The True Measure Of A Lease Comp

Tracking the market is a task that consumes some of our time as commercial real estate professionals. A fancy way of saying “what’s happening” in our commercial real estate world - we look at things such as comparable lease transactions, comparable sale transactions, number of new availabilities, and the number of months needed to complete a lease or sale once the property enters as an availability. 
 
By analyzing these metrics, we’re able to gauge the health of our business. New avails and time on the market are easy enough. The measures more difficult are the comparable sales and leases as you must factor in some equalizer. By this - and using housing as an example - you wouldn’t compare the price a 10,000 square foot beach front property to an inland condo without some means to level the comparison. Price per square foot helps along with age of construction and amenities. We’re then able to suggest a status of comparable, inferior or superior. If we get quite granular, we can suggest a percentage by which a comp is superior or inferior and add or subtract this from the sale price. 
 
Lease comps are trickier. Leases - different from sales comps are not a matter of public record. In other words, we can’t go to the county recorder to see where a deal traded. We must rely upon relationships with fellow brokers, who will share the points of a lease with us. 
 
Important to consider:
The starting rate. Defined as the lease amount the tenant pays upon commencement of the lease.
 
Operating expenses. In certain leases, an amount - in excess of base rent - is billed to the tenant. Operating expenses include costs such as property taxes, building insurance and maintenance. 
 
Annual increases. These are bumps in the lease rate that occur annually, or at some other throughout the term. Most leases these days are written with fixed annual increases versus the change that occurs in the consumer price index which we frequently saw in the 1980s.
 
Term. Number of months that the tenant commits to pay rent. 
 
And concessions such as:
Refurbishment. Generally referred to as rent, ready items, such as paint, carpet, and general cleanup. Not typically included in refurbishment, would be tenant specific improvements, which are referred to as tenant improvements.
 
Free rent. This period is and the tenant gets to occupy the building free of base rent.
 
Beneficial occupancy. Any occupancy granted prior to the commencement of the term is referred to his beneficial occupancy, and sometimes may be called early possession.
 
Improvements made to the building specifically for the tenant. As mentioned above in the refurbishment section, tenant improvements would be outside the scope of the normal cleanup. This could include things such as adding offices, or upgrading the power panel.
 
If a fellow broker is willing to share all the points above, we can then do some math and compute what’s known as the effective rate. Simply stated, the effective rate considers rent - including increases - over the term minus the concessions. The actual computation is a bit more complex. But you get the idea. 
 
Now, armed with the effective rate of each lease, we can assign the same - inferior, superior, or comparable tag used for sales comps - based upon amenities. As an example, a brand new class A offering should be superior to a thirty year old counterpart. How superior you may wonder? In certain cases, the 30 year old address may be functionally obsolete to modern occupants and may need to appeal to a smaller pool of tenants who don’t need class A amenities. 

Operating Expenses - A Primer

Generally, January is the time of year when your landlord will present you with an invoice for expenses - in addition to your base rent. This assumes - of course - that you lease your business home. However, if you own your business home - take heed - as you may be able to take a few more dollars from your left pocket and move them into your right pocket - by asking your occupant to pay for some stuff. This column is designed as a primer for these expenses.

Let’s define a couple of key terms - shall we?

Operating Expenses. Typically defined as the costs of maintaining the commercial real estate in which you reside.

Lease form. Forms of leases vary as widely as days of the week but commonly are either net or gross. Meaning - your base rent is net of the operating expenses - or in the case of a gross lease - your base rent includes operating expenses.

Now let’s dive in!

What expenses are included as operating expenses. Biggest in this category are property taxes. Currently, property taxes are based upon roughly 1% of the building’s assessed value. I say roughly because certain cities may add fractions to this percentage. You can easily check on the amount through your county assessor’s website. Next, insurance on the property - which is different from the liability policy you carry for your business and contents.

Finally, common area maintenance which is a broad category of expenses which can encompass mowing the grass, trimming the trees, sweeping the parking lot, disposing of the trash, exterior lights, property management, changing the air conditioner filters, and reserves for capital expenditures such as roof replacement. Treatment of these CAMs - as they are called - varies widely among owners. Simply, some may not bill for these until due whereas others may budget for them monthly. Still others may not ask for any reimbursement.

What expenses are not included in operating expenses. A major system replacement - such as a new roof or air conditioner - or, changes made to the exterior of the building - like new pavement or parking lot lighting - falls into a class known as capital expenditures. As noted above - some landlords budget for these through reserves while others bill their tenants when the changes occur. Please check your lease. Treatment of these costs should be outlined. Commonly - language allows your owner to bill you for portion of these expenses spread over time - but not a lump sum. Expenses related to accounting, mortgage interest, entity fees, and business licenses should not appear on your invoice.

Gotchas. If an ownership change occurred recently - property taxes will increase based upon the sales price. As a tenant - you generally shoulder this bump. Watch out for generalized expenses. Most leases allow for you to reasonably audit any expenses you’re asked to reimburse. If you don’t understand a line item or if your owner simply sends you a flat amount to pay - ask for back-up. Check to see if your lessor can require you to paint the exterior. This clause killed a deal for me recently. 

Finally, anticipate these costs when you negotiate your next lease or renewal. Simple things like asking for operating expense increases to be limited or moving a base year forward can save you loads.

Allen C. Buchanan, SIOR, is a pricipal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.com.