Leasing Lessons Maximize profit potential through rental increase
Transcription
Leasing Lessons Maximize profit potential through rental increase
A BILL GLADSTONE C O M M E R C I A L R E A L E S T A T E November/December 2006 Financing Focus Leasing Lessons Maximize profit potential through rental increase analysis. By Tony M. Guglielmo, CCIM, and Gene Trowbridge, CCIM, JD Analyzing commercial real estate leases in today's rapidly changing marketplace is a daunting task. But if performed properly, this process can have a very important economic impact on landlords, owners, and investors. While there are numerous ways to analyze leases, breaking down the investment into several variables is the most effective. Upon reassembling the pieces, commercial real estate pros often can make a prudent decision. Leasing Leassons © CCIM Institute. Reprinted with permission from Commercial Investment Real Estate, volume XXV, no.4, p.37-39. One key variable is the method used to determine rental increases and how these calculations affect a commercial real estate investment's performance and sales potential. Analyzing various rental increase methods is the best way to maximize a property's returns and streamline lease negotiations. Common Rental Increase Methods Market factors largely influence the types of rental increases property owners and landlords use when structuring tenant leases. Calculating a lease's present value is a useful way to analyze the impact of rental increases on the investment. Find the PV of an income stream by taking the sum of the discounted value of each cash flow at a discount rate. Using the PV approach converts a series of future cash flows into today's dollar value using a stated discount rate. PV analysis often is performed when using the following rental increase methods. Cost of Living Annual Increases COLA rental increases are common for all property types. To calculate a COLA increase, the base rent is adjusted ▲ SOLD – 10371/2 MACLAY ST., HARRISBURG The former Bavarian Motor Enterprises has been sold; a local investor purchased the real estate. (Continued on page 2) 1-5 3-7 8 Leasing Lessons Current Listings Bits and Pieces ▲ Phone: 717.761.5070 SOLD – 7835 PAXTON ST., HARRISBURG The building at 7835 Paxton Street has been sold to Larry Bowman, of Bowman Heating and Plumbing. www.BillGladstone.com [email protected] Commercial Real Estate Services, Worldwide. 717.761.5070 l www.naicir.com Information concerning these offerings is from sources deemed reliable, but no warranty is made as to the accuracy thereof, and they are submitted subject to errors, omissions, change of price or other conditions, prior sale or lease, or withdrawal without notice. Leasing Lesons Maximize profit potential through rental increase analysis. by changes in the U.S. Consumer Price Index (www.bls.gov/cpi) throughout the lease term. Many landlords prefer COLA increases because they offer some protection against inflation. For instance, suppose a lease includes a fixed rental increase clause rather than a COLA increase. If the inflation rate increases more quickly than the fixed rental rate, landlords will have to bear the higher property operating expenses. However, if the lease includes a COLA adjustment clause, inflationary increases can be passed on to tenants, who may in turn pass additional costs on to their customers or clients. Throughout the last 10 years the national average annual COLA increase has been approximately 2.89 percent, according to the Bureau of Labor Statistics. Fixed Annual Increases One of the most common types of rental increases, fixed annual increases are simple to calculate and oftentimes easier to negotiate. The fixed percentage varies widely from market to market, but should be close to the estimated inflation rate or COLA. For example, consider a 10-year lease that starts at $500,000 and has annual fixed increases of 3 percent. For simplicity, assume this is a net lease and disregard any purchase, sales price, 2 financing, or capital expenditure information. The annual rental income generated by this lease will grow from $500,000 to $652,387 over the 10-year lease term. Using a before-tax discount rate of 10 percent, this lease's PV is $3,611,223. Fixed Increases at Set Intervals Another type of rental increase commonly seen in net-lease investments is fixed increases at set intervals, often referred to as step leases. For example, a 10-year lease may call for level rent payments for five years, a one-time 15 percent increase at the start of the sixth year, and then level rent payments at the new amount for the subsequent five years. This differs slightly from the annual rental increases in that the investment is not earning annual compounding rent. By waiting until a later date for the increased rent, the time value of money eats away at the PV of future cash flows, having a negative impact on the return. For instance, suppose annual rental income generated by a lease remains constant at $500,000 for five years, escalates 15 percent to $575,000 at the beginning of the sixth year, and remains constant for years six through 10. When discounted at 10 percent, the lease's PV is $3,408,669. (Continued from page 1) Sensitivity on the Differential When comparing the two 10-year leases with different methods of calculating rental increases, the PV of the lease with a 3 percent annual fixed increase is $202,554 greater than the PV of the lease with the 15 percent increase at the end of a five-year interval. Is there some percentage rate increase that should be applied at the end of the first five-year interval at which the two leases would have the same PV? This question can be answered by doing a sensitivity analysis on the rate used for the increase at the end of the five-year interval. The first step is to calculate the differential cash flow generated by comparing each lease structure. As can be seen, after the first year, at all times during the remainder of the lease term the lease with the 3 percent annual increase produces greater annual cash flow. (See Table 1.) Through the use of sensitivity analysis, it is apparent that at a fixed rental increase at the end of the five-year interval of approximately 29 percent, the PV of the differential cash flow equals zero. (See Table 2.) If the lease is extended to 15 years, which would have increases at two five(Continued on page 5) Information concerning these offerings is from sources deemed reliable, but no warranty is made as to the accuracy thereof, and they are submitted subject to errors, omissions, change of price or other conditions, prior sale or lease, or withdrawal without notice. The Autumn/Winter 2006 edition of the Harrisburg Commercial Real Estate Review will be coming out soon! SEE what’s NEW in the Harrisburg Market. For more information, log onto www.billgladstone.com. ▲ INVESTMENT – 816 BELVEDERE ST., CARLISLE 5,000± sq. ft. medical office building currently 100% leased with two tenants. 22 on-site parking spaces. Immediate access to I-81 provides quick connections to Carlisle Medical Campus. ▲ LEASE – 1515 N. FRONT ST., HARRISBURG 1,527 sq. ft. medical office space available in midtown Harrisburg with quick access to all major hospitals in Central PA. On-site parking and attractive window lines. ▲ LEASE – 2410 GETTYSBURG ROAD, CAMP HILL 33,600 total sq. ft. freestanding warehouse on 3.18 acres; 130 sq. ft. finished office space. There are four dock doors with one ramped drive-in door; 16’ ceiling height. Easy access to Route 15 and Route 581 provide quick connections to I-81, I-83 and the PA Turnpike. ▲ LEASE/SALE – 7044 LINGLESTOWN ROAD, HARRISBURG 1,800 sq. ft. available between the Harrisburg and Hershey areas; formerly Linglestown Paintball. 10+ parking spaces. Also available for sale in conjunction with 7048 Linglestown Road; 6,800 sq. ft. available on same acreage; two buildings on one tract. Contact the Bill Gladstone Group at: 717.761.5070 www.billgladstone.com Commercial Real Estate Services, Worldwide. 717.761.5070 l www.naicir.com ▲ LEASE/SALE – 7048 LINGLESTOWN ROAD, HARRISBURG 3,000 sq. ft. available; 5,000± sq. ft. building on 2.55 acres conveniently located between the Harrisburg and Hershey areas. Open showroom space with hardwood floors, private office and a 575 sq. ft. garage with two overhead doors. 17+ parking spaces on-site. Also available for sale in conjunction with 7044 Linglestown Road; 6,800 sq. ft. available on same acreage; two buildings on one tract. Information concerning these offerings is from sources deemed reliable, but no warranty is made as to the accuracy thereof, and they are submitted subject to errors, omissions, change of price or other conditions, prior sale or lease, or withdrawal without notice. 3 w w w. b i l l g l a d s t o n e . c o m / c o m m e r c i a l ▲ LEASE – 5005 DEVONSHIRE ROAD, HARRISBURG 4,800 sq. ft. available; office/showroom and storage. Located near Colonial Commons off Route 22. 26 parking spaces; includes one handicapped space. ▲ SALE – 1889 OLD STATE ROAD, DAUPHIN Excellent visibility and great access. Eight-unit motel and one house on 10.74 acres just off heavily traveled Route 22/322. Zoning allows for both residential and commercial uses. ▲ LEASE – 415 MARKET ST., HARRISBURG 8,267 sq. ft. of first floor retail space and 5,120 sq. ft. of second floor office space available inside the Harrisburg Transportation Center. ▲ LEASE – 7830 WITMER DRIVE, HARRISBURG Ideal space for trade or service shops. Visibility from Westbound Route 322. Offices in place with convenient parking. 2,400 sq. ft. available. w w w. b i l l g l a d s t o n e . c o m / i n d u s t r i a l Front 4 Back ▲ LEASE – CAPITAL WEST BUSINESS CENTER., MECHANICSBURG 93,912 total sq. ft. available; 2,400 min. contiguous sq. ft. to 85,600 max. contiguous sq. ft. available in new office/warehouse flex building, located at Route 15 and PA Turnpike. Dock and drive-in combinations available. Typical bay size is 2,400-4,800± sq. ft. ▲ LEASE – 150 SILVER SPRING ROAD, MECHANICSBURG 23,000 sq. ft. warehouse space conveniently located off the Carlisle Pike. High ceilings and open floor plan are ideal for warehousing operators, light manufacturing or assembly. Outside storage is permitted. Ample parking available. ▲ LEASE – 101 SOUTH 17TH ST., HARRISBURG 20,611± sq. ft. of warehouse space with fully fenced-in lot just off I-83. Located in the Harrisburg City Business Zone. Drive-in door and four docks. Sprinkler system with 20.5 ft. clear ceiling height. ▲ LEASE – 1401 SLATE HILL ROAD, CAMP HILL Warehouse space with build-to-suit office space. Up to 8,960 sq. ft. of space available. Owner will create a dock for right tenant. Existing drive-in door and outside storage available. Information concerning these offerings is from sources deemed reliable, but no warranty is made as to the accuracy thereof, and they are submitted subject to errors, omissions, change of price or other conditions, prior sale or lease, or withdrawal without notice. Commercial Real Estate Services, Worldwide. 717.761.5070 l www.naicir.com Leasing Lesons Maximize profit potential through rental increase analysis. (Continued from page 2) 1) year intervals, a sensitivity analysis shows the five-year interval rate of increase required for the two leases' PV to be equal is approximately 22 percent. Presumably, extending the lease farther will continue to reduce the five-year interval rate increases necessary to achieve equal PV. Effects on Projected Sales Price Assuming that a sales value can be determined by applying a capitalization rate to the income generated from a lease, the lease with the highest income will generate the highest sales price at any cap rate. However, the timing of the rental increases can influence the optimal holding period of the property. For instance, in Table 3, during the first four years of the lease with 3 percent annual increases, income is higher than the lease with a 22 percent increase every five years. Therefore, assuming any going out cap rate, the lease with 3 percent annual increases would generate a higher sales price. But once the first step increase is applied, for three years the revenue stream is higher from the lease with the one-time increase every five years. The number of years in which to sell the property based on the highest lease revenue and therefore the highest sales price varies depending on which lease structure is used. While it is beyond the scope of this article, it also might be valuable to calculate the PV of each lease alternative using both the annual revenue and sales proceeds from each lease using different time assumptions. Rental increases clearly impact not only the PV of an investment's cash flows, but also the timing of a sale. To make the most profitable and practical choices, it is important to analyze how different types of rental increases affect different investments. Commercial real estate professionals also can use these analysis methods tonegotiate rental increases that are acceptable to both landlords and tenants. ■ Check out BillGladstone.com today ... The Bill Gladstone Group Working to exceed your expectations. ...and see what all the hype is about! Commercial Real Estate Services, Worldwide. 717.761.5070 l www.naicir.com Information concerning these offerings is from sources deemed reliable, but no warranty is made as to the accuracy thereof, and they are submitted subject to errors, omissions, change of price or other conditions, prior sale or lease, or withdrawal without notice. 5 w w w. b i l l g l a d s t o n e . c o m / o f f i c e 6 ▲ LEASE – 99 S. CAMERON ST., HARRISBURG 102 to 4,939 sq. ft. at the intersection of Market and Cameron Streets in Harrisburg. Smaller office sizes ideal for start-up companies. Located in Enterprise Zone. ▲ LEASE – 1500 N. 2ND ST., HARRISBURG Four suites available; 940 to 2,122 sq. ft. on second and third floors. On-site parking and attractive window lines. Quick and easy access to I-81, I-83 and the East and West Shores. ▲ LEASE – GATEWAY CORPORATE CENTER, HARRISBURG Multiple suites from 1,400 sq. ft. to 8,600 sq. ft. available in four single story buildings in a prominent business park with easy access to I-81, I-83 and Route 22. Warehouse space also available. Park is heavily landscaped including ponds. ▲ LEASE – 5939 LINGLESTOWN ROAD, HARRISBURG 2,225 sq. ft. available; rooms are built to suit. Located in Linglestown near the Square with easy access to I-81. 14 on-site parking spaces; includes one handicapped space. Permits many professional office uses. ▲ LEASE – 5943 LINGLESTOWN ROAD, HARRISBURG 2,125 sq. ft. office space on second floor and 1,824 sq. ft. retail space on first floor available; rooms are built to suit. Located in Linglestown near the Square with easy access to I-81. 14 on-site parking spaces; includes one handicapped space. Permits many non-intensive commercial, retail and office uses such as studios, personal services and other professional business offices. ▲ LEASE – 112 MARKET ST., HARRISBURG Great CBD location, directly across from the Dauphin County Courthouse. Easy access to all the downtown businesses and the entertainment district. A total of 8,425 sq. ft. available. 945 to 4,500 sq. ft. of contiguous space available. Building is being renovated. Parking available in Market Square Plaza Garage at market rates. ▲ LEASE – 4330 LEWIS ROAD, HARRISBURG 5,200 total sq. ft.; 3,851 sq. ft. office space; 1,349 sq. ft. storage space available. One 10’x10’ drive-in door per suite. Excellent exposure and anchored by strong tenant. Located just off Route 322 at I-83 and I-283 in busy Enterprise Zone with many neighboring businesses; SERB status. ▲ LEASE – 140 STURBRIDGE DRIVE, HARRISBURG 20,000 sq. ft. two-story office building to be constructed in prestigious Sturbridge Business Park; space will be built to suit. Information concerning these offerings is from sources deemed reliable, but no warranty is made as to the accuracy thereof, and they are submitted subject to errors, omissions, change of price or other conditions, prior sale or lease, or withdrawal without notice. Commercial Real Estate Services, Worldwide. 717.761.5070 l www.naicir.com w w w. b i l l g l a d s t o n e . c o m / o f f i c e ▲ LEASE – 17 NORTH 2 ST., HARRISBURG – MARKET SQUARE PLAZA The most prestigious office building in Downtown Harrisburg. 18 floors – floorplate 15,634 sq. ft.; 14th floor 11,627 rentable sq. ft.; can be subdivided. Newly constructed, high profile office space with attractive amenities, state of the art building systems and beautiful views of downtown and the river! Attached to the Hilton Hotel, Strawberry Square and Whitaker Center. Eight floors of on-site parking available for tenants. ▲ SALE – 883 S. ARLINGTON AVE., HARRISBURG ARLINGTON PROFESSIONAL CENTER 2,380 sq. ft. available on first floor; with 750 sq. ft. loft on second floor. Medical office building has four exam rooms, one large private office, waiting room, reception area and one surgical room. 68 parking spaces in front in common; 11 spaces on Arlington Ave. and 24 spaces reserved for employees in rear of building. Built for medical use, but could easily be retro-fitted for professional office use. ▲ LEASE – 3780 TRINDLE ROAD, CAMP HILL 1,010 sq. ft. on second floor located above Mountz Jewelers on Trindle Road with 43 parking spaces in common. This building has a nice window line, great visibility and excellent access. ▲ LEASE – 137 STURBRIDGE DRIVE, HARRISBURG 7,840 sq. ft. single-story freestanding office building to be constructed in prestigious Sturbridge Business Park; space will be built to suit. ND w w w. b i l l g l a d s t o n e . c o m / l a n d Location Acres Zoning Type Bent Creek Blvd., Mechanicsburg, Silver Spring Twp. 4.43 (2 lots) Community Commercial Lease Locust Point Rd., Mechanicsburg, Silver Spring Twp. 4.75 Industrial Sale Micro Dr. & Fisher Ave., Lickdale, Union Twp. 1.80 Commercial/Industrial Park Sale Milroy & Derry St., Harrisburg, Swatara Twp. 12± Industrial Land (subdividable) Sale Milroy & Derry St., Harrisburg, Swatara Twp. 17± Land (with approvals multi-family or commercial use; subdividable) Sale Paxton St. & 29th St., Harrisburg, Swatara Twp. 1.50 (1 lot remaining) Manufacturing Limited (permits commercial uses) Lease Rt. 22 & Rt. 39, Harrisburg, W. Hanover Twp. 7.70 (6 lots remaining) Commercial Highway and Office Sale S. 18th St. & Derry St., Harrisburg, Dauphin County 1.42 Business General Sale Wildwood Park Dr., Harrisburg, Dauphin County 2± Commercial (good restaurant site) Sale Commercial Real Estate Services, Worldwide. 717.761.5070 l www.naicir.com Information concerning these offerings is from sources deemed reliable, but no warranty is made as to the accuracy thereof, and they are submitted subject to errors, omissions, change of price or other conditions, prior sale or lease, or withdrawal without notice. 7 The property at 3552 Old Gettysburg Road, Camp Hill has been sold to Gibson-Thomas Engineering Co., Inc. This was a difficult deal to coordinate; however, Mark Gera and Richard Hilboky, two of the Gibson-Thomas people that purchased the building, were instrumental in keeping the deal moving forward. Time after time there were setbacks, but Mark and Richard didn’t give up and kept looking ahead. Their attorney, Scott Staruch, along with George Shoop, the attorney representing Sovereign Bank, were both very proactive. George did an outstanding job getting everything lined up to take the property to sheriff’s sale. Bill Balaban, an attorney representing another creditor, did an exceptional job keeping his client on board. Tom Young from Sovereign Bank, the lead creditor, directed George on how Sovereign wanted to approach this property. Finally, after agonizing over many issues that came up, because the Seller was out of the area and sporadic in his communication, everyone was still able to put the deal together and allow the buyers to purchase the property. I wish you guys the best and hope the expansion – into a building four times the size of what you are in now – works well for you. I trust our paths will continue to cross in the future. . The building at 7835 Paxton Street, Harrisburg has been sold to Larry Bowman, of Bowman Heating and Plumbing; Larry was represented by Jeff Gacono of Prudential Gacono Real Estate. Joel Menchey, the owner of the previous business and the property, was very pleased with the transaction. The property settled without a hitch. Both parties looked at a win-win situation and worked together to get through issues involving PennDOT and the driveway permit. Tony Troste of Dawood Engineering, Inc. did an outstanding job getting the paperwork for the driveway permits to PennDOT completed and delivered on time. The property settled and everyone was satisfied with the deal. It was a pleasure working with all of you. Best wishes for the future. Ferris Baker Watts, Inc., the securities brokerage firm has relocated to a Szeles Real Estate Development property at 635 North 12th Street in Lemoyne. Due to the company’s rapid growth, a need for more space caused them to start looking; the place they chose was the Szeles property. Working with Tod Shutt, the representative for Szeles, the process moved very rapidly. Tod was instrumental in keeping them focused, especially as it went from a five-year to a 10-year lease. Rick Szeles, a principal at Szeles Development, was also helpful throughout the process for both parties. Rick and Tod worked together to make sure Ferris Baker Watts had all of its needs addressed. Again, it’s a great tenant for the building; hats off to Rick and Tod for taking that one home! Andy Juliana, the owner of Bavarian Motor Enterprises, Inc. at 10371/2 Maclay Street, Harrisburg, has opted to go out of business by selling what he could from the business and the real estate. The real estate was sold to a local investor. Andy was very helpful in the process; he provided documentation and answered the necessary questions for the buyer. The property went to settlement with no complications and everyone was very pleased with the results. Great job Andy! I wish you the best as you continue on whichever path you choose to follow. Mark McCluskey, the Managing Director of MetLife in this area, has relocated his office to a Szeles Real Estate Development property at 101 Erford Road, Camp Hill. The building is well situated in the market, exemplifying the image MetLife uses to promote its business. Mark was instrumental in locating this building; he worked closely with Tod Shutt and Rick Szeles. Tim Dunne, the MetLife facilities person from Chicago, was also helpful in the process. As a result of the concerted efforts, MetLife is on the fast track to occupy its new office in the first quarter of 2007. Tod, Rick, Mark and Tim, it was a pleasure working with all of you. I look forward to our next deal. Thanks for the opportunity to be of service. ■ NAI/CIR P.O. Box 8910 Camp Hill, PA 17001-8910 PHONE: (717) 761-5070 FAX: (717) 975-0752 www.naicir.com www.BillGladstone.com E-mail: [email protected] BILL GLADSTONE, CCIM, SIOR PRESORTED STANDARD U.S. POSTAGE PAID Harrisburg, PA Permit No. 783