4A — August 19 - September 15, 2022 — Financial Digest — M id A tlantic Real Estate Journal
www.marej.com
F inancial D igest By David L. Church, CCIM Competing Lease Structures: Net Effective Rents and Annual Cash Flows
the Covid-19 Pandemic immediate- ly, the rami- fications of working from home or the hybrid model of em- W
hile most office properties were not affected by
leasing commissions and ten- ant improvements. Free rent is accounted for as reduced rent in the first year. The Initial Investment below and the following 10 years of Cash Flow generate the Incremental Annual Lease Return (IALR). If an owner has excess cash, is not concerned about the significantly diminished cash flow in year one due to free rent, and the tenant is credit-rated, they may want to invest excess funds for a 40% IALR – an excellent return in any environment. However, most mid-sized and smaller companies are interested in retaining cash in an unstable market and would prefer more stable cash flows through the entire lease term - and benefit from a phenomenal 79% IALR. U.S. Realty Capital assists in analyzing new lease oppor- tunities, managing rollover and cashflows, and arranging a variety of financing. David L. Church, CCIM is managing director at U.S. Realty Capital, LLC. MAREJ
ployment will ripple through the office sector for years to come. I suspect that this impact will be felt as tenants downsize, shorten their lease terms, or demand additional tenant improvements and/ or free rent to remain in oc- cupancy for a longer period. There may never have been a more important time for owners to consider the net effective rent, annual cash flows, and overall cash re- turn ramifications of various lease proposals. While public companies and large investor groups employ analysts to work on these issues, many mid-sized and smaller op- erations do not. Faced with the following lease proposals David L. Church
offering a 10-year term, the key is which proposal meets the needs of the owner. Although the parameters of the proposals are vastly different, they generate the same net effective rent per s/f (face rent per s/f less free rent cost, leasing commis- sions, and tenant improve- ments). This is the first level of analysis. While most owners will intuitively know that the proposals will generate vastly different annual cash flows and overall returns, they may not be able to quantify the
decision-making. The Initial Investment above includes
variances quickly. Precise quantification leads to better
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