Office Acquisition Basics v0.1

OFFICE ACQUISITION BASICS
(www.howrealestateworks.com)
Copyright @ 2010. Compress Reality LLC. 1

PROPERTY OF COMPRESS REALITY LLC
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TABLE OF CONTENTS
1- THE MARKET 6 / Overview 7 / Supply 8 / Class defined 9 / The Investor 11 / Investment Categories 12 / Demand 14 /
Change in Population 15 / Change in Unemployment 20 / Employed working in office buildings 22 / Building area that each
office worker occupies 23 / Real Estate Cycle 24 / The Four Phases 25 / Recovery Period 27 / Building Cost 28 /
Capitalization 29 / Target Rent 34 / Future Target Rent Methodology 36 / Future Building Cost 37 / Future Target Rent
Calculated 38 / Market Rent Now Theory 39 / How the Current Market Rent is estimated 41 / Rent Growth Scenarios 46 /
Market Rent Recovery or “Spike” 51
2- THE BUILDING 55 / The Office Building 56 / Chronology of Tall Buildings 61 / Building Area 62 / The Survey 63 /
Foundation 67 / The Structure 69 / Classification of Structural Systems 70 / Floor Plan 72 / Vertical Systems 75 /
Electricity 76 / Security 82 / Curtain Walls 83 / HVAC 98 / The Elevator 120 / Roof 124 / Lighting 128 / Plumbing 134 /
Interior Finish 136
3- THE LEASE 146 / Lease Basics 147 / The Tenant 152 / Sole Proprietor 153 / Corporation 154 / Partnerships 156 /
Services Provided by the Landlord 157 / Lease Economics –Use 163 / Lease Dates 165 / Lease Term 167 / continued …..
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Copyright @ 2010. Compress Reality LLC.
TABLE OF CONTENTS (continued)

3- THE LEASE (continued) - Leased Area 168 / Base Rent 169 / Rent Abatement 171 / Operating Expense
Reimbursement 172 / Pass Through Expenses 174 / Pass Through Expenses – Real Estate Tax 177 / Pass Through Expenses -
Gross Up Provision 178 / Tenant Improvements - Overview 179 / “As Is” Improvements 183 / Completion of Tenant
Improvements 184 / Amortization 186 / Alterations within the Lease Term 187 / Asbestos 189 / American Disabilities Act 190 /
Building Standard 191 / Appurtenances 192 / Hazardous Materials 193 / Abandoned Cable 194 / Future Factors – Expansion 195
/ Termination 196 / Right of First Refusal 197 / Renewal 198 / Right to Purchase 200 / What If - Landlord Access 201 /
Holdover 202 / Default 203 / Other – Fixtures and Trade Fixtures 204 / Security 205 / Guarantors 206 / Subordination 207 /
Estoppel 208 / Mechanic Lien 210 / Brokers 211 / Signage 212
4- THE INVESTMENT 213 / Why Invest 214 / The Investor 215 / The Cash Flow 216 / The Discounted Cash Flow 218 /
DCF Template 227 / Steps in the DCF 229 / Assumptions 230 / Market Rent 235 / How the Market Rent is Estimated 237 /
Growth Rates 242 / Lease Revenue 244 / Rent Roll 246 / Who is the Tenant / 248 / Financial Ratios 251 /
Rental Concessions 259 / Vacancy 261 / Lease up 264 / Vacancy Loss 266 / Recoverable Operating Expenses 267 / continued
….
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TABLE OF CONTENTS (continued)

4- THE INVESTMENT (continued) - Other Revenue 272 / Credit & Collection Loss 275 / Operating Expenses 276
/ Net Operating Income 280 / Capital Expenditures 281 / Calculate Cash Flow 283 / Reversion 284 / Discount Rate 289 /
Net Present Value 291
5- PURCHASE AND SALE AGREEMENT 294 / Calendar 295 / Letter of Intent 298 / The Purchase and Sale
Agreement 301 / The Purchase 302 / Purchase Price 304 / Sale Transaction 305 / Property Description 306 / Deposit 309 /
Seller Obligations before Closing 310 / Start Date and Closing Date 311 / Due Diligence Period 314 / Checklist 316 / Zoning
318 / Title and Title Objections 320 / Title Policy 32 2 / Estoppel Certificate 325 / Items to be Confirmed 329 / SNDA 332 /
Surbordination 333 / Nondisturbance 334 / Attornment 335 / SNDA Provisions 336 / Termination Rights 338 /
Indemnification 339 / Default 340 / Brokers 341 / Assignment 341 / Extension 342 / Conditions to Closing 343 / Closing
Costs 346 / Representations and Warranties 349 / Various Legal 363 / Closing Documents 370
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Table of Contents / Chapter 1 The Market / Chapter 2 The Building / Chapter 3 The Lease /
Chapter 4 The Investment / Chapter 5 Purchase and Sale Agreement
Chapter 1
THE MARKET

Chapter 1 The Market
Overview
The Market analysis is used to forecast the current and future market rent and occupancy of the office
building.
Data is gathered, including supply and demand.
The market cycle is then incorporated using the data to derive a time estimate for recovery.
The final step forecasts how the current rent will change in response to the cyclical market.
The overall US market is examined; each submarket has its own unique circumstances, but the general
approach can be applied to the smaller segments as well.

Supply
We start with the existing supply or inventory.
There are a multitude of resources to estimate the existing office stock in the US, including Torto
Wheaton (CBRE), Cushman & Wakefield, Jones Lang LaSalle (JLL) and Integra Realty Resources
(IRR) among others.
The surveys differ in total inventory, based on the submarkets surveyed. Of the listed sources, Jones
Lang LaSalle reports the smallest office inventory; Integra Realty Resources the largest. For purpose of
this discussion, the IRR estimate is used.
Total Inventory (SF) Vacancy (%) As of

Integra Realty Resources 4,833,536,000 13.7% 4Q08
Top 10 markets based on existing inventory are as follows (again according to Integra) –
New York, NY, Washington DC, Northern New Jersey, Houston, Dallas, Chicago, Philadelphia, Los
Angeles, Boston, and Atlanta.

Class Defined
Office buildings are categorized as Class A, Class B or Class C. The class is used to indicate the
physical condition and operating performance of the property. The properties are segregated based on
location, management, physical characteristics (age, construction type, renovation, if any, and
amenities) and tenancy. As a baseline, the Class B and Class C properties are categorized in reference
to Class A buildings.
The Class A buildings include trophy properties. A trophy building is a landmark property (typically
one-of-a-kind architectural designs, with the highest quality of materials and finish), well known by the
public, highly sought by institutional investors and pension funds and insurance companies, more
desirable than Class A properties that command significantly higher price than non-trophy buildings.
Class B buildings are, as a general rule, older properties. If the buildings are well located and can be
renovated with upgrades to the façade, common areas and operating systems, the Class B properties can
be returned to the Class A designation.
It is estimated that in the top office markets, over half of the buildings are categorized as Class A.

Class Defined (continued)

Class A Class B Class C
Design Above average Not the latest Dated, generally 15 to
preferences or 25 + years old
standards
Construction Above average Not the latest Dated construction

preferences or
standards
Location Excellent Above average Less desirable
Tenancy Strong credit Good to high quality Lower credit
Management Professional managed Good management Local management
Condition Well maintained Good to average; Average, with deferred

minor deterioration maintenance
Rental Rates 90% to 95% of rent 5% to 15% less than Below market average,
needed to justify new Class A product 5% to 15% less than
construction Class B

Investment Categories
Office buildings are segregated by their return and the group of investors seeking those returns. Office
buildings are grouped as core, core plus, value add and opportunistic.
Core
Buyer profile – longer holding U.S. and international institutional investors and some individual
investors
Motivation - want a secure return from the property cash flow
Target - “trophy” office buildings in major urban markets, Class A multi-tenant buildings with limited
lease rollover exposure and properties with long term leases to strong credit tenants
Core Plus
Buyer profile – core buyers
Motivation - slightly higher overall return than core, often generated from the residual value
Target - core investments with higher releasing risk

Investment Categories (continued)

Value Add
Buyer profile - knowledgeable institutional and individual investors
Motivation - some current cash flow but with focus on future appreciation
Target– buildings in recovering primary, secondary or even tertiary markets; properties with the
opportunity to increase cash flow as rental rates with current leases expire and roll to higher market
rents; offices repositioned due to a change in marketing, operating, or leasing strategy or with a
physical renovation
Opportunistic
Buyer profile- sophisticated, capitalized investors with high risk tolerance for higher levels of leverage
Motivation – majority of the return is from the sale or refinancing
Target - growth and development oriented projects with significant "turn around" potential, often
requiring significant capital based on major market trends

Demand
Forecast future office demand is a function of
the change in the population,
the change in unemployment,
the employed working in office buildings and
the building area that each office worker occupies.
Estimating future demand for office space is a subjective estimate, at best. Variables abound, and, with
the magnitude of the numbers, any small change can significantly impact the results. With this said, the
demand for office space will be estimated.

Change in the Population

The U.S. Census Bureau forecasts the population through 2050.
For this analysis, the following classifications are used: a) the working group defined as ages 20
through 69 years of age and b) retirees, age 70 and more.
The forecast effort for that many years in the future is an estimate only, but there are some trends to be
examined in regard to the impact on real estate and the office sector.
The population in total is estimated to be 310.2 million in 2010, growing to 439.0 million in 2050. This
increase equates to a change of 41.5%, or 1.04% per year over the 40 year period.
For the working age, identified in this analysis as the group 20 to 69 years old, the estimated 198.1
million increases to 259.1 in 2050, a change of 30.8%, or 0.77% per year.
For the retired group, ages 70 plus, the number swells from 28 million to 67 million, a change of over
130%, or almost 3.5% per year.

Change in the Population (continued)

The total population during the period through 2050 will increase an average 1.04% per year.
The working group numbers will increase .077% per year.
The retirees can be counted to grow at an annual rate of 3.5%.
The ratio of worker bees ages 20 to 69 divided by the retired ages 70+ in 2010 is 7.08 working age to 1
retired age person. In 2050, the ratio drops to 3.8 to 1.
The ratio approaches near the 4.0 to 1 level in the early 2030’s.
According to the Census forecast, the greatest change in number of retirees in one year will occur in
2030, when 1.6 million Americans will join the 70 plus age group.
The trend is visually presented on the next page,

Change in the Population (continued)

According to the Census, in 2020, the ratio of workers to retirees is forecast to decline, as fewer
workers are available to financially support government programs (i.e, Social Security).
The acquisition analyst in 2010 will attempt to estimate the value of the property in 2020. The chances
are great that the analyst will view “things as normal” as he estimates this reversion in 2020, and the
effect on values in 2010 will be minimal.
The acquisition analyst in 2020 will attempt to estimate the value of the property in 2030. For
properties purchased in 2020,however, the forecast future will be different. As the analyst seeks to
purchase properties in 2020, he will using the 10 year hold and estimate the reversion in 2030.
From the graph, in 2020 the ratio of workers to retirees will be in decline. Government will then seek to
address the social security issue, if not done so earlier. There is potential that a) the existing working
population will need to pay a greater portion of their income as tax to support the social security
program, b) the country’s financial debt will increase to absorb the social security obligations, or c) the
social security benefits will be reduced, potentially affecting the then retireds’ quality of living. Any
choice has the potential to affect the economy, the perceived 2030 reversion and the corresponding
value for a purchase in 2020.

Change in Unemployment
The U.S. Bureau of Labor Statistics – estimates by Major Occupation Code employment number ’06 to
’16 – averages 51% of the Total Population. All numbers between employed and total population agree.
There is an overriding trend that over a long period of time the employment may experience highs and
lows; over that long term, it usually will return to the mean.
According to the Bureau of Labor Statistics the unemployment as of November 2009 is 10.0%. While
that is considered extreme compared to recent years, that level did occur in the early 1980’s. Following
is the history of US unemployment in graphic form from the Bureau data base.

Chapter 2
THE BUILDING

Chapter 2 The Building
The Office Building

Who benefits from an office building?
-the tenant or occupant, who uses the property
-the landlord, the owner who receives financial returns on his investment
-acquisitionspersonnel, who sought the investment, performed the analysis and due diligence,
negotiated the contract, and closed the property
-property management company, the manager of the building
-engineers, who operate the property providing adequate services to the tenant or occupant
-accountants, who maintain the financial records of the property, including the billings to the
tenant, and
-thelender, who provided financing for the acquisition of the property, along with providing
additional loans for tenant improvements and capital outlays

Building Area
The most used method for determining usable and rentable areas in commercial office buildings is
"BOMA Z65.1-1996 Standard Method for Measuring Floor Area in Office Buildings.” The property is
measured on a building-wide basis. The floor area is classified by Gross Area, Major Vertical
Penetrations, Office Area, Store Area, Building Common Area, Floor Common Area and Apportioned
Area. The standard provides for locations of the boundaries between and within each class of space, i.e.,
dominant portion, finished surface, and wall centerline. The Standard also presents the mathematics
applicable to allocate common areas to tenant suites.
Because of the addition of the Building Common Area, a building measured using BOMA 1996 almost
always yields higher Rentable Areas than the same building measured according to the older standard,
BOMA 1980.
In its simplest terms, Net Rentable Area is the gross area of the full floor less the area of all vertical
penetrations, which include elevator and mechanical shafts, and stairwells. Net Rentable area can also
be viewed as the area that includes the tenant's premises plus an allocation of the common area directly
benefiting the tenant, such as restrooms, common corridors, mechanical and janitor's rooms and the
elevator lobby on the tenant's floor.

The Survey
Format - The most common survey format is the ALTA/ACSM survey, prepared per "Minimum
Standard Detail Requirements" adopted by a) the American Land Title Association (ALTA), b)
American Congress on Surveying and Mapping (ACSM) and c) the National Society of Professional
Surveyors.
Timing - The survey should be certified within 30 days (approximate) before closing.
Certification - The form of certification is based on client requirements. If the ALTA/ACSM

certification is required, then the surveyor's certification should state a) parties included in
certification: owner, Buyer, lender, title insurance company, b) the actual on the ground survey was
performed on the date the survey performed and c) the survey performed according to the
ALTA/ACSM standards.
"Same as Survey" provision - The "same as survey" endorsement to title policy may be available. This
provision insures that the land described in Schedule A of title policy is same as land shown on the
survey.
Who pays for survey? - The party signing the contract with the surveyor is responsible for the
surveyor’s fee. The Purchase and Sale Agreement can include reimbursement provisions as to who is
the ultimate payor.

The Foundation
The foundation is the lowest segment of the building, whose primary function is to support and anchor
the structure above and transmit the structure's loads safely to the earth. Principal loads are live and
dead loads that act vertically and horizontally. Loads are derived from wind, uplift, ground movement
and pressure from surrounding soil and groundwater.
Foundation systems are classed as shallow or deep.
Shallow -
also called spread foundations.
used with stable soil with adequate weight bearing capacity relatively near the ground surface
transfers loads directly to the soil by vertical pressure.
lowest part is called the spread footing, which extends laterally distributing the load.
most common spread footing - strip and isolated. Strip footings are continuous spread footings
on foundation walls or a reinforced concrete footing extended to support a row of columns.
Isolated footings are individual spread footings, i.e., with supporting freestanding columns and
piers

The Structure
The purpose of the structure is to carry vertical gravity loads. Vertical load resisting systems are the
same for high rise as low rise. In addition, the structure should withstand lateral wind and seismic loads
from any direction. In the current environment, structures should also be able to withstand blast loads.
Wind forces at the maximum 100 year interval will differ greatly depending on location. Forces in the
continental interior are typically 20 pounds per square foot at ground level. In the coastal locales, the
maximum force is greater, i.e. up to 50 pounds per square foot. Wind forces also increase with building
height to a constant or gradient value as a result of the effect of ground friction diminishing. For
example, in hurricane areas, the maximum design wind force in tall buildings is about 170 pounds per
square foot.
The principal elements of the structure are the column, beams, slab, and loadbearing wall.
For office buildings the elements are horizontal spans crossed by reinforced concrete slabs, a
hierarchical arrangement of girders, beams, and joists overlaid with decking.


Electricity
The office building is powered by alternating current or AC (voltage and current flips back and forth 60
times per second) as opposed to direct current or DC.
In the building, electrical power enters through the primary service feeder then through transformers,
switchboards, panels, before arriving at the load, i.e., the elevator, ceiling light, or computer. The
electrical system has motor control centers (MCC) used to serve various equipment in the mechanical
room, elevator machine rooms, and penthouse mechanical room.
Major pieces of electrical equipment have a typical useful life expectancy of 40 to 50 years.

Electricity - Utility to Transformer

Primary transformers may be located either outside or inside the building. If space is available, an
outdoor transformer on a grade-level concrete pad is the first choice (less capital, better cooling,
accessible and easy to service, less noise to occupants and increased fire safety). These are very heavy
and need a thicker pad support than the rest of the building.
There are dry-type and oil-filled transformers. With the former, the switchgear, i.e., disconnect
switches, secondary switches, fuses, and circuit breakers, can be located in the with the transformers in
a unit substation. With the latter, in large buildings, the switch gear is typically located in a room
adjacent to the transformer vault.
For buildings greater than 25,000 SF, electric utilities deliver electricity at high voltages, typically
13800 or 4160 volt. This primary service enters the building at 120/240 VAC (volts alternating current)
if single phase, or if in 3 phase, 120/208 VAC, 277/480 VAC or higher (up to 2400/4160 VAC found
only in largest buildings). Note – the first number is voltage between any single phase and the ground
and 2nd is voltage between any two phases.
With these higher voltages, the landlord receives a lower utility rate and also provides his own primary
transformers at the service entrance. The transformers take this high voltage and reduce it to lower
voltages that can be utilized directly to the building, typically 120/208 volts or 115/230 volts in wall
and floor receptacles, and up to 480/277 volts in some types of machinery and lighting fixtures.

Curtain Walls - The Window Unit and Glazing

The office window assembly, known as an insulated glazing unit (IGU), contains the glazing (one or
more layers of glass with air spaces in between) in the window frame. The glazing has spacers around
the edge and, if more than one pane, with gases in the spaces between glazings.
The frame can be made of aluminum, steel or composite material. Aluminum frames are light, strong,
durable, non-corrosive, formed to complex shapes, and fabricated to extremely close tolerances. A
disadvantage is the aluminum can conduct thermal heat. The thermal resistance is affected by the
surface area of the frame versus the frame thickness. In addition, in cold weather the simple aluminum
frame (non-thermally broken frame) can condense moisture or frost on the inside surfaces of window
frames. One solution is to add a "thermal break.” The frame components are separated into interior and
exterior pieces joined by a less conductive material, which can decrease the heat loss rate by 50%.
The edge spacer separates the glass units from the frame, absorbing stress from expansion and pressure
changes, preventing water / vapor from fogging the unit, sealing the interior gas in the air space and
lowering the interior condensation at the edge. It has a thermal effect that extends 2 ½” wide beyond
the spacer edge, reducing heat loss and condensation at the bottom edge of the window.

Curtain Walls - Design Wall Construction - Energy efficiency

There are various measurements to determine the energy efficiency for curtain walls.
The Solar Heat Gain Coefficient (SHGC) indicates the amount of solar energy striking the window that
is transmitted, absorbed and released inside the building, warming the building’s interior. It is reported
between 0 and 1. A lower SHGC means the less solar heat the window transmits and the greater its
ability to shade.
The U-factor measures the rate of heat transfer through the window (from inside to outside when it is
cold and vice versa when it is hot). It is the rate of heat loss of a window assembly and is the inverse of
the R-value (the insulating factor). The lower the U-factor, the greater the resistance to heat flow and
the better its insulating value. The U-factor ranges from 0.3 to 1.2. The U-factor can range from 0.35 or
less in the northern sections of the US to 0.75 or less in the southern sections. In general, the larger the
heating bill, the more important a low U-factor becomes.
Visible transmittance (VT) is the measure of how much visible light passes through the assembly. The
rating is from 0 (no light) to 1.0 (all light). Most values are between 0.3 and 0.8. The greater the VT
indicates more daylight.

Chapter 3
THE LEASE

Chapter 3 The Lease
Lease Basics
Overview
Most people are familiar with a lease, particularly the apartment lease. With that lease comes the right
to lease and occupy the apartment for a set period of time, provided rent is paid on a timely basis and
the tenant acts in an orderly manner. In the majority of cases, the prospective tenant does not retain
legal counsel.
The office lease is substantially different. Legal counsel is used by both the tenant and the landlord.
Both parties seek to protect themselves and maximize their position. Everything is negotiable, but as in
all commercial real estate, the market place dictates lease parameters. In general, the focus of the tenant
is possession of the leased area, the premises. The landlord concentrates on the rent and reversion.

Chapter 3 The Lease
Services Provided By The Landlord

The landlord furnishes the following services to the building tenants during their lease term. The costs
of the standard services are included as operating expenses. The landlord can, at any time, make
reasonable changes, as long as the changes are in line with the standard services offered in comparable
office buildings in the submarket, taking into account age, size and other relevant operating factors
(typical lease verbiage).
These services include (not all inclusive)

hot and cold water to common area rest rooms and water fountains,
HVAC during normal business hours as the landlord deems appropriate based on competing
properties’ operations or as required by government regulations
maintenance and repair,
janitorial service for x business days per week,

Chapter 3 The Lease
Lease Economics - Use

The specified use of the space by the tenant is described in the lease. There is a trend by office tenants
to use the premises in a way not related to their primary business. This is a potential trouble spot for
both parties because of ambiguity. A use can be
excluded,
exclusive,
general,
mandatory,
permissive, or
specific (should be specifically described in the lease).
Office leases typically do not include mandatory occupancy of the premises (like retail leases). In
addition, some tenants have specific operations that require certain licenses and/or permits. The
landlord may be liable if licenses are not maintained.

Chapter 3 The Lease
Lease Economics - Lease Dates

Leases contain a variety of dates, some being apparent. All may be different or the same. These
include:
date of the lease,
date of the lease commencement,
date the rental payments begin, and
date to determine the expense reimbursement base year.
Depending on the jurisdiction, a lease signed by both parties does not need to be delivered to be
effective. Execution generally means signing and delivering. This is compared to deeds for property
which do need to be delivered to be effective.
The lease is signed before the tenant has the right to occupy the premises.
The interval between the contract signing and the time of an actual right to possess or occupy by the
tenant is called the contract interval. During this period the tenant improvements can be constructed.

Chapter 3 The Lease
Lease Economics - Lease Term

The lease term is the specified time that the tenant may occupy and use the lease space. The
commencement date, the expiration (last day of lease) and duration must be defined in the lease.
In theory, the longer the lease term, the greater the tenant responsibilities. Repairing the roof is not
expected in a short term lease; but requiring replacement is reasonable with a 20 year lease. If the lease
term exceeds a specified duration in some states, the lease must be recorded at the court house.
Note that a termination of the lease (ending the lease before the lease termination date) can affect
tenant improvement expenditures,
broker commissions (depends on the agreement with the broker, which can be a separate
document), and
lease assignments.

Chapter 3 The Lease
Lease Economics - Leased Area

The space the tenant leases can be called the leased premises, the premises, the demised premises, the
leased space, or the space. The specific description should be insufficient detail to identify the location.
The building location itself should be specifically defined.
The amount of leased area in square feet the premises contains should be presented, i.e., net rentable
square feet. If the tenant should take the entire floor, the landlord will include lease language that all
corridors and restrooms located on each full floor will be considered part of the Leased Area.

Chapter 3 The Lease
Lease Economics - Base Rent

The Base Rent is the lease’s most obvious provision. The term “base rent” is often used with office
leases. The term “face rate” is the full rental rate without abatement. In a typical scenario, the base rent
is paid in equal consecutive monthly installments, on or before the first day of each month.
The rent can be stated in a variety of ways, i.e., $ per square foot of net rentable area, $ per square foot
of net usable area, $ per month, $ per year. One example for 10,000 SF net rentable area is:
Period $ PSF $ per Year

Commencement Date to 12th lease month $21.50 $21,500
13th Lease Month to 24th lease month $22.50 $22,500

Chapter 3 The Lease
Lease Economics - Base Rent (continued)

If the rental rate structure increases over the term, the specified increases or steps can be date specific
or begin a number of months from lease commencement or other begin date.
Effective rate includes the effects of the rental abatement and is less than the face rate – if the face rate
is $12 per square foot per year for a three year term and the abatement period is 3 months, the effective
rent is $11.00 per square foot per year.

Chapter 3 The Lease
Lease Economics - Rent Abatement

Rent abatement is described in the lease, generally as the number of months of monthly rental
minimum rent, or in some cases as an amount that the tenant does not pay rent. It is also called free rent
or rent incentive. Free rent can be a landlord tool to get space leased.
The abatement typically does not affect the reimbursement of operating expenses, which remain
unaffected and are payable by the tenant. The free rent can include the abatement of other categories,
i.e., parking, storage, or overtime expenses.
The free rent given is equivalent to the term needed to find, identify and negotiate a lease with a
prospective tenant.

Chapter 3 The Lease
Lease Economics - Operating Expense Reimbursement

The tenant pays its share of expenses in the form of an operating expense reimbursement.
As part of the negotiations, verbiage is agreed upon in the lease stating the share of increasing operating
expenses the tenant is to pay to the landlord. This is negotiable but depends in large part on the market
conditions. Reimbursement methods vary by market.
The operating expenses typically are included by account - maintenance, repairs, management, utilities,
tax and insurance.
Reimbursable operating expenses typically exclude administrative costs, advertising, franchise tax,
leasing commissions, tenant alterations, income tax, and legal fees.
In some markets, real estate tax expense is separated from operating expenses and treated separately.
Parking expense is generally segregated from the other building operations.

Chapter 4
THE INVESTMENT

Chapter 4 The Investment
The Investor
The buyer of an office building represents a diverse group, from the extremely large and sophisticated
investor to the single user needing a particular building for a particular purpose.
Institutional Banks, insurance companies, pension funds and retirement funds
Syndicators Groups of individuals or companies formed to transact some specific business, including
tenants in common (TICs) and private REITS
Funds Privately sponsored equity and opportunity funds
Private parties Investors seeking to operate, develop or invest in commercial real estate
Other Corporations, educational, governmental, non-profits and private parties

The Cash Flow

Again, the investor focuses on two items –
what is the future cash flow from the property and
how much the property will sell for in the future
The cornerstone of the DCF is the Cash Flow. The Cash Flow is the Income Statement plus or minus
any items that affect cash flow, such as capital. The basic formula is
Revenue
(-) Operating Expenses
= Net Operating Income (NOI)
(-) Leasing and Capital Costs
= Cash Flow

The Cash Flow (continued)

The following expands the basic formula and is the typical format for a commercial office building.
Revenue Base Rental Revenue

(-) Absorption & Turnover Vacancy
(-) Base Rent Abatements
= Total Base Rental Revenue
(+) Operating Expense Reimbursement
(+) Other Income
= Gross Potential Revenue
(-) General Vacancy & Collection Loss
= Effective Gross Revenue
(-) Operating Expenses (-) Reimbursable Operating Expense
(-) Nonreimbursable Operating Expense
= Net Operating Income (NOI) = NOI
(-) Leasing and Capital Costs (-) Capital
(-) Tenant Improvements
(-) Lease Commissions
(-) Reserves
= Cash Flow = Cash Flow

The DCF Template

The template for the DCF is as follows. The cash flow for each succeeding twelve month period is
calculated. The number of years utilized is a function of the holding period. The general rule for the
time period for the investment analysis of office buildings is ten years. The details will be explained in
the following pages.
The overall general assumptions are –
Discount rate – 10.0%

Reversion cap rate – 9.0%
Rental growth overall – 2.3%
Expense growth – 3.0%

Steps in the DCF

The sequence to arrive at the value using the discounted cash flow method is to estimate -
assumptions for the future Cash Flows over the holding period
the market rent for the property,
growth rates for future projections of market rent, tenant refit and operating expenses,
lease revenue relative to contract rent levels, lease expiration dates, renewal options, expense recoveries, other
conditions that can impact collected rent from the tenant,
rental concessions, including free rent,
loss due to vacancy,
lease up of vacant space,
recoverable operating expense,
other revenue,
credit and collection loss,
annual operating expenses, both recoverable (or reimbursable) and non recoverable,
the Net Operating Income (NOI),
the timing and magnitude of capital expenditures,
the forecast Cash Flow,
the reversion capitalization rate to convert future NOI in the reversion year,
the appropriate discount rate to convert future cash flows, and
the net present value of the discounted future cash flows and reversion.

Assumptions for Future Cash Flow

The investor of an office building purchases the right to receive the revenue stream from leases in place.
If he expects to own the property for a period of time, he must estimate the future revenue stream from
the lease obligations.
Following are the assumptions used for the DCF. NOTE: for this example, there is one tenant in the
building; the building contains 1 SF NRA. Some assumptions are considered industry standard. These
are –
Start Date January 1 (the actual date the building is closed is January 2; 1 day rent is immaterial
Fiscal Year End 12/31 (Calendar Year Analysis)
Analysis Period 11Years (10 year hold)
Reversion Capitalization of Year 11 Net Operating Income
NRA 1 SF; 1 tenant (for illustration)
Expense Growth 3% per year

Assumptions (continued)
Some assumptions are based on probability, particularly at the end of the tenant lease.
Excluding default and early termination, a tenant may
renew with no downtime, with monies spent by the landlord for space improvement and a
commission to a leasing broker (if any), or
vacate at the end of the term.
If the tenant vacates, the buyer will forecast a period of downtime for lost revenue and costs while a
new tenant is found, a lease is negotiated, and monies are spent to improve the space for the new tenant
and to pay the broker a commission for securing that tenant and the attorneys for lease preparation.
Either scenario can be modeled in the future cash based on the best forecast of the tenant's future.

If it is not known if the tenant will definitively renew or vacate, then a probability is applied to the
renewal, i.e., there is a 75% chance the tenant will renew (and a 25% the tenant will vacate).
Typically it is not known with any degree of certainty if the tenant will renew or not renew the lease, so
the buyer will estimate some monies for tenant improvements and lease commission and for lost
revenue in the form of months the space is vacant, based on the probability the tenant will stay. For
cash flow purposes, a probability of renewal is estimated, based on various factors, including historical
evidence of the property itself. Typically, there is a 75% probability that the tenant will renew the lease.
Lag Vacancy is the period that the office space will remain vacant until another tenant is secured
(which includes adequate timing to prepare the space for touring, finding a tenant, negotiating the lease,
and preparing the space for occupancy).
Tenant improvements, i.e., money sufficient to demolish the existing space improvements (if not
applicable for the operations of the new tenant) and construct the new office configuration.

Lease commissions represent payments to
the broker of the leasing company representing the landlord (the inside broker) and
the broker representing the tenant (the outside broker).
Both fees are typically agreed in the leasing agreement between the inside broker and the landlord,
which has already been negotiated.
Probability of renewal 75%

Lag Vacancy 12 months
Vacancy based on probability 3 months = (1 – 75%) x 12 months
Tenant Improvements New lease $25.00 PSF NRA
Renewal $10.00 PSF NRA
Blend (based on probability) $13.75 (25% x $25.00 + 75% x $10.00)
Lease Commission New = Renew = Blend = 6%

Market Rent for the Property

Year 1 2 3 4 5 6 7 8 9 10 11
Market $26.50 (how this is estimated is discussed in the next section)

Rent
Factors for higher rent are -
location factors –
proximity to where the chief executive officer lives (which may not be as close for the
majority of the employees),
ease of access to current and future employees (i.e., highway access, access to mass transit,
adequate parking caused by increasing worker densities in office spaces), and
quality of the neighborhood,
recent construction (first generation space goes for more than second generation space),
status of ownership,

Chapter 5
THE PURCHASE AND
SALE AGREEMENT

Chapter 5 Purchase and Sale Agreement
Calendar - Major Dates

Date of the Purchase Agreement
Date Purchase Agreement is signed
Effective Date
Date of final acceptance of Letter of Intent
Date of full execution
Date of acceptance
Date of deposit money due to be paid to Buyer or agent
Date deposit is non refundable
Date that begins the Review or Due Diligence Period
Date that ends the Review or Due Diligence Period
Date of Termination of the Contract
Date for tenant interviews
Date for interviews with 3rd party contractors
Date of receipt of documents and materials requested during the Review Period
Date of delivery of documents and materials requested during the Review Period
Date of Closing
Date of Closing extension

Calendar - Major Dates (continued)

Dates regarding title issues -
Date Buyer causes title search to begin
Date of delivery of Survey to Buyer
Date of delivery of Title Commitment to Buyer
Date of delivery of Title exception documents to Buyer
Date of the Title Commitment
Date of receipt of the Title Commitment
Date of receipt of Buyer’s objections to title
Date Seller replies to Buyer’s objections to title
Date Buyer responds to Seller’s reply to title objections
Other dates -
Expiration date of letter of credit
Date of default by Seller
Date of Notice of Default by Seller
Date of creation of the entity of the Buyer

Calendar - Major Dates (continued)

Date of the Estoppel certificate
Date Estoppel Certificates due
Date SNDAs due
Date of receipt of Notice of Casualty
Date of Notice to tenants notifying them beginning date rent is sent to Buyer
Date for calculation of prorations after Closing Date
Date of payment prorations to be paid after Closing Date
Date of demand for tax proration after Closing Date
Dates of certificate of occupancy
Dates of 3rd party contracts or agreements
Date of insurance contracts
Date of flood hazard map
Date of knowledge in environmental issues
Date Seller learns Seller’s reps/warranties are not correct as of Closing Date
Date of any notice
Date of commission agreement with outside brokers
Date of acceptance or contract will be null and void

The Letter of Intent (LOI)

The Letter of Intent is also called the a) the LOI, b) Letter of Interest, c) Agreement to Agree, d)
Memorandum of an Agreement or e) the Preliminary Binding Commitment. These all describe a
document that serves to outline an agreement between the Buyer and the Seller to purchase the property
before the purchase and sale agreement is finalized.
Major points the typical LOI contains are as follows.
Name of the Buyer – The Buyer is ________(can be a General Partnership, Limited Partnership,
Limited Liability Corporation, Corporation, individual, etc.)
Purchase price - dollar amount in number and written form, in total or on a per unit basis
Which party pays for the following transaction costs – 1) broker's fee paid to a specified broker,
2) survey, 3) title insurance and other costs, and 4) costs and expenses allocated between the
Buyer and Seller at closing, known as prorations

The Purchase
The most negotiated transaction item is price.
The purchase agreement is

dated and
between ____ (Seller) and ____ (Buyer). Both parties must have the legal ability to act.
For good and valuable consideration, the Buyer and the Seller agree to the terms of this Agreement.
Unless the Agreement states differently, the Buyer is entitled to the right to receive marketable title to
the property.

The Purchase (continued)

The Seller wants the following:
a qualified Buyer,
receive a large, non-refundable, earnest money/deposit, ideally released to the Seller,
certainty of close at a defined price, by a specific date, with good funds,
sell the Property “as is”, i.e., no representations or warranties provided from the Seller,
sell with no contingent liabilities,
remove any items beyond the Seller’s control, and
after the sale, the Buyer assumes all environmental responsibility.
Note – the 2nd most negotiated item is the Representations and Warranties (i.e., reps/warranties) of the
Agreement. From the viewpoint of the Seller, sell the property "as is" with no reps/warranties; the
Buyer wishes to allocate some or all risks between the Buyer and the Seller.
The Buyer should verify the Seller actually owns the property. Resources from the Seller include an old
title policy and deed showing ownership transfer and organizational documents. These documents can
also be obtained from public records if the Seller is a limited partner or a corporation.

The Property Description

Seller will sell/convey to Buyer the property, described with by plat or metes and bounds.
All items are collectively called "the Property.”
From the viewpoint of the Buyer, the Buyer should include verbiage in the Agreement that if the land
or building area is different from the initial representation, then the Buyer can choose to a) cancel the
Agreement or b) change the Purchase Price.

Seller obligations before Closing

The Seller will
maintain the Property in good condition and repair and make all repairs and replacements,
operate the property in the manner before this Agreement date for a described period of time
(usually from Execution Date to Closing Date)
not change the Property lease structure or waive any rights of the Seller, without first obtaining
the Buyer's written consent at the Buyer's sole discretion, and
not enter into any sales contract, any assignment, or encumber the property once the Agreement
is effective.

Start Date and Closing Date

All dates are negotiable.
The Start Date of the Agreement is also called the Reference date or Effective date.
The Reference date is the starting point for all important dates and specified time periods to be
determined from this date. It can be
the date contract is executed,
the Effective date of the contract, or
some other date.
The Effective Date is the starting reference point for dates and/or deadlines in the contract.and can be
the date the contract is last signed,
the date of the contract,
the date that the letter of intent (LOI) is signed or
a specified number of days when monies are deposited.

Start Date and Closing Date (continued)

The Closing Date can be -
a specific date,
a specific number of days (calendar or business) from end of the due diligence period, or
a specific number of days (calendar or business) from the deposit of the Deposit or Earnest
money.
The contract should specify the dates that the Seller must provide copies of –
the survey,
the title commitment, and
the title exception documents.

To obtain the full 373 page Office Acquisition Basics, go to
www.howrealestateworks.com

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OFFICE ACQUISITION BASICS

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PROPERTY OF COMPRESS REALITY LLC

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TABLE OF CONTENTS (continued)

TABLE OF CONTENTS (continued)

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Data is gathered, including supply and demand.

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Total Inventory (SF) Vacancy (%) As of

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Class Defined (continued)

Construction Above average Not the latest Dated construction

Location Excellent Above average Less desirable

Tenancy Strong credit Good to high quality Lower credit

Management Professional managed Good management Local management

Condition Well maintained Good to average; Average, with deferred

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Investment Categories (continued)

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the change in the population,

the change in unemployment,

the employed working in office buildings and

the building area that each office worker occupies.

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Change in the Population

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Change in the Population (continued)

The working group numbers will increase .077% per year.

The retirees can be counted to grow at an annual rate of 3.5%.

The trend is visually presented on the next page,

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Change in the Population (continued)

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The Office Building

-the tenant or occupant, who uses the property

-property management company, the manager of the building

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Certification - The form of certification is based on client requirements. If the ALTA/ACSM

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Foundation systems are classed as shallow or deep.

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Electricity - Utility to Transformer

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Curtain Walls - The Window Unit and Glazing

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Curtain Walls - Design Wall Construction - Energy efficiency

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Services Provided By The Landlord

These services include (not all inclusive)

maintenance and repair,

janitorial service for x business days per week,

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Lease Economics - Use