APPRECIATION DIVERSIFICATION TAX BENEFITS Why invest in real estate 22 Total Return Breakdown Institutional Real Estate Since 1978 Appreciation Income Source of Return Average Annual Return ID: 807491
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Slide1
Commercial Leases
Slide2CASH FLOW
APPRECIATION
DIVERSIFICATION
TAX BENEFITS
Why invest in real estate?
Slide322%
Total Return Breakdown: Institutional Real Estate Since 1978
Appreciation
Income
Source of Return
Average Annual Return
Income return
7.06%
Appreciation return
1.97%
Total return
9.03%
78%
Slide4Conveys
specific space for a
specific period
of time
What is a lease?
Landlord
Tenant
A
contract
by which one conveys real estate, equipment, or facilities for a specified term and for a specified
rent.
Promises
to pay rent
Slide5What lease provisions directly affect value?
Slide6Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowanceRenewal option
Fixed expansion optionRight of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
Slide7Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowance
Renewal optionFixed expansion optionRight of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
List
Slide8How are rents measured for…
Type
Quoted Rent
Office space
Industrial space
Retail space
An apartment
Base rents and bumps
List
Slide9Base rents and bumps
Office
List
Slide10Type
Quoted Rent
Office space
$30+E / SF
Industrial space
Retail space
An apartment
Base rents and bumps
How are rents measured for…
List
Slide11Base rents and bumps
Industrial
List
Slide12Type
Quoted Rent
Office space
$30+E / SF
Industrial space
$4 NNN / SF
Retail space
An apartment
Base rents and bumps
How are rents measured for…
List
Slide13Base rents and bumps
Retail
List
Slide14Type
Quoted Rent
Office space
$30+E / SF
Industrial space
$4 NNN / SF
Retail space
$50 NNN / SF
An apartmentBase rents and bumps
How are rents measured for…
List
Slide15Base rents and bumps
Apartment
List
Slide16Type
Quoted Rent
Office space
$30+E / SF
Industrial space
$4 NNN / SF
Retail space
$50 NNN / SF
An apartment$2,000 / monthBase rents and bumps
How are rents measured for…
List
Slide17Quoted rent
The primary rent owed over the lease term
May include initial abatement
“3% per year” likely refers to year-to-year changes in starting base rents (i.e., market rent)
3% “bumps” refers to pre-negotiated increases over the term of a lease
Rent “bumps” ≠ market rent increases
Base Rents
List
Slide18Base rent increases or “bumps” are contractual increases
Example:
“Base rent shall escalate 3% per year on
each anniversary of the commencement date”
Base rents and bumps
List
Slide19Market rents in a strong growth scenario
Strong market rent growth scenario (e.g., Austin)
Base rents and bumps
List
Slide20Market rents in a recession scenario
Recessionary scenario (rent declines)
Recession
Base rents and bumps
List
Slide21Rent “bumps” ≠ market rent increases
b
elow market rent
a
bove market rent
Base Rents and Bumps
c
ontract rent
(at market)
List
Slide22Key Takeaway
Differences between
contractual rents and market rents
drive future income growth/declines
Example 1
Below Market
Rent
Example
2
Above Market
Rent
List
Slide23Below Market Rent Example
Revenue will trend up
List
Slide24Above Market Rent Example
Revenue will trend down
List
Slide25Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowance
Renewal optionFixed expansion option
Right of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
List
Slide26Lease Term
Start
End
1
2
3
4
5
6
7
8
9
10
Example:
10 year lease
List
Slide27Lease Term
Start
End
1
2
3
4
5
6
7
8
9
10
Example:
10 year lease
Two types of start dates:
Lease commencement date
Rent commencement date
List
Slide28Lease Term
Start
End
1
2
3
4
5
6
7
8
9
10
Example:
10 year lease
Lease End Date is the scheduled expiration of the lease.
List
Slide29Lease Term
Property
Type
Typical Lease Length
Rollover
per Year
Office
5
–
10
years
10
– 20% Industrial5 – 10 years10 – 20%
Retail
5
–
10
years
10
– 20%
Multifamily
1 year
100%
Hotel
1-3 days
12000%+
More Volatile
List
Slide30Lease Term
Property A
Property B
Property C
Beginning Occupancy
90.00%
90.00%
90.00%
Average Market Rent
32.00
32.00
36.00
Average In
Place Rent
25.00
36.00
25.00
Lease Expirations in Y1
5.00%
25.00%
25.00%
Lease Expirations in Y2
5.00%
25.00%
25.00%
Lease Expirations in Y3
5.00%
25.00%
25.00%
Lease Expirations in Y4
5.00%
0.00%
0.00%
Lease Expirations in Y5
5.00%
0.00%
0.00%
Rank the properties in order of highest revenue growth over the five year hold period?
List
Slide31Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowance
Renewal optionFixed expansion optionRight of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
List
Slide32Expense Reimbursements
In addition to base rent,
tenants often bear the burden
of operating expenses related to their tenancy.
Expense Reimbursements
List
Slide33Gross lease
Modified gross lease
Net lease
Lease types define reimbursement method:
Expense Reimbursements
List
Slide34Gross lease
Modified gross lease
Net lease
Lease types define reimbursement method:
Expense Reimbursements
Gross leases impose all burdens related to operating expenses on the landlord.
Example:
“Tenant shall pay $35/SF, increasing by 2% per year, and has no additional operating expense burden.”
List
Slide35Gross lease
Modified gross lease
Net lease
Lease types define reimbursement method:
Expense Reimbursements
Modified gross leases share operating expense burdens between tenant and landlord. Landlords pay expenses up to the “base year” amount, and tenants pay their pro rata share over the base year amount.
List
Slide36Gross lease
Modified gross lease
Net lease
Lease types define reimbursement method:
Expense Reimbursements
Net leases impose operating expense burdens on the tenant. The tenant pays its base rent and all operating expenses related to its tenancy.
List
Slide37Reimbursable vs. non-reimbursable
Caps on reimbursable expense growth
Cumulative vs. non-cumulative caps
Frequently negotiated topics:
Expense Reimbursements
List
Slide38Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowance
Renewal optionFixed expansion optionRight of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
List
Slide39AKA “work letter”
Heavily negotiated
TI vs. turnkey finish out
A Tenant Improvement (TI) allowance is a concession from the landlord to offset the cost of building a tenant’s interior space.
Expense Reimbursements
List
Example: $50 / SF
Slide40Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowance
Renewal optionFixed expansion option
Right of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
List
Slide41Renewal Option Example
Big Law Firm LLP
15,000 SF
Leased
2020 through
2030
15,000 SF can be renewed by tenant for 5 years (at fair market rate) with notice by 2029
List
Slide42Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowance
Renewal optionFixed expansion option
Right of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
List
Slide43Fixed Expansion Example
Big Law Firm LLP
15,000 SF
Leased
2020 through
2030
5,000 SF Must be Delivered by LL in 2025
Fixed Expansion Space
List
Slide44Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowance
Renewal optionFixed expansion option
Right of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
List
Slide45Right of First Offer (ROFO) Example
Big Law Firm LLP
15,000 SF
Leased
2020 through
2030
Big Law Firm LLP has a “first look” at leasing 5,000 SF of adjacent space when it becomes available (could be on-going)
ROFO Space
5,000 SF
List
Slide46Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowance
Renewal optionFixed expansion option
Right of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
List
Slide47Right of First Refusal (ROFR) Example
Big Law Firm LLP
15,000 SF
Leased
2020 through
2030
Big Law Firm LLP has a “last look” at leasing 5,000 SF of adjacent space by being able to match any legitimate offer from another user
ROFR Space
5,000 SF
List
Slide48Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowance
Renewal optionFixed expansion option
Right of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
List
Slide49Termination Example
Start
End
1
2
3
4
5
6
7
8
9
10
Example:
10 year lease with termination option in year 7
Tenant has the right to prematurely end the lease at a pre-specified date, often must pay penalties.
List
Slide50Base
rents and “bumps”
Lease term (start and end dates)
Expense
reimbursements
Tenant improvement allowance
Renewal optionFixed expansion option
Right of first offer (ROFO)
Right of first refusal (ROFR)
Termination/contraction option
Exclusive uses
10 Major Lease Terms
List
Slide51An “exclusive” gives a tenant the only right to do something within a building or project.
Expense Reimbursements
Example:
As
long as Tenant leases four (4) full contiguous floors in
the
Building, Landlord will not lease any space within the Building to a Financial Institution or any Competitors, as defined below, unless prior approval is received from Tenant.
Competitors
(
includes affiliates
)
: JP Morgan Chase & Co, Bank of America, US Bancorp, Citigroup, Wells Fargo
List
Slide52Sample Rent Roll
Sample Rent Roll
List
Exercise