Analyze Cash Flow In Terms Of The Operating Cycle Understanding Commercial Real Estate Leases

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Understanding Commercial Real Estate Leases

When you list a property for sale or lease, you need to understand what type of lease you are giving. There are definite differences between leases at all levels and therefore it is essential to read the lease thoroughly before proceeding.

A lease is the foundation of the property’s performance. The best salespeople understand the leasing process and the high value it brings to future sales. A good lease can increase the sale price when the time comes.

As mentioned, there are many types of leases, but there are certain rules and general basic elements that allow you to understand the lease or potential lease that you may apply to a property. It’s all about interpreting the lease document, and that means you should read the document.

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After years of working in the industry, I’ve seen the best people build the foundation of success around the leasing process. This means that they have grounded themselves with investment skills and knowledge by renting property for a few years. So now let’s see how you can go down this path of skill development in terms of leasing.

The better you negotiate and the more accurately you interpret the lease, the more professional you are and appear to the people you work with or serve.

You can and do add strategic value to clients in every lease you negotiate. A lease is not just a document allowing the tenant to occupy the premises; It is a strategic cash flow that can attract or detract from the property.

The way a lease works for a property investor will have a substantial impact on the property and its performance for the duration of the lease. When you are working with tenants or buyers for a property, the type of lease that applies will also affect the negotiations. Let’s look at the main lease types and expand on some of the most relevant issues for you.

Total Lease:

Under a gross lease, the tenant pays the full rent, which includes a component for outgoings, and the building owner pays all building operating expenses (also known as outgoings). This means the lease itself will have rent review provisions that only increase the total rent.

In this type of lease the landlord needs to know that they can maintain the building outgoings to a predictable level over the term of the lease as the landlord bears all the risk of overpayment. The level of rent review increases in the lease is expected to cover or exceed the level of outgoing increases in future years or else the landlord will lose money.

Gross leases are common in retail and office properties. Your choice of using these rental and lease types should be balanced against the projected level of outgoing costs and future changes to the subject property.

Obviously an older building will have a steady increase in outgoings more than a smaller one. As the building ages and deteriorates, the total lease method becomes less attractive and more risky for the landlord.

Semi Gross Lease:

In this type of lease the landlord initially sets a total rent that is paid by the tenant and is reviewed over the term of the lease, however, the landlord is also paid some regular payments for outgoings that increase according to a certain calculation. This is done like this:

The landlord typically recovers the increase in outgoings above the nominated outgoing base year. This base year is chosen at the start of the lease and is usually the last reconciled outgoing year before the commencement of the lease, which is usually the financial year preceding the commencement of the lease (as it is fully reconciled and known as set value).

As the new semi-gross lease progresses to its term, the lessee has to pay the outgoing increment above the nominated base year. For example, if the base year for outgoing purposes in a lease is set as financial year 08/09 and the known level of outgoings for that year is $85m2 pa, then in financial year 09/10 when outgoings increase to $97 m2, the lessee will have outgoings of $12m2pa. have to pay Depending on the age of the lease and in the financial year 12/13, outgoings could be $108m2 and in that case the tenant would have to pay $23m2.

A base year is set in this type of lease and the outgoing ‘gap’ will increase significantly as the lease ages. This type of lease is good for a landlord with a small property, as it protects the landlord from increases beyond the base year while still allowing the landlord to use the gross rent as a basis for charging and collecting rent.

In this type of lease it is common for the outgoing base year to be updated during any market rent review during the lease. This type of lease will have market reviews if the lease is long (more than 3 years) and therefore market rent reviews will be done every 3 or 4 years.

It is not necessary to review the market rent at any particular point in the lease as this is negotiable at the commencement of the lease, however be aware of the fact of re-setting the basis for outgoings and its impact on the landlord.

For further explanation of this type of lease see the type of outgoings you charge in the calculation. It is not uncommon for ‘lease savvy tenants’ such as governments or large corporations to nominate the type of outgoings to which the base year increase will apply.

Obviously the landlord is better off recovering all outgoings in the building above the base year, however governments and corporate tenants are known to limit this to calculated rate and tax increases.

Obviously a lease is a product of negotiation, but you need to understand what can be done and then get the best lease deal for your client.

Net Lease:

The term net lease is at first general; So you should know that there are 3 types of net leases in the category. So let’s look at them.

Net Lease: In this lease the lessee pays some or all rates and taxes for the property or premises.

Net-Net Lease: In this lease the lessee pays nominated rates and taxes on a ‘net lease’ basis but then also pays the insurance premium for the property and premises.

Net-net-net lease: In this lease, the tenant will pay the rates and taxes, insurance of the premises and then they will also pay the repair and maintenance costs related to the premises.

So which lease type is best for a homeowner? In most cases a net-net-net lease is the way to go, however it is a matter of whether the tenant will accept and sign that type of lease.

As a point of negotiation any net lease or net-net lease would be wise to have higher rent for the landlord and better rent review provisions that would result in less cost recovery for the landlord.

Net-net-net leases are common on properties fully occupied by one tenant. This method of lease structure is widespread in industrial properties and office properties.

Percentage Lease:

This type of lease is more commonly seen in retail property as the rent calculation is linked to the trading figures of the tenant. In most leases of this type, the tenant first pays a fixed base rent that is determined by some rent review method, and then the tenant also pays additional rent calculated from their turnover or sales. As the tenant improves his trade, the rent increases.

An essential part of this lease structure is to oblige the lessee to provide you with accurate and regularly audited turnover figures. The lessee must support and implement an audit process for the landlord. Monthly turnover figures are the best way to go about this, with tenants providing audited figures to the landlord by the 7th of the following month. The landlord then charges the turnover rent from the tenant based on the audited figures.

This type of lease can also be seen in new shopping centers as new tenants stabilize custom and sales levels, for the same reasons as supermarkets and hotels or motels. The basic strategy of turnover rent is to give the landlord some cash flow from the establishment of the original rent from the beginning of the lease and then collect additional rent as the property and tenants become more successful in selling and generating customers.

Spell it out

In all leases, the collection of rent and outgoings should be clearly stipulated to avoid disputes and disagreements with the tenant. As you can now see, the choice of lease type you use on the property will significantly affect the future of the landlord. It will also affect any sales situation.

It pays to know what’s going on in the market regarding leases and rental types so you can negotiate a lease that matches or better than the rest of the market. Proper lease structure, documentation and rent will help sell the property at a good price.

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