Lease Strategies in Investment Sales

hen meeting with a property owner to discuss the sale of a property you should have a good practical knowledge related to established leases in the area. This includes the rents that are achieved in the local market. It is the rents and leases that underpin the performance of the asset as an investment. This knowledge will help you identify if the property is ‘lease attractive’ or ‘lease weak’ from the perspective of the buyer; it will affect your price, the target market, and the time on market.

The important point here is that for you to sell an investment property, you need to know the rents, how they work, and what should be the best rent structure for each property type in the prevailing market. Great rents and leases produce great investments and in turn produce better sales.

Given that leases and rents change with the business sentiment and economic environment, you are the real estate professional that can help the landlord with the best strategy for the long term. It does not really matter (within reason) what the start rent is on a lease, but rather its escalation over time should be the main focus in any new lease. That should be your strategic priority.

Rents are Unique

Rents are unique to the property type and the location, so even if you specialise on selling just industrial property it is very much the case that industrial property from suburb to suburb will vary in rent level, strategy, and type. You need to know how and why the changes occur. The more skilfully you can talk about that and package it to the client or the customer, the more professional you will be in the provision of commercial real estate services. When considering your competitive position that is what matters.

Variables

Rents can be gross or net by type and added to that will be the levels of outgoings that apply in each location. Outgoings in your property sale must be in parity to other properties in the location otherwise you will be trying to sell something that is different than everything else. Whilst that may be acceptable for your listing, you will have to identify why the outgoings are higher and why someone will want to buy a property like that.

The ‘golden rule’ here is that your market awareness on leasing is fundamental to your sales skills and value provided to landlords.

Some Rent Strategies

So let’s look at some rent definitions that you frequently come across.

‘Market rent’ is that rental determined by assessing a given tenancy and its location and with its size, and then comparing it to other similar tenancies. Care must be taken in locating other ‘market rents’ because they may have been established by alternate means such as CPI adjustment, Fixed % adjustment, Ratchet, or Cap and Collar. In that case they are not real market rents and are not useful in any rent comparison. – True market rent comparisons are generally not to be restricted or enhanced by Ratchet clauses (this stops the rent falling), or Cap and Collar limitations (this stops the rent rising too far or falling too far). These mechanisms do commonly exist in Commercial and Industrial type leases and tenancies. They are sometimes restricted by legislation in application in retail lease situations. Make sure you know your local legislation in that regard so that the lease rent escalation method is legal.

‘Base rents’ are sometimes used as a ‘floor’ rent below which the tenants rent would not fall. This gives some stability to the Landlords cash flow in a new lease occupation. In a new retail property development with unstable or growing levels of trade, this is a useful tool. A lease with a ‘Base rent’ is usually enhanced with a turnover rental provision or clause, so that the success of the tenants business and sales will lift the rent level. – This ‘turnover’ is structured by some calculation from the tenants monthly trade such as:

a) ‘The rent paid shall be the greater of the ‘Base rent’ or 10% of the lessee’s turnover for the previous month’.

b) In this scenario, the % may change and the method of turnover calculation may be revised at the anniversary of a nominated period. This is usually once per annum, and the adjustment for any extra rent (as a result of the turnover) above the base is calculated and charged.

Assessment of existing base and market rents and their possibility for future growth involves complete review and analysis of the tenancy schedule on a tenant-by-tenant basis. You need to cross reference the leases to the tenancy schedule so that errors do not ‘cloud’ your calculations. Growth in rent will usually be provided in a lease by one of the following mechanisms:

a) Structured review

b) Stepped increases

c) CPI review (or other index)

d) Market review

Leases are individually assessed for the benefit that they give the landlord from:

a) Length of term

b) Lease clauses

c) Options

d) Future reviews

e) Historical reviews (implementation)

f) Occupancy costs