Real Estate Finance Lease Case Study

Nick Milo

Leases and Management Contracts

Question 1

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Question 2

For a net lease the landlord is reimbursed for a portion of the operating expenses. In a NNN for the owner, NOI is constant since the increase in costs are reimbursed by the tenant. Since this income is constant it is clear why it could be considered fixed income investment. Tenants typically pay for utilities, property taxes, insurance, and maintenance and may also agree to pay certain recurring capital outlays for repairs, alterations, and modifications to the interior of the building.

Question 3

Free rent is simply when the landlord offers “free rent” to a tenant. It means that for some portion of the lease, the tenant does not have to pay for the rent. It is usually given as an incentive for tenants to sign leases. It would be useful to receive this whenever I was short in capital such as the beginning of the lease if I just had to put down a big downpayment. Since time value of money decreases the value of the rent over time it is better to have free rent in the beginning of a lease if rent is constant after the fact.

Question 4

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**Note: If part C is intended from the property manager’s point of view I would rather have incentive fee as 6% of GOP because it is a higher amount in this case and you do not have to deal with negotiating an owner’s hurdle rate.

Question 5

The problem that lies with hotels is that if they are the principal owner and hire an agent, they would have ownership of the property, but not control of it. This means that they would not be able to have a direct say in how the hotel is operated on a daily basis, which is ultimately a deciding factor in the amount of return you receive in the future. What a typical management contract does is reflect both the needs of the owner and agent through a bargaining agreement. This way, both parties will be able to work together to come up with a plan to best run their property and mitigate disputes. This can be done by debating termination agreements and incentive fees. Operators want long management agreements in order to mitigate risk while the owners are stuck with carrot incentives, which makes the owner want to grow the hotel revenue while keeping a large percentage of earnings.