Leasing Term Impacts to Valuation

Transcription

1 Leasing Term Impacts to Valuation Lachlan MacQuarrie, Vice President Oxford Properties Group Vice President, Real Estate Management National Programs. S. Michael Brooks, Partner Aird & Berlis LLP Real Estate Practice Group Leader RealLeasing Conference October 2nd. 2013

2 Static Model: Real Estate Finance Investor Cap Rates, DCF, IRR, NPV, FFO, Financial Modelling Owner Amortization, Yield Lender NER, Discount Rate, yield, budgeting, lease vs buy Tenants Real Estate Budgeting and financial modelling Contractors and suppliers

3 Retail, Office, Industrial Net Lease Income Net Effective Rent NER NER is the effective net rent to the landlord over the term of a lease after present valuing leasing commissions, leasehold improvement allowances, old lease takeovers, and free rent periods, then amortizing that PV over the fixed initial term of the lease like an annuity Gross Effective Rent GER GER is the effective gross (ie inclusive of tax and operating costs) rent to the landlord over the term of a lease same mechanics as above NER key metric: owners run NER screens Face Rents that shown on reading the lease rent clause - illusory: but buyers buy Face Rent (rent roll) Face Rent may be significantly higher than market NER s

4 Leasing: NER s answer the question: which deal best? Deal 1 Deal 2 Deal 3 10 year term 10 year term 10 year term $14 net psf/yr $16 $18 $10 LIA $20 $30 $1 Commission $1 $1 Right to terminate yr 5 Option to expand yr 3 6 mos rent free 9 mos 12 mos First right of refusal adjoining space

5 3 Step NER: PV calc then net annuity Deal 1 a b c d e Year face rent $ 7.00 $ $ $ $ PV to Yr 1@10% $ 7.00 $ $ $ $ 9.18 f total PV rent a-e $ g less LIA $ h less Commission $ 1.00 i Net PV (f-g-h) $ j $ 9.43 $ 9.43 $ 9.43 $ 9.43 $ 9.43 therefore NER $ 9.43 Should we do an NER if they don t terminate yr 5?

6 Deal 2: The 3 step approach a b c d e f g h i j Deal 2 Year face rent $ 4.00 $ $ $ $ $ $ $ $ $ PV to Yr 1@10% $ 4.00 $ $ $ $ $ 9.44 $ 8.48 $ 7.65 $ 6.88 $ 6.19 k total PV rent a-j $ l less LIA $ m less Commission $ 1.00 n Net PV (k-l-m) $ o $ $ $ $ $ $ $ $ $ $ Therefore NER $ But what about the option to expand Year 3? Do we have to hold space off the market? Should we compute that opportunity cost?

7 Deal 3: The 3 Step Approach a b c d e f g h i j Deal 3 Year face rent $ - $ $ $ $ $ $ $ $ $ PV to year 1@10% $ - $ $ $ $ $ $ 9.54 $ 8.64 $ 7.74 $ 6.97 k Total PV rent a-j $ l less LIA $ m less Commission $ 1.00 n Net PV (k-l-m) $ n re-amortize@10% $ $ $ $ $ $ $ $ $ $ Therefore NER $ What about the First Right of Refusal to Lease adjoining space? Does that cost us anything?

8 Leasing: NER s answer the question: which deal best? Deal 1 Deal 2 Deal 3 10 year term 10 year term 10 year term $14 net psf/yr $16 $18 $10 LIA $20 $30 $1 Commission $1 $1 Right to terminate yr 5 Option to expand yr 3 First right of refusal adjoining space 6 mos rent free 9 mos 12 mos $9.43 NER $10.53 NER $10.09 NER

9 Approaches to Direct Real Estate Valuation Discounted Cash Flow (Income Capitalization) Relative Valuation (Sales or Direct Comparison) Replacement Cost

10 Cost Assumes value = cost = Land value + (building replacement cost accumulated depreciation) Land value estimated separately direct comparison Depreciation estimated from observation, age of building, building condition. Useful for specialized properties and as a touchstone

11 Direct Comparison Useful if sufficient comparable sales available Sale prices of comparable sale prices indicate a range within subject property should sell But must equalize for differences subjectivity Result is an equalized value for each comparable typical in residential markets but value to unique user may be higher than for investor use as touchstone for investment property ($/psf or $/unit)

12 Income Approach PV of future benefits - current income and resale value upon reversion capitalized into current lump sum value 2 Methods: Direct capitalization and yield capitalization Direct Capitalization: take current income stream and use market capitalization rate, or market based gross income multiplier Yield Capitalization: uses Discounted Cash Flow: PV of income stream and PV of terminal value Current cash flow a reflection of Face Rent NOT NER, and does not reflect the investment the Landlord has made to secure those tenants

13 Discounted Cash Flow: Example 1 Yield Capitalization 2% rent increases: D.C.F Summary Sale at a 6 cap ( a ) ( b ) ( c ) ( d ) ( e ) = (b) + (d) Year NOI 8% REV 8% Total PV 1 $481, $ 446, $ 446, $ 491, $ 421, $ 421, $ 501, $ 397, $ 397, $ 511, $ 375, $ 375, $ 521, $ 354, $ 354, $ 532, $ 335, $ 335, $ 542, $ 316, $ 316, $ 553, $ 299, $ 299, $ 564, $ 282, $ 282, $ 575, $ 266, $ 9,790, $ 4,534, $ 4,801, Total = $ 8,031, Direct Capitalization 6% cap rate = $8,031,250

14 DCF Example 2. Yield Capitalization 2% rent increases D.C.F Summary Sale at a 5 cap ( a ) ( b ) ( c ) ( d ) ( e ) = (b) + (d) Year NOI 7% REV 7% Total PV 1 $481, $ 450, $ 450, $ 491, $ 429, $ 429, $ 501, $ 409, $ 409, $ 511, $ 390, $ 390, $ 521, $ 371, $ 371, $ 532, $ 354, $ 354, $ 542, $ 337, $ 337, $ 553, $ 322, $ 322, $ 564, $ 307, $ 307, $ 575, $ 292, $ 11,748, $ 5,972, $ 6,264, Total = $ 9,637, Direct Capitalization 5% cap rate= $9,637,500 14

15 Deal structure impacts the value of leases and the valuation of the asset Rate Term Options / ROFR / Right to Expand Tenant Allowances Restoration Clauses Exclusivity / Restrictions Operating Costs Termination Options Parking Commitments to Subletting and Assignments 15

16 Rate obviously! Flat vs. stepped Over market (or under market) Last rent paid? Same NER can have different valuation impacts Favored nations clauses in particular new builds, or large tenant deals, can impact valuation Clear IMPACT to valuation! Sometimes even if over market. 16

17 Term Commitment to rent 10 years is better than 5 in a falling market ST is better than LT in a volatile market it depends Ideally consider the market the more stabilized the longer the term, the more volatile the shorter (assuming things are going up!) Use rent steps to protect Standard fit out / uses vs customized Staggered terms can help an asset (requiring leasing and AM to talk) ½ of the value of an asset occurs outside of the lease term of the committed cash flow the residual value 17

18 Options / ROFR / Right to Expand etc Options give control to the tenant ROFR gives control to a tenant, credit worthiness is a concern in extreme cases Right to Expand is like a melting ice cube for an asset Right to Terminate (LL) can limit securing the best tenants and introduces risk / cost to valuation models Control will impact how PV cash flow + residual value is forecasted 18

19 Tenant Allowances Give tenants a market TI, maintain the face rate. Analysts capitalize the face rent for residual, and the last rent paid has an impact on negotiations Over market TI s analysts will see past the face rent, assume termination, and then renewal at market an impact to valuation! Psychology has an impact, even in valuation! 19

20 Restoration Clauses Can be an unseen cost of a lease deal if waived Significant exposure to high tech, excessive partitions, specialty uses such as libraries can detract value on assets The main issue is the impact on valuation if the use / equipment is unique, non-standard. Should be a cost in NER if waived, will be considered in valuation 20

21 Exclusivity / Restrictions / Use Clauses Exclusivity may be more common in retail Restrictions limit the pool of possible tenants. Use clauses that impact wear / tear on a building can impact asset value. Largely these are a qualitative impact on valuation unless the impact is significant which can be the case in thin markets 21

22 Operating Costs Any restriction on recoverability will impact the valuation CAM stops Exclusions Semi-gross Inflationary controls Only costs which must be recovered by everyone Will get picked up in valuation as an impact to value. 22

23 Termination Options Why not just give a ST deal as opposed to giving a tenant control. T. Options give the benefit of a buyout in an over market situation to the Tenant. Analysts look at forecasted rent curves to see market vs. termination rate. Better to give ST deals and a market renewal avoid the valuation impact Avoid analysts assuming a termination will occur, which impacts valuation. 23

24 Parking Don t over commit make sure future tenants can have appropriate ratios otherwise deals will be impacted Impacted deals mean capital (if parking can be added), or loss in face rent both impact valuation. Lack of parking, or overcommitted can t always be cured! 24

25 Commitments to Renovations Lobbies Certifications (such as LEED) Control on others All have an impact on valuation analyst will assume the commitment to be met which will require capital! 25

26 Subletting and Assignment No significant impacts unless Tenants end up competing with LL to fill space LL should control the right to take back space if necessary, and consider buy outs In a rising market LL should capture any upside Tenant s secure. If terms and controls are not strong enough generally then major impacts on quality can impact cap rates. 26

27 Questions and Discussion? Lachlan MacQuarrie, Vice President Oxford Properties Group Vice President, Real Estate Management National Programs. S. Michael Brooks, Partner Aird & Berlis LLP Real Estate Practice Group Leader RealLeasing Conference October 2nd. 2013