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)
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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,
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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.
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▲ 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.
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Front
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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
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▲ 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.
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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