tenant Improvements Clause Hours-Of-Business Clause Use Clause Signage Clause Condemnation Clause Commercial Rental Structures  Gross Lease – – Landlord pays for all expenses Expense Stops  Net Lease – – Tenant pays for ―pro-rata‖ share of determined expenses Triple-Net (NNN): Tenant pays for pro-rata share of Common Area Maintenance (CAM), Ad Valorem Taxes, Hazard Insurance Commercial Rental Structures  Percentage Rent (Overage Rent) – – – Portion of Tenant’s rent based on business income Fixed Rental Portion + Overage Portion Recapture Clause (helps hedge owner risk of tenant’s poor business performance)  Escalated Rents – – Flat rent amount over a set period, increases periodically thereafter Escalators contracted or based on consumer indices Examples of Rental Structures 1. Tenant pays $50,000, and Landlord/Owner pays all operating expenses. Tenant pays $30,000 annually, PLUS 2% of all retail sales over $750,000. The store’s gross sales were $900,000. 2. 3. Tenant pays $10,000 annually plus its share of hazard insurance, ad valorem taxes, and CAM totaling $30,000 per year. Tenant pays $24,000 annually for the first year, and the Landlord pays all operating expenses. In years 2 through 6, the rent increases by an amount equal to the respective CPI, or 3.5%. 4. Real Estate Finance and Investments: Lecture 8 Industrial Real Estate Industrial Building Investments  Industrial buildings have the advantages of reliable, credit-worthy tenants, long-term leases, and opportunities to shift many operating expenses to tenants Business operators, short on capital, prefer to channel resources into business expansion rather than real estate ownership  Demand for Industrial Space   Largely a function of demand for products produced by industrial sector Periodic shifts in demand for industrial space of various types and in different locations reflect alterations in composition of the industrial sector – – Growth in service and technology Decrease for products of heavy industry Locations Factors  Near fuel or power supply Near markets   Synergy Types of Industrial Buildings  No official classification system for industrial buildings. Can be characterized by nature of building’s construction or type of tenant it attracts: – – – – Heavy industrial buildings Loft buildings Modern one-story structures Incubator Buildings Real Estate Finance and Investments: Lecture 8 Office Real Estate Office Building Investments      Dramatic growth in service sector has increased demand Demand for office space is a derived demand – related to demand for services supplied by occupants of office buildings Unlike owner-owned office buildings, investor-owned buildings tend to be more functional and less luxurious Multi-year leases Options to renew on occupied space Difficulties of Analyzing Office Space 1. Analysts need to know how many tenants made local relocations (within the same market area) Gross Absorption vs. Net Absorption 2. Tenants planning on future expansion may have leased extra space (―shadow space‖) 3. Office market made up of distinctive ―class levels‖ Office Property Definitions   Gross Square Feet: Total constructed area Net Useable / Leasable Area: Area of a building that can be leased Efficiency Ratio / Core Factor: Percentage of total useable space to the total gross space in the building  Office Class Levels ―Class A‖ – Excellent location and accessibility, high-quality building and management, over 100K sf in CBD, over 50K sf in suburbs, rent rates upper 33% High land values in a CBD create need for ―Class A‖ structures. Class “A” Office Class Levels ―Class B‖ – Good location and access, structure showing minimal obsolescence or deterioration, minimum size 50K sf in CBD, minimum 25K sf in suburbs, rental rates in upper 60% of market “Class B” Office Class Levels ―Class C‖ – Buildings generally more than 15 years old, with rent rates in the lower 40% of the market, located in less-desirable areas, little (if any) common space and amenities “Class C” Office Market Trends      Demand may decrease from hotelling and office sharing Telecommunicating allows employees to work from home Less filing space required, as files are saved electronically Increased density of occupancy per worker has created problems with parking ―Green design,‖ ―intelligent buildings,‖ and increased security have become more important. Real Estate Finance and Investments: Lecture 8 Shopping Center Real Estate Shopping Center Investments  Investors and developers have long provided favorable lease terms to anchor tenants— major stores that attract customers Recently, developers have allowed major tenants to construct their own buildings on sites leased from owners  Lease Arrangement in Shopping Centers    Owners set base rental rate and increase rental rates as tenant’s sales volume increases (percentage clause) Large shopping center tenants typically lease space on net basis, paying all expenses associated with operation of their space; smaller tenants often pay own utility expenses Shopping center tenants often pay common area maintenance fee Types of Shopping Centers      Neighborhood shopping centers Community shopping centers Regional shopping malls Super-regional shopping malls Lifestyle centers