Cirrus Commercial can help you through the many steps required in securing a good tenant. The information provided below can be helpful to anyone who wants to become more informed about the complexities of leases.

 

The lease creates a contractual relationship between the owner of the real estate and the user of the space.  The lease specifies the rights and obligations of the owner and user and legally divides the bundle of rights in real estate into two interests.  In a long-term lease, the lessee is committed to make a series of payments, much like the commitment to make debt-service payments under a mortgage.  Failure by the tenant to make lease payments is the equivalent of default in that the owner forecloses on the lease.

 

·         Base (contract) rent: This is a face, quoted, contract dollar amount of periodic rent. The annual base rate is the amount upon which escalations are calculated.

·         Total effective rent: This is the base rent adjusted downward for concessions and allowances and upward for costs that are the responsibility of the user (such as operating expense pass-throughs). Total effective rent is the total of all cash flows over the term of the lease.

·         Average annual effective rent: This is the total effective rent divided by the lease term.

·         Average annual effective rate: This is the average annual effective rent divided by the square footage.

·         Discounted effective rent: This is the cash flows over the term of the lease, discounted to the present value.

 

·         A fixed amount of contract rent over the entire lease term

·         Rental payments that change, or step up, by set amounts or percentages at given dates (step leases)

·         Variable levels of contract rent based on changes in an index (indexed leases)

·         Variable amounts of monthly rent based on a percentage of the tenant’s gross sales receipts (percentage leases)

·         Periodic changes in contract rent (usually every two to five years) based on renegotiation

 

Expense Pass-Throughs Some, if not all, operating expenses frequently are paid by the owner and then passed-through to the tenants. This is especially true in multi-tenant office buildings and shopping centers. In retail properties, a tenant’s share of these expense pass-throughs is based on the gross leasable area (GLA) of the tenant’s store as a proportion of the GLA of the entire shopping center. In office properties, the pass-through is based on the tenant’s rentable area as a percentage of the building’s total rentable area.

 

Common Area Maintenance common expense pass-through, especially in shopping center leases, is a pass-through of common area maintenance (CAM) expenditures. These are the costs associated with maintaining the common areas of a property, such as hallways, lobbies, and parking lots. These costs may be included in a gross lease or excluded in a net lease, but in either case usually are calculated on the percentage of rentable space that the tenant is occupying. CAM clauses benefit owners in that when maintenance costs or taxes increase, the increase is passed on to the tenants. Tenants also benefit at least in theory, to the extent that monies collected for CAM cannot be used for other expenses, helping to ensure that property is properly maintained. As with any expense pass-through, the contract rent is lower than it would be in the absence of the CAM clause.

   

Tenant Improvements  Many major components of commercial properties, such as roofs and flooring, wear out faster than the structure itself, thus owners may replace them several times during the structure’s expected economic life. In addition, owners often incur retenanting expenses when leases expire and vacant office or rail space must again be made ready for occupancy. As an example, the releasing of office space often requires that substantial changes be made, such as removing oradding walls, raising ceilings, and altering electrical capacity. In fact, many office and retailleases provide a new tenant with an improvement allowance. This lease provision obligates theowner to incur a prespecified dollar amount of expenditures to improve the space to the new tenant’s specifications.  These up-front expenditures reduce the present value (PV) of the lease to the owner and therefore must be included in comparative lease analyses and in discounted cash flow models.