Panama City Commercial Real Estate Articles
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Introduction to Leases - Part 4
Analyzing Lease Cost
In most commercial leases, base rent does not equal effective rent. An in-depth analysis includes all costs to the user.
The basic formula for calculating the user’s effective rent is:
Base (contract) rent + Additional Costs - Concessions and/or allowances = Effective rent paid by tenant
An in-depth analysis from the owner’s perspective must include all costs.
The basic formula for calculating the owner’s effective rent is
Base (contract) rent - Net additional costs - Concessions and/or allowances= Owner’s effective rent
Alternative Leasing Strategies
A ground lease is for the land alone, and is usually a long-term net lease. With a ground lease, land ownership and improvements are kept separate, with the tenant owning the land improvements. These leases are prevalent in areas with a shortage in highly desirable land, and are traditional in other areas. At the end of the term of a ground lease, title to the land, and improvements reverts to the lessor/property owner.
A sublease is a lease in which the tenant leases all or part of the leasehold interest to another tenant while remaining liable to the owner for the rent.
Risks of Subleasing
The owner or user may be unwilling to bear the following significant risks in subleases and buyouts.
- Re-lease risk: The length of time it will take to find a sublease is unknown.
- Rental rate risk: It may be necessary to sublease at below-contract rent.
- Tenant quality risk: It may not be possible to find a high-quality tenant.
- Lease-term risk: A sublessee may want a shorter or longer lease than that of the primary lease.
- Lease agreement risk: A sublessee may want concessions, allowances, and other features that are not provided in the primary lease.
- Tenant improvement risk: The sublessor may have to pay fit-out or retrofit costs for the sublessee.
All of the tenant’s leasehold interest in a property is transferred to another party. Generally, this releases the original tenant from any responsibility to pay rent to the owner.
Build to Suit
In a build-to-suit development, the owner agrees to develop or finish the property or space to the specifications of the tenant, with the cost usually partly carried by the tenant in the form of increased rent. A build-to-suit strategy typically seeks a tenant/user with strong creditworthiness.
In a sale-leaseback, the owner purchases land, builds for their own use, sells the entire property to an investor, and retains a long-term net lease. Companies use this strategy to convert their equity in real estate to working capital where it hopefully can generate a higher return from the operations of the business.
There are many different ways to structure lease transactions in commercial real estate. One of the most important things to remember is that most lease clauses are associated with a cost to the tenant or the owner. Commercial leases need to be reviewed carefully so that profitability is assured.
© Copyright 2008 Jennifer MacKay. All Rights Reserved.
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