|July 11, 2018||No Comments|
Net Effective Rents
“Where the Rubber Meets the Road”
Effective negotiations for an office lease require a thorough understanding of the underlying economics of the transaction. Great deals are not only found, but also negotiated.
There are several factors that can impact the terms an office tenant and his broker can negotiate such as:
Having the financial skills to measure the impact of various economic components on the value of the lease and to quantify the landlord’s effective rental rate is a valuable tool.
By viewing the lease from the landlord’s perspective it is relatively simple to benchmark the landlord’s projected return and measure the impact of various changes in financial components of the lease on the landlord’s bottom line. In essence, the landlord’s “effective rental rate” is the net profit level from the lease before the building’s debt payments expressed on a square foot basis.
The Anatomy of the Effective Rental Rate
Understanding how a landlord proforma’s his building is important. They have to project their effective
rental rates. This is what is left over to service the debt on the building and provide a return to the building investors. To determine their projected effective rent structure they look at:
In simple terms, it is a calculation of all the projected in-flows and outflows of cash from leasing and operations. They do project vacancy periods for unoccupied space, but they basically are targeting and effective rent structure that forms a basis for leasing decisions.
For illustration purposes, below I present the calculation of the Landlord’s net effective rent for three sets of leasing terms without using discounted cash flow analysis to take into to consideration the time value of money based on the timing of cash flows. In practice, we use discounted cash flow models, which is even a more thorough analysis.
To put this calculation into the context of a negotiation, let’s assume “Proposal A” is the Landlord’s initial preliminary space planning and construction pricing you determine you can reasonably expect to renovate the space to fit your needs at the cost of $20.00 per square foot. Your broker goes back to leasing agent and proposes the terms outlined in proposal C. However, the Landlord responds to your offer with the terms outlined in Proposal B. The analysis tells me the Landlord has not given me equal monetary value for giving up $5.00 per square foot in tenant improvement allowance and there is still money on the table, therefore negotiations continue.
Comparing effective rental rates among various proposals and to other transactions in the building is an excellent indicator of achievable terms. Rarely do two lease transactions even with identical rental rates yields the same return to the landlord.
Effective Rental Rates are where the rubber meets the road and by utilizing this analysis you can more closely pinpoint the Landlord’s bottom line and prevent leaving money on the negotiation table.
For more questions, you can refer to www.huntkloffice.com
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