Chapter 23 Commercial Brokerage and Leasing

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Chapter 23 Commercial Brokerage and Leasing
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Major Topics

• Commercial Brokerage Functions
• Lease analysis from the tenants perspective
• Lease analysis from the landlords perspective
• Influences on effective rent
• Cash flow analysis and buyer/seller perspectives
  on proforma assumptions
• Cap Rate influences
• Before and after tax cash flow and resale analysis

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Introduction and Overview

• Commercial brokers on average have far more
  training than residential brokers and tend to
  earn far higher earnings
• Good commercial agents will have a great deal of
  general business knowledge and tend to specialize
  by property type within a given market region
• Specializations may include office, retail,
  multifamily, industrial, agricultural or even
  recreational property

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The Building Block of Investment Value Begins
With the Tenant and Lease

• While in residential brokerage the qualitative
  factors may dominate value, but within the
  commercial brokerage industry it is the financial
  terms that dominate views on value
• The value of a building is primarily the summed
  value of the net productivity of leased space, as
  now constrained by lease contracts and as
  affected by operating expenses, market trends and
  longer term prospects

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Investment Value (Contd.)

• LPV Lease Present Value
• For the landlord, the appropriate discount rate,
  k, is based on the potential yield for similar
  risk investments in the capital market and for a
  similar term or time horizon
• Thus, k could be derived from the credit
  worthiness of the tenant as revealed through the
  tenants borrowing rate
• In any scenario k is derived from opportunities
  in the market adjusted for risk and timing

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Types of Lease Analysis

1. The net present value of the lease for the
   entire period of the lease
2. The effective rent or lease costs per period on
   a level basis
3. The total dollar outflow or to be received
4. The net present value of the lease per square
   foot
5. The effective level rent payment or receipt per
   square foot.

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Key Terms

• Sector or Submarket
• Peer Group Analysis
• Discount Rate
• Tenant Improvements
• Landlord Concessions
• CAM
• CAM Proration Formula
• Caps on expenses or Expense Stops
• Effective Annualized Rent
• Effective Monthly Rent
• Effective Annualized or Monthly Rent Per Square
  Foot

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Computing the "Effective Rent" of a Lease

• Simply comparing the initial or average base rent
  charged in two leases could be very misleading
• The effective rent is a way of expressing the net
  present value of the rental payments of the lease
  in an equivalent annual level payment (or
  "annuity") form
• The "effective rent" controls to some extent for
  factors such as expenses and different lease
  duration, and is therefore a measure that allows
  different types of leases to be compared

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Effective Rent Calculation Procedure
Step 1) Calculate the Lease Present Value, LPV,
as described earlier Step 2) Calculate the
Annualized Value ("Level Annuity Payment") of
the LPV
where "k" is the same discount rate as above,
and "T" is again the term of the lease

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Numerical Example of Effective Rent Calculation
Lease "A" Term 5 years Rent
20/SF, net Concessions 1 year free rent, up
front

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Effective Rent Calculation (Contd.)
Lease B" Term 6 years Rent
25/SF, net Concessions 2 years free rent, up
front
Landlord would prefer Lease A over Lease B, even
though lease B has a higher "nominal rent"
(25/SF vs. 20/SF) Similarly, the tenant would
prefer Lease B

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More In-depth and Detailed Lease Comparison and
Submarket Analysis

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Revisiting the Proforma, and Cap Rates for a
Specific Building Value Estimation

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Proforma (Contd.)

• Notice that in the next three years the
  projected NOI will decrease before it increases
• This is simply the result of flat leases that
  become below market over time (prior to turning
  over) and later on being adjusted towards market
  rent
• It is also the result of some assumed longer
  term vacancy rate of 5 which is not expected to
  occur for at least one year

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Recap of Calculating Before and After Tax Cash
Flow

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Resale Proceeds
Step 1 Estimate the resale price Step 2
Subtract expected selling costs and other
transaction costs to derive Net Selling
Price Step 3 Subtract the mortgage balance
remaining at the projected time of sale and any
prepayment penalties due on the mortgage, to
derive the before tax resale proceeds. This is
where the analysis would stop if the investor is
not a taxable entity Step 4 Subtract the taxes
due on sale to derive the projected after tax
proceeds from resale

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Sample Proforma
Real Estate Principles for the New Economy
Norman G. Miller and David M. Geltner
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Tax Law Trends Matter to Investors and Commercial
Real Estate Firms

• General income tax rates
• Capital gains tax rates
• Depreciation rules and economic life
• Passive loss limitations
• Tax Credits

Real Estate Principles for the New Economy
Norman G. Miller and David M. Geltner
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Commercial Leasing and Brokerage Fees

• Like residential brokerage most commercial
  brokers or agents make their income mostly based
  on contingent commission fees
• Contingent fees are paid only if a lease is
  signed or a property is bought or sold
• These fees must include sufficient margins to
  subsidize the deals that dont close and be large
  enough to cover overhead, research and support
  staff cost
• Fees vary significantly but typical fees for a
  lease might run 6 of the base rent calculated
  over the initial term of the lease for a newly
  signed lease, and 3 to 5 for a renewal lease

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Research Is Becoming More Valuable to Commercial
Brokerage Firms

• CB Richard Ellis
• Colliers International
• Cushman Wakefield
• DTZ
• Grubb Ellis
• Jones Lang LaSalle
• Prudential
• Staubach Company
• Stiles Riabokobylko
• Strutt Parker
• Studley, Julien J. Inc

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