BOMA2016 Understandng Demand- Tenant Determinates
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This document provides an overview of key concepts for understanding tenant demand for commercial real estate, including: 1) It defines demand determinants as the factors that give rise to tenant demand, including price, substitutes, income, tastes/preferences, and expectations. For CRE, the major determinants are amenities of location, efficiencies of use, economics of occupancy, and ego amenities. 2) It explains how landlords can differentiate their properties and premises based on these determinants, such as through location, physical attributes, pricing, and amenities, in order to attract tenants and command premium rents. 3) It provides a hypothetical example comparing three office buildings to demonstrate how a tenant would evaluate properties based on how they
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BOMA2016 Understandng Demand- Tenant Determinates
- 2. • Michael Davids, RPA – 35 Years in CRE – A variety of positions allowing observation & experimentation with approaches and methods • Purpose- Definition – You already know “intuitively” what I am discussing – I provide terms and reference points for communication Welcome & Introduction All drawings are strictly for your amusement. This can be a dry subject matter The Real Asset Management Institute, Inc.
- 3. • Marketing Basics for CRE – Marketing, not advertising • Concepts & Terms – Product – Demand – Determinates • Demand by Tenant – Tenants- focus today – Excluded today, owner/occupants Our Discussion Today 5 P’s of Marketing: Price, Product, Placement, Packaging, Promotion
- 4. • Product Transaction – Purchased by economic entities for productivity – Mission critical product – Purchased for fixed term – Tenants weight productivity versus cost – Characteristics given weighted subjective & objective values What Is Product? The Real Asset Management Institute, Inc. • The Product (Tenant) – Premises as Product – Premises = Bundle of Occupancy Services – Place for Bodies & Boxes – Asset is Packaging, Not Product • Complex Product – Configuration, mix for specific requirements – Reconfiguration to suit
- 5. • Purchased by economic entities, in square feet, by lease • Consumed by occupants, in hours, during operating hours • We are looking at demand expressed thru a single lease transaction What is Demand? • Demand is the desire to obtain & keep occupancy services • Demand is the need to place & keep bodies or boxes in a physical premises. • Derived from level of economic activity creating on-going need
- 6. • Demand is expressed through an economic decision, a lease • Tenants select a single premises from a pool of viable premises. • Selection is based on tenant’s perception of value compared to price Expressing Demand Occupant does not select the asset from a pool of assets
- 7. • Factors Giving Rise to Demand • Five “Classic” Determinants – Price of Good/Service – Price of Substitutes/Alternates – Income of Those Demanding – Tastes/Preferences of Those Demanding – Expectations of Future What Are Determinants Five P’s of Marketing: Product, Price, Placement, Packaging & Promotion
- 8. • Complex Needs & Products – Not one marble from a bag of marbles- too many differences – Must weight the factors • The Four Major Determinates – Amenities of Location (Place) – Efficiencies of Use (Product) – Economics of Occupancy (Price) – Ego Amenities (Positioning) What Are CRE Determinates The 4 P’s of CRE Marketing: Place, Product, Price, Positioning
- 9. • Premises are contained in competing assets • Landlords “differentiate” their assets and premises to attract tenants within mkt. segments • Landlords attempt to differentiate to – capture max. share of demand – create product & pricing advantage Differentiation- Complexity What’s Hot, what’s not! Class A, B, C
- 10. • Group of Similar Assets – Location- no advantages or disadvantages – Use- standard configuration – Economics- commodity pricing – Amenities- neutral perception from market, from occupants • No premiums, no discounts – All are Ford Escorts – Not Ford Escort vs Mercedes Undifferentiated Product Plain Jane Office Commodity Space Base Model
- 11. • Refers to the physical location of the asset within its market space & the market, submarket, or district • Location is external to the asset • Amenities accrue indirectly to the asset, asset does not create this directly • Location can’t be changed by owner, inelastic Amenities of Location “PLACE”
- 12. • Infrastructure – Transportation Modes – Telecommunications – Supporting Services • Perception of Location – By economic partners – By occupants – By customers – By suppliers What Are Amenities of Location • Adjacency – To economic partners – To occupants – To customers – To suppliers • Access – Ingress/egress – Logistics – Barriers
- 13. • Refers to the physical attributes of the real asset & premises • Internal to the asset & the premises • Efficiencies accrue directly to the asset & premises • Asset efficiencies can’t be materially changed. Premises efficiencies can be maximized. Within limits. Efficiencies of Use “Product”
- 14. • Premises Configuration – Physical Layout • Size, configuration, columns, ceiling height – Ingress/Egress • Contiguous & adjacent • Traversing premises – Services • Type & capacity delivered • Continuous & consistent • Privacy & security barriers What Are Efficiencies of Use • Asset Configuration – Physical Layout, public & service areas – Ingress/Egress • Vertical & Horizontal • Exterior to Interior – Services • Available selection, capacity, extendibility, expandability • Continuous & consistent
- 15. • The cost/benefit analysis • Direct financial or indirect financial costs/benefits – Direct landlord and non-landlord cost/benefits – Indirect costs/benefits are the non- occupancy factors • Economics of occupancy are situational, price versus value Economics of Occupancy “Price”
- 16. • Indirect Financial – Opportunity cost/benefits created by selection – Potential for new business – Loss of existing business – Productivity gains/losses – Risk management & security matters – Transportation, shipping & freight Economic Factors • Direct Financial – Landlord charges – Additional services • Parking • R&M – Employee occupant charges – Transportation costs – Non-Landlord occupancy Add’tl services- telecom, security, storage
- 17. • Perception- Bus. Positioning – By clients & business relationships – Occupant employees – Suppliers & distributors • Perception- Relative Quality of Surfaces • Perception- Available Personal Services • The Asset is the Package, the Premises is the Prize Ego Amenities “Packaging” & “Promotion” equal Asset Positioning
- 18. • Compare and rank assets & premises by assigning financial cost/benefit values • Advantages are assigned a premium, discounts are applied to disadvantages • Apply to undifferentiated product rate, validate paying more to obtain value Premiums and Discounts Advantage = Premium Disadvantage = Discount
- 19. • Starting Point- Undiff. Product – What is it minimum acceptable premises & does it meet the Tenants needs • Comparative Characteristics – Compare needs to undiff. product – Escort vs Gran Marquis vs Mercedes • Competitive Characteristics – Compare Mercedes to Porsche • Tenant Decision Matrix – Evaluate both sets of factors but apply value calculations to comparative characteristics Tenant Decision Matrix “Oh, Lord, won’t you buy me a Mercedes Benz. My friends all drive Porsches, I must make amends.”
- 20. • Assume we are a tenant looking at 3 office buildings in Miami • We have a full knowledge of all office assets and their premises • We have a complete super perfect CoStar analysis! • Undifferentiated office product is $17/sf, gross rate/service A Practical Example How can we use these concepts & terms for success?
- 21. • Full service, gross rate for comparability • We know how much operations at each location will cost the landlords • We know how much the tenant’s non-landlord costs will be Three Office Buildings • Product Pricing PSF – Undifferentiated Product = average of $17.00/sf – Class C Product = average of $22.76/sf – Class B = average of $27.71/sf – Class A = average of $37.14/sf
- 22. • Contains 45,000 sf, surface parking, streetscape views, perceived as Class C within its submarket. • Modest services, no on-site presence, local owner/operator Office Building 1 Profile Fort Escort with upgrades
- 23. • Contain 250,000 sf, surface parking, suburban view horizon, perceived as Class B within its submarket. • High quality services, maintenance, but no management on-site, • Regular floorplates, ease of access to & within asset & premises Office Building 2 Profile Mercury Gran Marquis
- 24. • Contains 500,000 sf, garage, amenities view, full tenant services, perceived as Class A within its submarket • High quality services, maintenance & mgmt. onsite, pro owners, national players • Irregular floorplates Office Building 3 Profile Mercedes S Class
- 25. Landlord Price Matrix Building 1 Building 2 Building 3 Gross Rent Rate $ 21.00 31.00 38.00 Parking Charges $ 0.00 0.00 2.00 Lease Concessions $ 0.00 0.00 -1.00 Amort. TI’s $ 0.00 4.00 6.00 Gross Effective Rate 21.00 35.00 45.00
- 26. Landlord Price Differential Building 1 Building 2 Building 3 Undifferentiated $ 17.00 $ 17.00 $ 17.00 Gross Effective $ 21.00 $ 35.00 $ 45.00 Premium/Discount $ 4.00 $ 18.00 $ 28.00 Spread Between Assets $ 15.00 $ 10.00 Ratio To Undiff. 1.2 2.0 2.65
- 27. Translate To Class Class Determinate Ratio Example Buildings A 2.45 to 2.75 Bldg. 3 = 2.65 B 1.95 to 2.44 Bldg. 2 = 2.0 C 1.00 to 1.94 Bldg. 1 = 1.2 UD - 0 - D < 1.00
- 28. • Building 3 – Difficult commute, shopping, services, entertainment in walking distance, high market acceptance of place (hotspot), Valuing Amenities of Location • Building 1 – Zero value – Some shopping & services – Easy of access • Building 2 – Suburban, highway access, shopping & services, respectable market perception of place
- 29. Valuing Location Building 1 Building 2 Building 3 Adjacency $ 0.00 $ 5.00 $ 5.00 Access $ 0.00 $ 3.00 $ -2.00 Infrastructure $ 0.00 $ 0.00 $ 1.00 Market Perception $ 0.00 $ 0.00 $ 5.00 Net Valuation $0.00 $8.00 $9.00
- 30. • Building 3 – Irregular floorplate induces inefficient cubical layout, garage access limited, high security limits guest traffic thru central lobby/elevator core, – Awkward internal columns require architect to work around Valuing Efficiencies of Use • Building 1 – Rectangular floorplate, ease of parking & access, low level perimeter security only • Building 2 – Regular floorplate, strong perimeter security w/ease of access for guests
- 31. Valuing Efficiencies Asset & Premises Building 1 Building 2 Building 3 Physical Layout $ 2.00 $ 2.00 $ -5.00 Ingress/Egress $ 0.00 $ 0.00 $ -2.00 Available Services $ -1.00 $ 0.00 $ 0.00 Services Delivery $ 0.00 $ 1.00 $ 2.00 Net Valuation $1.00 $3.00 $-5.00
- 32. • Building 3 – Free rent is in the deal – Garage parking charges – Improvements amort. into lease rate. – Add for additional parking over/above standard ratio – The indirect business impact is positive, requiring less marketing/advertising, improved staff retention. Valuing Economics of Occupancy • Building 1 – Premises previously config’ed for user, – has on-going maintenance matters, – no add-ons to add costs • Building 2 – No add-ons – Requires improvements amort. into lease rate.
- 33. Valuing Economics Building 1 Building 2 Building 3 Direct- Rents $ 0.00 $ 0.00 $ 1.00 free rent Direct- Landlord Services $ 0.00 $ 0.00 $ -2.00 addt’l parking Direct- Non Landlord $ 0.00 $ 0.00 $ 0.00 Indirect Financial $ -1.00 weak services $ 0.00 $ 5.00 business savings Net Valuation $ -1.00 $ 0.00 $ 4.00
- 34. • Building 3 – Central lobby with very high quality surfaces – Fitness center, emergency generator, on-site security, on-site restaurant & hotel, – Occupant controllable environmental controls – On-site services coordinator/representative Valuing Ego Amenities • Building 1 – None • Building 2 – Central lobby with high quality surfaces – Fitness room, shared conf. room., emergency generator
- 35. Valuing Ego Amenities Building 1 Building 2 Building 3 Perception- Relationships $ 0.00 $ 0.00 $ 3.00 Perception- Staff $ 0.00 $ 0.00 $ 3.00 Quality of Surfaces $ 0.00 $ 2.00 $ 4.00 Personal Services $ 0.00 $ 3.00 $ 5.00 Net Valuation $ 0.00 $ 5.00 $ 15.00
- 36. Arraying The Values Building 1 Building 2 Building 3 Undiff. Product $ 17.00 $ 17.00 $ 17.00 Amenities of Location $ 0.00 $ 2.00 $ 7.00 Efficiencies of Use $ 1.00 $ 3.00 $ -5.00 Economics of Occupancy $ -1.00 $ 0.00 $ 4.00 Ego Amenities $ 0.00 $ 5.00 $ 15.00 Total Value $ 17.00 $ 27.00 $ 40.00
- 37. • The tenant’s perception of value is not the price they will pay. It is the benchmark or line to which they will negotiate • Managing spread between value and deal price is the game. Their Values, Not Your Pricing
- 38. Finding the Spread Value Versus Price Building 1 Building 2 Building 3 Tenant Perception of Value $ 17.00 $ 27.00 $ 40.00 Less Non-Landlord Economic Factors $ 0.00 $ 0.00 $ 0.00 Value of Landlord Occupancy Service $ 17.00 $ 27.00 $ 40.00 Landlord Price $ 21.00 $ 35.00 $ 45.00 Spread $ -3.00 $ -8.00 $ -5.00
- 39. • What You Can Change – Economics of Occupancy • Structure deal to absorb tenant’s discounts into pricing – Ego Amenities • Improve asset position • Improve surfaces • Improve services • To increase the premiums accruing to the selection Closing the Spread for Deals • What You Can’t Change – Economic Conditions • Undifferentiated rental rate as measure of economic activity – Amenities of Location • Very little the LL can change – Efficiencies of Use • Very little the LL can change
- 40. The Take Aways • Walk away with the terms and concepts • Truly evaluate your competition & your asset • Think thru a tenant’s decision making process • Manipulating your asset’s determinates to create max. pricing potential • Sell flexible “value” instead of inflexible “price” • Direct fee manager, leasing agents to targeted marketing
Editor's Notes
- Good Afternoon, You are in the Chesapeake E Theater. This presentation is “Understanding Demand- Tenant Determinate”.
- Good afternoon my name is Michael Davids. I am here today to present Understanding Demand –Tenant Determinates. By way of background, I have spent 35 years in the commercial real estate industry. And most of these positions I have tested, experimented with a variety of approaches and methods. I am a field tested asset manager, property manager, leasing agent and leasing manager. The purpose of today’s presentation is definition. One of the most frustrating issues I find in our business is the lack of definition. We use terminology from other fields- architecture, law, banking. How many definitions of “net” can there be? In a sense, if you have been leasing real assets, you already know what I am discussing. I am going to organize your thoughts, give you terminology, so you can communicate with your CRE peers.
- Today we are discussing an element of marketing basics for CRE. We are talking about “marketing, the technical practice”, not the soft fuzzy stuff of advertising and promotion. This is the mathematical modeling of marketing, but without the math today. Today is concept & vocabulary. We are going to start with a few clarifying definition to the terms, product, demand and determinates. We are limiting ourselves to investment assets where a landlord is leasing premises to tenants for income purposes. We are talking about the tenant decision process for obtaining premises. Specifically the determinates tenants use to evaluate premises.
- THE PRODUCT Landlords may lease premises, but Tenants purchase occupancy services. So our product is actually a bundle of occupancy services delivered by and through a premises. Tenant need occupancy services to house their “bodies & boxes”. Their premises are contained in an asset, so the asset is packaging, not product. Asset is not the product. COMPLEX PRODUCT Our product, that bundle of services, is complex. The configuration and the mix of services is highly specific to each tenant and tenants come in all types. Existing premise varying greatly often requiring physical changes to be suitable for a tenant. PRODUCT TRANSACTION Tenants are typically a business entity who uses the premises for productivity. These premises is mission critical- no premises, no business. The typical purchase is for a fixed term and difficult to alter after the purchase. The purchase decision is driven by weighing productivity against cost. Product characteristics are assigned economic value to facilitate a selection.
- For our purposes Demand is the need for occupancy services delivered through premises. Demand is the need to house bodies and/or boxes in a central place for economic activities. The number of bodies and boxes housed creates the volume of demand. Demand is constant and on-going for any level of economic activity. For our purposes we are not talking about incremental demand, that is, not just the needs of those tenants actively looking for premises. Demand is what is required/needed at any one time by the population of tenants needing premises. CRE is purchase by tenants in square feet, but consumed by its occupants by time slices, by hours. Today we are going to use a single lease transaction to express demand and convey the concepts and terms.
- For our purposes today demand is expressed thru purchase of a premises by lease transaction. Purchasing a premises is an economic decision. Tenants first eliminate any available product that is not physically viable to their needs. Any premises with disadvantages that make the premises dysfunctional are eliminated. The result is a pool of viable candidates. Occupants value viable competing product based on define economic criteria, eliminating those that do not fit within their specifications. The purposes is to select one premises from a pool of competitive viable premises based on their perception of economic value compared to the negotiated price.
- The title uses the term, “determinates”. What is a determinate? The classic marketing course definition is: A determinate is a factor that give rise to demand for a product or service. There are five classic determinates. These are: The price of a good or service The price of substitutes or alternatives to that good/service Income of the persons who need/want the good or service The tastes and preferences of the buyer The buyer’s expectations for the future
- If all premises and asset were identical, like pulling one marble from a bag of marbles, the decision process would be simple and easy. Unfortunately each tenant’s need differ, each premises differs. A tenant’s selection process creates a complex decision criteria. Decisions give us our four major determinate classes specific to CRE. The four determinants we are discussing today are 1) amenities of location, 2) efficiencies of use, and 3) economics of occupancy, and 4) ego amenities. From a landlord perspective these are Place, Product, Price & Positioning
- Tenant needs are complex. The result is a complex array of assets with differing characteristics. The result is asset differentiation. Landlords attempt to modify the characteristics of their assets and premises to attract tenants from specific groups/types/classes, to attract a maximum share of the demand (market share). They modify assets to differentiate their product from competing product to improve chances of attracting and keeping tenants.
- As a market matures we end up with newer assets supplanting older assets with “newer and better”. These supplanted assets create a pool of assets that no longer appear different from each other. They are undifferentiated. Undifferentiated product has no premiums or discounts associated with its characteristics. Its location as neutral perceptions. The configuration is acceptable. The pricing, the costs of occupancy, reflect neutral conditions. There are no premiums for ego amenities but no discounts for lack of them. From the tenant view point, the Ford Escort of product. It is undifferentiated from the similar product next door, down the street, across town. Landlords tend to think “differentiation” means the difference between their asset and their competition as in “I am leasing a Mercedes, my competition is a Jaguar”. Tenant tend to think differently, as in “should I lease a Ford Escort, Toyota Avalon or Cadillac CTS. These are comparative.
- Amenities of location refer to the physical location of the asset within its market space within its submarket and even within its district. As a determinant, Amenities of Location is external to the asset. The asset does not create location. Once an asset is located, placed within a market space, its position is fixed, meaning its “place” is fixed. The owner of an asset cannot simply move it to a new place. Amenities of location accrue indirectly to the asset. Place is endemic to that particular market area and may accrue to all assets within that market place. We can say that the components of Amenities of Location are relatively inelastic, unable to be changed by market conditions in the short term. Over the long term a market or location may be considered hotter or less desirable potentially providing some relief to the limitations of Place.
- The four major classes of amenities of location are adjacency, access, infrastructure, and perception. Adjacency refers to the physical location of the marketplace to the perspective or current occupants economic relationships. How close is the location to its occupants it, its customers, and its suppliers. Access refers to the ease or difficulty in getting a Person to the Place. Access refers to the ease of ingress egress, physical logistics issues, digital logistics issues, and barriers, both physical and digital, to accessing the place. Infrastructure refers to the physical services available in two and out of the place. These include methods of transportation modes of transportation, telecommunications networks, and supporting services such as food and beverage, hotel, personal services and related. Perception of Location refers to who was hot and who’s not. Specifically were referring to the perception of the tenant’s economic partners, its occupants, its customers, and its suppliers. Do these third parties feel as if the location matches the tenant’s place in their economic scenario?
- Efficiency of use refers to the acceptability of the physical configuration of the premises and the asset. We are talking about floorplate, size, axial ratios, ceiling height, regular & contiguous spaces. We also refer to the types and capabilities of the services. Are the electrical, telecom, plumbing, HVAC, vertical transport services adequate to the tenant’s needs? We would include parking services, These are attributes, characteristics that define how effectively and efficiently the premises and asset will be in the conduct of the tenant’s business. Since we can’t change the layout of the asset and generally can’t change the major characteristics of the premises, efficiencies of use are fixed, relatively inelastic.
- What are the major efficiencies of use? These are physical layout, ingress/egress factors, available services. These are separated by the configuration of the asset, the premises within the asset and the premise itself. Physical Layout refers to the actual configuration of Structure/Space. Can the tenant be physically located within the confines of the asset & premises envelopes? Ingress/Egress refers to ease with which bodies and boxes can enter and exit the asset’s exterior envelope, travers the asset’s interior to the premises. And the ease with which bodies and boxes can travers the premises. Services refers to asset’s physically installed Systems and the Services such Systems can deliver to the occupants. Does the asset/premises offer what is needed? Are the available system configurable to meet the tenant’s requirements. Services also refers to the ability of the Tenant to select and receive only what occupancy services they want, when they require them.
- Economics of occupancy refers to the financial factors related to the selection of a specific premises. As part of the commissioning process the tenant will do some kind of costs/benefit analysis. The tenant needs to determine the productive worth of the premises. The financial impact of selecting a particular premises would include quantifying both direct costs, plus indirect costs. Direct costs would include payments to the Landlord. Non-landlord direct costs would be those occupancy costs to obtain services the Landlord does not supply. Economics of occupancy are situational to the each tenant. Different tenants will value premises according to their needs. The landlord does have the ability to alter the economics within certain limits.
- Tenants will evaluate both the premises using both objective and subjective criteria. And attempt to apply a business costs on the subjective criteria as well. For those of you involved in leasing assets, you have likely run afoul of these subjective judgements. Direct Financial costs are those that the tenant transfers monies to a 3rd party directly. Third parties include the Landlord and others. These others are service providers who deliver occupancy services the Landlord does not such as telecommunications, security, storage and other utilities. Direct financial costs are clear and well defined for the premises, easily added to the decision model. Indirect Financial costs are those that may or may not be clearly quantifiable. Tenants may need to apply a subjective estimate to the financial cost/benefits. Opportunity Cost/Benefit: Tenant incurs indirect economic costs and benefits when selecting between competitive products. These are the “intangibles” that induce the uncertainty into what appears to be a straight forward deal.
- Ego amenities contain three major categories. These are 1) positioning, 2) perceptions of services, and 3) perceptions of services. Positioning are the benefits resulting from perceptions accruing for quality of asset into four premises. Association with having a premises within an asset places the tenant into a perceived position in the marketplace. Notice this is the tenant positioning themselves, not us positioning the asset. This is part of the tenant’s marketing budget, buying an “address”. Perception of surfaces are the emotional benefits accruing from personal and professional responses to physical services. You would know these as the difference between the VCT and marble flooring. Perceptions of services are the emotional benefits accruing from personal and professional responses to level of services delivered and were variety of services delivered. Ego Amenities are the “asset” as a package and the premises as “prize”. The landlord does have control over surfaces and services. .
- If all produce was undifferentiated, selection would be simple. “You can have your choice of color, as long as it is black.” That is not our CRE reality. Tenants want/need differentiation and will assign economic values to the factors that they perceive as advantages or disadvantages. The dollar value assigned is either a premium or a discount to the value of the asset/premises. So what do we apply the premiums and discounts to? Remember this is the tenant valuing to select between comparable products. So that tenant would be valuing the difference between undifferentiated product and various differentiated products. Think “what is the cheapest acceptable space I can get, and what do I get if I pay more?”. And, “is it worth it?”.
- Our premises decision is started by comparing our needs to the most economic solution, typically undifferentiated product. Does undiff. Product meet our needs or do we need more? Does the Ford Escort fulfill all our requirements. If we need and can afford more, we compare various differentiated products to our requirements. If we array our determinates we can compare undifferentiated to differentiated assets (comparative characteristics). Think, maybe, the difference between our Ford and a Mercedes. We use Comparative Characteristics to find our level. The same factors be used to compare differentiated assets (competitive characteristics). Think the competitive differences between a Mercedes and a BMW. The resulting array of selections and determinates is a decision matrix.
- We have our terms and our concepts in place. Lets going thru a “practical” example. Lets assume the following: We are a tenant evaluating three office buildings in Miami, FL for our relocation. We have access to full market and product knowledge, say we have Super Accurate CoStar We are able to fully evaluate the population of competitive premises with our perfect data From this we know that undifferentiated office product is $17.00/sf gross rate for full service office.
- We have selected three office buildings, one from each quality class. These three are our “short list”. Each has currently available premises sufficient to our needs. In addition to our perfect market knowledge we also have: How much our operations will costs at each location How much our non-landlord costs are at each location Howe much our indirect costs will affect our productivity Based on our market data we can measure that Class C space averages $22.76/sf, Class B space averages $27.71/sf and Class A space average #37.14/sf in direct landlord costs. The differences between our undifferentiated price of $17.00/sf and the average for each class is the “value” of the relative differentiations.
- Building 1 is a Class C suburban office building with uncovered parking lot. A suitable premises is available without any modifications. Services are modest but acceptable. There is no on-site staff and the owner is a local who occupies a portion of the asset.
- Building 2 is a larger suburban office mid rise with parking lot. The asset is perceived as Class B, has quality services but no on-site staff. There is an acceptable premises but will require improvements of $20/sf on a five year deal, or $4.00/sf/year. Floorplates are regular with some “cuts” along the long axis. No inefficient corner clips or cutouts.
- Building 3 is a large CBD office hi-rise with parking lot. The asset is perceived as Class A, has quality services and surfaces with highly responsive on-site staff. There is an acceptable premises but will require improvements of $30/sf on a five year deal, or $6.00/sf/year. Floor plates are unusual, with radii on two side. Configuring for use will require architectural services and expense to maximize efficiency, but there will be loss of space.
- Gross rent rates include typical services resulting in quoted rates of $21.00, $31.00 and $38.00/sf We add $2.00/sf to Building 3 for parking charges for the garage. We add $4.00/sf to Building 2 for amortization of TI’s. We add $6.00/sf to Building 3 for amortization of TI’s. The end result is $21, $35 and $45/sf asking rates for our selected assets.
- If we array the Landlord’s asking rates versus the undifferentiated rate we can see the spread. Building 1 asks a premium of $4.00/sf, Building 2, $18.00 and Building 3, $28.00 over undifferentiated product. Between our three selections, Build 2 asks $15.00 over Building 1. Building 3 asks $10.00 over Building 2. Our total spread between buildings is $25.00/sf. If we take the ratio of asked rate to undifferentiated rate we find Building 1 is 1.2 times, Building 2 is 2.0 times and Building 3 is 2.65 times the undifferentiated rate. Why do we care about this kind of analysis?
- We can use this ratio to create an objective qualification criteria. The Class system is subjective and frequently misused. Based on our assumed perfect market knowledge we can determine: Building 1 is at the low end of the Class C range Building 2 is just barely considered Class B Building 3 is at the high end of Class A
- As we look at the market and submarket we find: Building 1 has essentially no premium and no discount for amenities of location. Building 2 is perceived as being is a stronger physical location Building 3 is considered to be in the hot location in its market
- Based on our knowledge of the market, we assign zero value to Building 1. Building 2 receives a premium of $8.00/sf for adjacency and access. Building 3 receives a net of $9.00/sf with premiums for adjacency, infrastructure and market perception and loses $2.00 for access.
- Valuing efficiencies of use we find the following factors: Building 1 is physically effective & efficient and has easy access. Security is modest. Building 2 is equally effective & efficient with improvements. Security is stronger. Building 3 is physically is effective with improvement but is inefficient, access is complex for vehicle & pedestrian, but services are strong in delivery
- Based on our evaluation: Building 1 nets a $1.00 premium, losing $1.00 for security concerns. Building 2 nets a $3.00/sf premium Building 3 nets a $5.00/sf discount due to floorplate and access issues.
- The premises at Building 1 has existing improvements configured specifically for the Tenant. The HVAC system is older and can fail periodically though the system is appropriately maintained. However, there are no additional economic add-ons from the Landlord and no atypical non-Landlord services to purchase. Building 2 has no additional economic add-ons from the Landlord and no atypical non-Landlord services to purchase. Tenant improvement amortization is already calculated in the Landlord asking price, so no adjustment here. Building 3 has free rent worth $5.00/sf over the five year deal, or $1.00/sf/year. The standard allowance for is $2.00/sf in the Landlord’s asking price. Tenant improvement amortization is already calculated in the Landlord asking price, so no adjustment here. An additional charge for parking spaces over the standard allowance is required, another $2.00/sf. The position of the Building, its market profile and the services provide to the Tenant’s staff accrue a premium due to savings on marketing/advertising, staff satisfaction/retention saves on recruiting/training expenses.
- Building 1 receives a discount of $1.00 due to on-going HVAC maintenance issues. There are no other adjustments. Building 2 is unchanged, no adjustments to make. Building 3 receives a premium of $1.00/sf for free rent, a discount of $2.00/sf due to additional parking charges to get to the necessary number of spaces and a $5.00/sf premium for business savings in marketing, advertising, recruiting and training costs.
- Building 1 simply has no ego amenities. Building 2 has a well appointed central lobby with high quality surfaces. The building offers a fitness room, a shared conference room and limited connection to an emergency generator. Building 3 has a central lobby with very high quality surfaces (natural wood, marble/granite, metals, furnishings and graphics), a full service fitness center, full emergency generation, on-site security and management, on-site restaurant and adjacent hotel. The lobby is manned by security 24/7 and by a services coordinator during business hours.
- Building 1 has no adjustments for ego amenities, a neutral ranking. Building 2 has a net premium of $5.00/sf for quality of surfaces and services. Building 3 has a net premium of $15.00/sf for perceptions, quality of service and of surfaces.
- When we apply the net premiums and discounts for all four determinate classes we calculate a total value for each asset/premises. The final values to the tenant are $17/sf for Building 1, $27.00/sf for Building 2 and $40.00/sf for Building 3.
- Remember we are calculating the tenant’s perception of economic value, not the price they intend to pay. These values are the maximum economic value the tenant is willing to pay. Remember this value contains non-Landlord costs. The size of the spread between the landlord’s price and the landlord component of the tenant’s value is where deals are made or lost. The greater the positive spread between landlord price and tenant value, the better the deal for the tenant. A landlord’s goal is to price for a zero dollar spread, leaving nothing on the table.
- The spread between Landlord price and Tenant’s perception of value in our example ended up in negative territory. Landlord asking prices are quoted at the high end of the range with deal ranges and we are near deal terms. The landlord might be overpricing product and needs to adjust to current market conditions to get within deal range. The tenant may be underestimating the true economic costs or the tenant might be overreaching and needs to adjust needs & wants to get within deal range.
- The items we can’t change to reduce the spread between value and price are Economic conditions and the price of undifferentiated product The amenities of location Efficiencies of use We can attempt to change the deal pricing & structure and, to some extent, the ego amenities.
- Here is what I hope you take away from this presentation. Take the terminology and concepts and use them. These are specifically for our industry and not borrowed from the legal, architectural, construction, banking or other industry. Know your asset. Use these terms and concepts in your SWOT analysis. Do a Competitive Product Survey by inspecting your competitive products thoroughly. Know why there is a pricing difference and know whether it is justified. Think like your buyer to understand value, use this to mimic a tenant’s decision process. Manipulate your asset’s determinates to match/better your competition. Sell value, so you can rely on your pricing strategy. Be able to express your leasing strategy and pricing structure to the team doing the selling. Be able to ask them if they understand what your target market values and how they will price their needs. If your asset is a larger property, find more granularity in your pricing strategy.