1 Leasing
Introduction
Our discussion of property investment begins with a description of the typical components of a lease. This is because as an investor in commercial property, you want to know what cash flow the property will be able to generate during the time that you own the building. The most significant source of cash flow is the rent paid by a propertyâs tenants, and contracted rent payments are specified in each tenantâs lease.
Upon closer examination, however, a lease specifies much more than the periodic rent owed by a particular tenant. More generally, a lease is a legal agreement between the owner of a set of property rights, the lessor or landlord, and the temporary user of those same rights, the lessee or tenant. From the investorâs perspective, not only does the lease specify the rent to be paid, but it also typically contains additional features that may also affect the value of the property. This chapter begins with an overview of these features. This is then followed by a discussion of how property investors should compare leases, both with respect to their explicit value as well as their implicit benefits to any property.
Overview of lease features
Generally speaking, all leases will contain some common characteristics. These are:
- 1 The space
- 2 The term
- 3 The rent
- 4 Expense sharing
- 5 Concessions
- 6 Options
The space
The lease will specify the space being granted to the tenant for use over the course of the lease. In an apartment building, the space might be Apartment 413. In a single-tenant industrial space, it might be 4205 Industrial Park Way. In an office building, the space might be the 7th floor. If 4 tenants in the office building share the 7th floor, each tenant might have a lease specifying their right to occupy a particular 4500-square-foot area on the 7th floor. It is important to recognize that certain spaces have unique features that may impact how attractive the space is to potential tenants. The location of the space can be important â not only with respect to the buildingâs location but also with respect to the location of distinct locations within a single building. Retail space closer to the street may be more valuable than similar space on the interior of the same building. Space on higher floors with better views may command higher rents than space on lower levels.
The term
The lease will also specify the term during which the tenant has use of the space. For example, an apartment lease might last for 12 months. The term of a typical lease varies by property type. Hotels (implicitly) have very short leases â overnight! Office tenants often sign leases for 5 or more years, whereas specialized industrial warehouses may lease for 10 or more years at a time.
The term of a lease will influence property cash flows because the expiration of a lease indicates the likelihood that a landlord needs to grant concessions (discussed further in a following section) to a new tenant. Thus, all else equal, a longer lease is beneficial for cash flow. Put another way, a landlord may be willing to accept lower rent in exchange for a longer term to avoid the costs associated with getting the existing tenant to sign a new lease or finding a new tenant. The risk of getting a tenant to sign a new lease is also likely to be systematic, in that the ease with which one can lease a property is related to the state of the economy. Therefore, cash flow from a property with higher vacancy (and thus a greater need for leasing) is riskier than cash flow from a similar property with less vacancy.
The rent
Quotation
Rent can loose...