Commercial Real Estate Lease Analysis - Comparative Lease Analysis

The following are definitions of the critical manual inputs and instant results that 24-year veteran John Tobin will provide you in a single Executive Summary page of “Swiftcalc” (see a sample below), a more simplified Excel based version (see a sample below) or using LseMod or Procalc as you prefer.   Clients have told us that reviewing our following Swiftcalc definitions below provide a good refresher on the critical factors in office lease cost comparison/ lease analysis.  The definitions below are listed in the order that each "Input" and "Result" appears on the Swifcalc Executive Summary page. 

After personally previewing all the available office properties in the desired geographic area and short listing those properties that meet your standard corporate criteria, John Tobin will send a client approved Request For Proposal to the Landlord Rep of each competing office property.  In the Request For Proposal John will request all the property data required to instantly compare the Landlord responses in a one page, side by side, Excel based, Executive Summary cost comparison for your review.  See a sample Executive Summary by clicking on the thumbnail above. 

The four different cost comparisons above analyze the same office leasing transaction in a different way.  Each presentation was customized by John Tobin based on a client request.  The Swiftcalc Executive Summary can be easily  customized for your SPECIFIC NEEDS.  (see early termination cost comparison above AS AN EXAMPLE.)  John Tobin can provide a simplified version, Or any variation on the samples ABOVE,  for your easy presentation and verification of the results TO upper management. 

Note that the results of the "Simplified Presentations" correspond exactly with both the "Swiftcalc Executive Summary" and the "Early Termination Cost Comparison" results.  Each cost comparison serves as proof of accuracy of the other since the "Simplified" cost comparison and the "Swiftcalc" cost comparisons were each generated independently. 

Further note that Swiftcalc's Net Present Value Cost result is the Net Present Value for a series of cash flows that are never uniform.   It is based on the exact date of each tenant payment/ benefit and exact dollar amount of each payment/ benefit.  This is more accurate than the Net Present Value given by a hand-held financial calculator which assumes uniform timing for a series of cash flows.  Swiftcalc discounts the series of cash flows to the equivalent Net Present Value Cost as of the Start Date of the lease using tenant's NPV Discount Rate. 

• Rentable Square Feet:  John Tobin will input the square footage stated in the lease, stated in the lease proposal or quoted by the landlord rep. The Rentable Square Footage generally includes an Add On Factor (common area factor) that accounts for common area not within the tenant premises but still utilized by tenants (also called "building common area").  The Rentable Square Footage is multiplied times the annual BASE RENT rate to calculate the tenant's annual BASE RENT cost.

INPUT

• Add On Factor:  If the Landlord Rep quotes an Add On Factor of 5%, John Tobin will input 1.05 here.   If a 9% Add On Factor is quoted, John Tobin will input 1.09 here, etc . . . 

Rentable Square Feet divided by the Add On Factor equals Usable Square Footage.  The Add On Factor (or common area factor) includes the area of the building not within the tenant premises but still utilized by tenants.  The landlord generally adds a pro-rata share of the building common area to the tenant's Usable Square Footage to determine the tenant's Rentable Square Footage. Some landlords do not have an Add On Factor.  In that case John Tobin will input the number zero here.

Loss Factor and Add on Factor are not the same thing.  If a 15% Loss Factor is quoted on 10,000 rentable square feet, the usable square footage is 10,000 x .85% = 8,500 usable square feet.   The Add On factor for the same office space is 10,000 rentable square feet ÷ 8,500 usable square feet = 1.17647

• Usable Square Feet (Rentable Square Feet divided by Add On Factor):  The measured area within the Tenant's leased premises.  Usable Square Feet times the Add On Factor (common area factor) equals Rentable Square Feet.

• ANNUITY AT THE NPV DISCOUNT RATE (on a per usable square foot, annual basis):  A net present value, usable square foot comparison.  Highlighted in light blue in the Swiftcalc “Results” section.  THE MOST TELLING COST COMPARISON since it takes into account both the time value of money and the building Add On Factor.  It is the monthly NPV Equivalent Cost times 12 months divided by the usable square footage of the lease.  If you want to get technical, it is the Annuity Equivalent Payment x 12 months = Annual Annuity Equivalent (per usable square foot).  For more on this see below at ANNUITY at the NPV discount rate (monthly) and AGGREGATE NPV at the NPV discount rate (total dollars). 

• AVERAGE COST (on a per usable square foot, annual basis):  An absolute value, usable square foot comparison.  It takes into account the building loss factor but not the time value of money.  It is the Absolute Value Cost (total dollars) below, divided by the # of Years of lease term divided by the Usable Square Feet.  For more on this see AGGREGATE RENT (total dollars) below. 

• ANNUITY AT THE NPV DISCOUNT RATE (on a per rentable square foot, annual basis):  A net present value, rentable square foot comparison.  It takes into account the time value of money but not the building loss factor.  It is the monthly NPV Equivalent Cost times 12 months divided by the rentable square footage of the lease.  If you want to get technical, it is the Annuity Equivalent Payment x 12 months = Annual Annuity Equivalent (per rentable square foot).  For more on this see below at ANNUITY at the NPV discount rate  (monthly) and AGGregate NPV at the NPV discount rate (total dollars). 

• AVERAGE COST (on a per rentable square foot, annual basis):  An absolute value, rentable square foot comparison.  It is the average yearly cost of the lease that does not take into account the time value of money nor the building loss factor.  It is the Absolute Value Cost (total dollars) below divided by the # of Years of lease term divided by the Rentable Square Feet.  For more on this see AGGREGATE RENT (total dollars) below. 

• # of Years:  The total length of the lease in years. This is automatically calculated from the data input in the Analysis Start Date and Analysis End Date below.

RESULT

• ANNUITY AT THE NPV DISCOUNT RATE (monthly):  A net present value comparison.  It is the monthly cost of the lease that takes into account the time value of money.  It is the equal periodic payments over the lease term having a present value cost equivalent to the Net Present Value Cost.   If you want to get technical, it is the Annuity Equivalent Payment (on a monthly basis) = Net Present Value.  For more on this see AGGregate NPV at the NPV discount rate (total dollars) below. 

If Annuity Cost is higher than Average Cost (i.e. a flat or increasing pmt. schedule) the landlord will invest the tenant's money at the NPV Discount Rate with the net result of earning more over the term than the Average Cost on a time value of money basis.  If Annuity Cost is lower than Average Cost (i.e. an increasing pmt. schedule) it means the tenant will invest the delayed rent over the term with the net result of paying less than the Average Cost on a time value of money basis.  If the Annuity Cost is equal to the Average Cost neither the landlord nor the tenant have a time value of money advantage.  For this reason Aggregate Net Present Value and the related Annuity Cost are more telling cost comparisons.

• AVERAGE COST (on a monthly basis):  An absolute value comparison.  It is the average monthly cost of the lease not taking into account the time value of money.  It is calculated by taking the Absolute Value Cost and dividing by the # of Months of lease term.  The Absolute Value Cost is calculated by simply adding all the tenant costs and subtracting the benefits without accounting for the timing of the payments/ benefits and the related tenant income potential from other investments during the lease term.  See AGGREGATE RENT (total dollars) below.

RESULT

• AGGREGATE NET PRESENT VALUE AT THE NPV DISCOUNT RATE (on a total dollars basis):  Net Present Value means equivalent cost today of an amount to be paid in the future based on a compound interest rate (NPV Discount Rate).  Tenants often overlook Net Present Value Cost as the most appropriate analytical tool for evaluating leasing alternatives.  Commercial real estate leases require multiple cash outlays over different time periods.  Net Present Value Cost needs to be weighed heavily to enable the decision maker to decide between and among such alternatives.  Under the Net Present Value method the decision maker discounts all future capital outlays at tenant's required Discount Rate (return that could be obtained from other investments, or return mandated or desired by the user) to determine Net Present Value Cost of the lease. 

Swiftcalc's Net Present Value Cost is the Net Present Value for a series of cash flows that are never uniform.   It is based on the exact date of each tenant payment/ benefit and exact dollar amount of each payment/ benefit.  This is more accurate than the Net Present Value given by a hand-held financial calculator which assumes uniform timing for a series of cash flows.  Swiftcalc discounts the series of cash flows to the equivalent Net Present Value Cost as of the Start Date of the lease using tenant's NPV Discount Rate. 

The Net Present Value Cost reflects the time value of money. The time value of money states that payments made sooner are more costly than payments made later.  In other words, the later in the lease term a lease payment can be scheduled the greater opportunity the tenant has to earn income from the available capital.  (The tenant needs to know that for the landlord the opposite is true.  The earlier the landlord can schedule a tenant lease payment the greater opportunity the landlord can earn income from the available capital.)  The annual rate of return that the tenant estimates it can earn while keeping the money in its control is the NPV Discount Rate. The resulting monetary benefits reduce the tenant's Net Present Value Cost of the lease.  In contrast, the Absolute Value Cost is calculated by simply adding all the tenant costs and subtracting  all the tenant financial benefits without accounting for the timing of the payments/ benefits and the related tenant income potential from alternative investments during the lease term.

• AGGREGATE RENT (on a total dollars basis):  TENANTS OFTEN MAKE THE MISTAKE OF USING THE ABSOLUTE VALUE COST AS THE SOLE CRITERIA IN THEIR DECISION MAKING PROCESS WITHOUT RECOGNIZING THE NEED TO WEIGH THE NET PRESENT VALUE COST HEAVILY AS AN ANALYTICAL TOOL.  Absolute Value Cost is the total dollar cost of the lease adding every tenant payment to the landlord and subtracting every dollar benefit from the landlord without taking into account the scheduling of the payments/ benefits or the time value of money.  The time value of money states that payments made sooner are more costly than payments made later.  See Net Present Value Cost for more on the time value of money.

INPUT

• NPV Discount Rate:  Under the Net Present Value method the decision maker discounts all of the future capital outlays at the tenant's required NPV Discount Rate (the percentage return that the tenant could obtain from other investments, or the percentage return mandated or desired by the tenant) to determine the Net Present Value Cost of the lease.  8% is currently a typical NPV Discount Rate.

For example, over the years the tenant may have established the practice of investing all surplus capital in a stock market index fund.  The tenant may have found that it could consistently expect an average 8% return on surplus capital.  In this example, 8% would be the tenant provided NPV Discount Rate.

The NPV Discount Rate, Net Present Value Cost and Annuity Equivalent Pmt. reflect the time value of money.  The time value of money states that payments made sooner are more costly than payments made later.   In other words, the later in the lease term a lease payment can be scheduled the greater opportunity for the tenant to earn income from the available capital thereby reducing its Net Present Value Cost. 

The tenant needs to know that for the landlord the opposite is true.  The earlier the landlord can schedule a tenant lease payment the greater opportunity the landlord can earn income from the available capital thereby increasing the landlord's Net Present Value Return and the tenant's Net Present Value Cost.  The annual rate of return that the tenant estimates it can earn while keeping more money in its control for a longer period of time is the Discount Rate.  The resulting monetary benefits reduce the tenant's "Net Present Value Cost' of the lease.  

The higher the tenant Discount Rate the larger the reduction in the Net Present Value Cost and Annuity Equivalent Pmt.

• The Consumer Price Index (C.P.I.) Pass Thru also known as the "Annual Base Rent Percentage Increase":  In place of or in addition to a stepped base rental schedule the landlord rep may request an "Annual Base Rent % Increase" that is determined by the Consumer Price Index (C.P.I.).  It is customary that this base rent percentage increase is compounded annually like the interest in your savings account.  The calculation here reflects the annual compounding.  The introduction of a C.P.I. Pass Thru will dramatically increase the tenant cost in the later years of the lease. 

INPUT

• COMBINED TAX & OPERATING costs:  Tax & Operating Costs can be a substantial portion of a commercial tenant's lease cost.  The two broad categories for commercial leases are Gross and Net.   In a Gross lease the tenant pays only the increase in the annual Tax & Operating Cost above a certain Base Year multiplied times the percentage of building rentable area that the tenant occupies.  In a Net lease the tenant incurs 100% of the annual Tax & Operating cost associated with the commercial property.  There are variations on the two broad categories described above.  These variations exclude certain items as a tenant cost.  In this case all that is needed is for John Tobin to . . . 

1)     Ask the landlord rep whether the lease fits into the broad category of a Gross or Net lease.  

2)     If it is a Gross lease John will ask the landlord rep for the Base Year Tax & Operating Cost on a per rentable square foot basis.  If it is a Net lease John will ask the landlord rep for the 1st year Tax & Operating Cost on a per rentable square foot basis. 

3)     John will ask the landlord rep if any cost items will be excluded from the Annual Tax & Operating Cost provided.  (i.e. capital improvement costs, asbestos abatement costs, etc...) 

4)     John will ensure that the excluded cost items are excluded from the Base Year or 1st Year Cost that John enters here.  

• Annual % Increase:  John Tobin will input the landlord’s estimate of the annual increase in COMBINED TAX & OPERATING expenses for each Option.  John will request from each prospective property a 5 or 10 year tax and operating expense history to verify the accuracy of landlord’s estimate.  If a landlord rep will not provide us with this information, John Tobin will recommend removing that property from consideration.

• Annual % Cap:  If a cap, ceiling or limit is provided on the Annual % Increase in COMBINED TAX & OPERATING expenses, John Tobin will insert the Annual % Cap.

INPUT

• Gross Lease:  A gross lease includes all tax and operating costs - heating ventilation and air conditioning (HVAC), insurance, janitorial serves and maintenance charges.  The base year is the initial period during which a tenant on a gross lease will pay no pass-throughs, i.e. increases in tax and operating costs over and above the base year.  This should typically be the first full calendar year of actual occupancy or can be negotiated as such.  When paying pass-throughs after the base year the tenant is reimbursing the landlord for only the increase in Tax and Operating Costs over the base year multiplied times the percentage of rentable building area that the tenant occupies.  This customary practice is reflected in the automatic calculations below.

John Tobin will ask the landlord what base year for the "Combined Tax & Operating" Costs (i.e. 2008, 2009, etc . . .) will be utilized and the combined rentable square foot cost for that base year.  John will input the combined rentable square foot cost number here.  In a Gross lease, Tax & Operating Costs are subject to varying interpretations and can be a major profit center for some landlords.  John will clarify in writing exactly the manner in which the tenant charges for tax and operating costs will be determined and ensure that those charges are customary at each competing property.

INPUT

• Net Lease:  Generally, there are two types of Net leases.  A triple Net or "NNN" lease is a lease whereby, in addition to the rent stipulated, all of the tax and operating costs associated with the commercial space (i.e. such expenses as taxes, insurance and maintenance) is paid directly by the tenant.  A "Net" lease includes partial payment of tax and operating costs.  Be certain that this is clearly spelled out.

Swiftcalc’s automatic calculations will handle either a "NNN" or "Net" lease.   John Tobin will ask the landlord rep for the 1st year tax and operating cost for which the tenant will be responsible as well as a 5 or 10 year history of those same costs.   John will input the combined 1st Year rentable square foot cost number here.  He will use the cost history of those expenses to create an estimate of the Annual % Increase/Cap above. 

If the OPTION is a multi-tenant property, the Tax and Operating Costs are multiplied times the pro-rata percentage of building area that the tenant occupies.  These charges begin on the lease commencement date and include any increases in tax and operating costs through the end of the lease term.   Note that Swiftcalc’s automatic calculations below are only an estimate derived from a 1st Year Cost amount and a fixed annual percentage increase.  Historically, the increase in annual Tax & Operating Costs for commercial properties has varied from year to year and a 3% projected annual increase is recommended by most Landlords.  John Tobin will request capping the increases at a certain "not to exceed" percentage each lease year.

• Tenant Early Termination Penalty:  If Tenant desires an Early Termination option, John Tobin will request one from each prospective Landlord.  Tenant early termination rights are always tied to an early termination penalty amount to be paid on a specific date prior to the effective early termination date.  John will calculate the early termination penalty amount for each prospective property and input here.  He will also input here the tenant's payment date.  This payment date and payment amount will be picked up and used in Swiftcalc’s automatic present value calculation.  John does this when the tenant wants to compare the Aggregate Cost of each prospective property on a minimum lease term/ early termination basis.  (See a sample "Early Termination Cost Comparison" below.)

• Tenant Additional Tenant Improvement Cost:  These are not Tenant Improvement costs that the landlord is paying.  John Tobin will input here only the rentable square foot cost of Tenant Improvements that the tenant will absorb, if any.  He will also input here the tenant's approximate payment date.  This payment date and payment amount will be picked up and used in Swiftcalc’s automatic present value calculation.