Commercial Investment Real Estate September/October 2019 | Page 18

INVESTMENT
A N A LYSIS
Understanding
Quantitative Analysis
When it comes to analyzing lease proposals
for office space, know what makes for a better deal.
edited by Nicholas Leider
Economic Comparison
Comparative lease analysis examines leases for potential ten-
ants. First, to establish a vocabulary of the most commonly used
measures of occupancy, here are some terms that either are not
always consistently used in the industry or their definitions vary
from market to market.
• Base (contract) rent/rate is the lease amount specified
by the contract typically stated on monthly basis as a total
amount or per square foot rate. The base rent/rate is the
amount upon which escalations are calculated.
• Total effective rent is the base rent adjusted downward
for concessions and allowances provided by the lessor (for
example, free rent and operating expense contributions) and
upward for costs that are the responsibility of the lessee (such
as operating expenses). Total effective rent is all cash flows
over the term of the lease.
• Total effective rate is total effective rent divided by the
square footage.
• Average annual effective rent refers to the total effective
rent divided by the lease term.
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September | October 2019
• Average monthly effective rent is total effective rent divided
by the lease term (in months).
• Average annual effective rate equals the average annual
effective rent divided by the square footage.
• Average monthly effective rate is the average monthly
effective rent divided by the square footage.
• Net present value is the cash flows over the term of the lease,
discounted to a net present value.
Sample Lease Comparison
To see how a thorough comparison can inform decision-
making, let’s look at a hypothetical situation where an
owner has proposed two five-year lease options for 24,000 square
feet of rentable office space. Rent for Proposal A is $10 psf for the
first two years and $11.50 for the final three years. Proposal B
starts at $10.50 with annual increases of 4 percent for the remain-
der of the lease (with payments made monthly).
First, the cash flows for both leases can be seen in Table 1.
Table 1: Rental Cash Flow
Year 1
Year 2
Year 3
Year 4
Year 5
Proposal A Proposal B
$20,000
$20,000
$23,000
$23,000
$23,000 $21,000
$21,840
$22,714
$23,622
$24,567
Next, determine effective rents and rates from lease cash flows,
as you can see in Tabels 2 and 3.
Table 2: Annual Effective Rate
Year 1
Year 2
Year 3
Year 4
Year 5
Proposal A Proposal B
$10.00 psf
$10.00 psf
$11.50 psf
$11.50 psf
$11.50 psf $10.50 psf
$10.92 psf
$11.36 psf
$11.81 psf
$12.28 psf
COMMERCIAL INVESTMENT REAL ESTATE
I
n simplified terms, success in commercial real estate means,
at times, displaying skills for matchmaking. A client comes to
you with a need — a need, for instance, to lease office space
that would be an ideal fit for her and her interests.
If only one property effectively satisfies your client’s needs,
there’s no need for a process of elimination, even if it remains
critical to understand the cost of occupancy. But what if a few
options can check all the boxes for your client? In this case, an
effective, comprehensive comparison is required.
Comparative lease analysis utilizes modeling to compare
various options, addressing the quantitative aspects that
go into the contract. (Qualitative aspects of the properties
are also significant in occupancy decisions, but will not be
addressed here.) This model will allow you to analyze leases
based on total occupancy cost, annual occupancy cost, and
net present value.