CHAPTER 9

INTRODUCTION TO INCOME-PRODUCING
PROPERTIES AND VALUATION FUNDAMENTALS

Property Types:
Residential-
Single family
Multifamily
Nonresidential-
Office
Retail
Industrial
Hotel/Motel
Recreational
Institutional
Mixed use Developments
Regional Economic Influences on Property
Values

“when undertaking a real estate analysis, the analyst

must identify the regional economic drivers and
make a judgment about whether these drivers will
provide a source of growth or decline in a region.”

Why do certain kinds of economic activity tend to

“cluster” more in some regions and urban areas than
others?
 Comparative Advantage

Comparative Advantage- some geographic regions have a

comparative advantage over other regions in that certain
goods/services can be produced more efficiently and
profitably in that region than in other regions.
Reasons: Transportation
Natural Resources
Climate
Leadership
Labor Force
Educational Skills
 Economic Base Theory
Many analysts rely on employment data to evaluate a region’s
comparative advantage. One widely accepted approach in
regional economic analysis is to calculate what are referred
to as location quotients for a region.

(Regional Employment in a particular sector/Total Regional Employment)

(U.S. Employment in a particular sector/Total U.S. Employment)

If this ratio is greater than 1, then the sector would be

identified as a base or driver industry for a region because it
employs a greater than proportionate amount of workers in
that industry than is the case for the U.S. as a whole.
Economic Base Theory

Employment Multipliers- Used to estimate how total

employment in the region is affected by changes in
base employment. Relate total employment to base
employment, calculate the ratio; estimate increase
in base employment ; estimate the increase in total
employment.
Using this type of macro analysis can help real
estate investors identify the potential demand for
various types of real estate.
Supply and Demand Analysis
Location and User-Tenants
Successful real estate investors and developers realize
that location as viewed by user-tenants is also important
to recognize. They must understand the business
operations of potential tenant-users and how certain
locations will appeal to those users.

This process of profit analysis and competition by many

different firms for space in locations that tend to
maximize profits produces certain general land-use
results in real estate markets.
Lease or Purchase ?

Most tenants find leasing to be more cost-effective

than owning. Why?

Owning requires a large commitment of capital

Owning puts the user in the real estate business

Owning may reduce operating flexibility

Owners must operate, maintain, and repair the building

Chapter 9 - Continued
Introduction to Leases, Projecting Cash Flow and
Investment Value
Leases: Longer terms than 1 year normally
Base Rent - specified dollar amount of initial lease.
Step-Up Provision - specify that rents will increase
(step-up) periodically by predetermined amounts
over term of lease.
CPI Adjustment - periodic increases tied to CPI
(protects landlord against inflation.
Percentage Rent - Landlord shares in tenants sales -
typical for shopping centers - Adv/Disadv? - Share in
Gross, net, are what?- verifiable? - Min + % (called
overage) - can be sliding scale.
Who covers expenses on building? (property
taxes, insurance, utilities, & maintenance)
Gross Lease - Lessor (landlord) pays all
expenses ->risky on L-T Leases that don’t have
escalation clauses.
Net Leases - Lessee pays some or all of the
expenses -
Net - property taxes
Net-Net - property taxes + property insurance
Triple Net - property taxes, insurance and
maintenance. (or all expenses
except debt service.
Expense Stops - Lessor pays operating
expenses up to a specified amount, then
expenses “pass-through”
Expense Pass-Throughs - if tenant (s) lease only a
portion of the building --> their proportional share
pass-through.
Lease Considerations/Concessions:
Free Rent - used in tough times, high vacancy rates --> “Get them in
the building and hope you can keep them.”
Tenant Improvements – lessor usually pays for improvements.
Face Rents/Asking Rents - Quote standard rates before discounts
are given.
Rent Premium or discounts- based on unit location
Signage
Non-Compete Clauses
Lease renewal options - allows tenant to lock space in future at
specified rate.
Right of First Refusal
Tenant Relocation Option - allows lessor to move tenant within
building during lease terms
Everything is negotiable!!
Lease Terms by Property Types
Hotel/Motel: daily/weekend/weekly - the ultimate
inflation protection
Apartments: 6/12 month terms, renegotiated at end of
lease term.
Office: 3-5 years, options possible, may include rent
increases or tied to CPI, may be net leases or expense
pass-throughs.
Retail: vary considerably, smaller retailers=short
terms (1-2 yrs.), larger retailers (1-20 yrs.). Malls often
percentage leases with floors.
Industrial: Highly individualized. 3-5 years or longer.
Typically triple-net leases.