Project Economics: The Value of Leasing. Russell Banham, Savills

Transcription

1 ICSC European Retail Property School Project Economics: The Value of Leasing Russell Banham, Savills (Investment, Development & Asset Management)

2 Introduction

3 Who I am Russell Banham Over 30 years of experience UK, Europe & Middle East Major Developers / Entrepreneurs / Funds

4 One of my Current Projects

5 Learning Objectives for the session 1. Identify various ownership positions and expectations 2. Explore financial impact of a single lease and its various components 3. Examine the economics of releasing, buy-outs, take-backs and relocations 4. Look at development appraisals and Leasing s role in that process Section I Section II Section III

6 Key Points to Remember Value is driven by the quantum & perceived quality of income. Cashflow is the receipt of income, not just the right to receive income. Cost is cost not VALUE! Income is generated by leasing activity. Good leasing in shopping centres is about the creation of high quality income - in the context of the right tenant mix (adjacencies matter).

7 Section 1 Financial Issues Ownership Positions & Financial Issues

8 Ownership Positions and Expectations Different shopping centre owners have different requirements: Property Companies REITS - accretive growth Quoted Companies - income growth and capital appreciation Trader Developers - development profit Funds Pension Funds income growth and capital appreciation Investment Companies Sovereign Wealth Funds - trophy assets Opportunity Funds - capital appreciation and income growth

9 Ownership Positions and Expectations Mortgagees / Debt Providers Banks Insurance Companies - secure income to repay debt Pension Funds Asset Managers Asset Management Companies - fees (often minority equity investors) Retailers Large /small /established / start-ups - profitability, market coverage, total cost

10 What about REIT s? REIT s are generally public equity; similar to traditional stocks but with differences Seek accretive growth via new development & acquisition Funds from operations (FFO) and Net Asset Value (NAV) are the primary measures; Not NOI Most are traded on public exchanges but private or closely held REIT s do exist.

11 Shopping Centre Valuation What Drives the Value of Retail Real Estate? Location, location, location Tenant mix Competitive environment Market Demographics Land costs & hard costs Length of leases / lease terms Supply & Demand (retailers/investments/finance) The economy!

12 Shopping Centre Valuation They all play a part, but the fundamental driver of value for retail real estate is... - the underlying sales productivity of the asset!!

13 Financial Terminology 1. Capitalisation Rates 2. Measuring Return 3. Amortisation 4. Depreciation 5. Discounted Cash Flow (DCF)

14 1. Capitalisation Rates The Official ICSC Definition: The rate used to convert income into value So what does that mean? ICSC s Guide to Shopping Center Terms Capitalization is the process by which anticipated future income is converted into a lump sum present Value. Why is it relevant? It is the basis of valuation! The Dictionary of Real Estate Terms Value = Income x Cap Rate eg 100,000pa at 6.0% is (100,000 x = 1,666,000)

15 1. Capitalisation Rates Factors affecting the Capitalisation Rate Perceived Risk Market Transactions The Economy Weight of Money

16 2. Measuring Return Return on Investment (ROI): A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio. ROI = Return / Cost e.g. 100,000 pa x 100% = 6.0% ROI 1,666,000 pa

17 Measures of Return Let s look at a few basic measures of return: Cash on Cash Return Total Return Internal Rate of Return Developers Profit (see later) This is not a complete list, there are other measures.

18 Cash on Cash Return The cash on cash return on investment is the Net Operating Income divided by the initial cash investment. The formula looks like this: Cash on cash ROI = NOI / Initial Cash Investment The Net Operating Income (NOI) is simply the total income from the property minus the total annual expenses (in any year).

19 Total Return The Total Return on Investment (TROI) provides a better and more complete measure of a property s financial performance. This is because you can include other factors such as interest repayment and depreciation along with appreciation gained over time. Total ROI = (NOI (adjusted for interest and depreciation, as required) + Net Sales Proceeds (or Net Valuation) Initial Cash Investment) / Initial Cash Investment This is a key measure for the performance of Property Companies and Funds and can be greatly affected by the state of the market. (Everyone wants to be in the top quartile!)

20 The Best Measure of Return? Internal Rate of Return (IRR) Measures the percentage return on each for the period of time it is invested in a given asset. The IRR of an investment is the discount rate at which the sum of the PV of future cash flows equals the initial capital investment. Often used as the hurdle rate whether to invest or not invest in a particular project.

21 IRR Proof Take an initial investment of 10,000 at a 10% pa interest rate, which returns in income, 0, 1000, 5000, and 7931 in subsequent years; the IRR is 10%. YR Invested Interest Incurred Invested & Interest Cash Flow Invested 1 10,000 1,000 11, , ,000 1,100 12,100 1,000 11, ,100 1,100 12,210 5,000 7, , ,931 7,931 0 Total 3,931 13,931

22 T-Bar Method CCIM TM T-Bar Method N 10% Discount / Interest Rate 0 (10,000) Initial Investment 1 1,000 Interest Earned - 2 1,100 Interest Earned 1,000 Cash Flow (Out) 3 1,110 Interest Earned 5,000 Cash Flow (Out) Interest Earned 7,931 Cash Flow (Out) 10% Internal Rate of Return

23 3. Amortisation The gradual paying off of a debt by periodic instalment The Dictionary of Real Estate Terms This is an actual cash transaction between a borrower and lender! This is the basis of a repayment mortgage.

24 A Basic Example A 1,000 5-year self-amortising loan with annual payments and 10% Interest Year Payment Required Interest on Unpaid Balance Principal Repaid Unpaid Balance Total 1,

25 4. Depreciation The process of estimating and recording lost usefulness ICSC s Guide to Shopping Center Terms Allocating the cost of an asset over its useful life Dictionary of Real Estate Terms This is a non-cash accounting transaction that does not affect NOI

26 5. Discounted Cash Flow (DCF) The process of Discounting a Future Cash Flow back to a Present Value (PV) To Calculate: Future Value, Net Cash Flow Discount Rate (Interest Rate)

27 Valuation Valuation is a tool used to evaluate the value of an asset at a given date using various combinations of variables. In real estate those variables are often: Capitalisation Rate, Discount Rate (DCF), NOI/ NOI forecasts and ERV of unlet units.

28 Sensitivity Analysis Different scenarios are modelled to judge the sensitivity of the project to changes in the key variables (eg rent, capitalisation rate, costs). Conservative, Most Likely, Best Case & Worst Case The goal is Accuracy not Fantasy The process is dynamic and needs constant review

29 Tenant Risk Factors What are some Risk Factors? Credit Issues: Fiscal strength can the Tenant fulfil all lease obligations? Operations: Is it a proven concept? Ownership: What about assignment, sub-letting, sale of business. Rents: Ability to pay the rent/sustainability of the rent. Incentives: Did the landlord make a fit-out contribution?

30 Tools to Address Risk Factors Credit: Rent deposits, guarantees, security deposit, letter of credit Operational: Shorter base terms, Options (Mutual), performance clauses Change of Ownership: What about unilateral right of approval, pre-set credit requirements, % rent conversion clause. Rents: Varying rental levels by size, rent reductions, % Rents Incentives: Stage payments, repayment penalties

31 Return Vs Valuation For those who may be less comfortable with these concepts, here is a summary: Cash on Cash, Total Return and Internal Rate of Return are measures of Return: Are measures of an Asset s PERFORMANCE over a PERIOD OF TIME Future Value, Present Value and Net Present Value are measures of Value: Are measures of an Asset s WORTH on a given DATE

32 Section II: Leases The Value of a Lease

33 Value of a Lease Impact of a single lease on financial performance of a shopping centre Sensitivity analysis relative to assumed percentage rent Financial effects of tenant allowances (TA), % turnover rents and service charge caps / exclusions Premiums for tenant mix needs

34 Impact of a Single Lease on the Financial Performance of a Shopping Centre Discounted Net Cash Flow Analysis Net Present Value over the term Does not tell us the impact upon value Comparative Process versus: Pro-forma budget Look at impact on value

35 Methodology Base Rent T-Bars Sq m:size 200 sqm TA (psqm) Sq m:size 200 sqm TA (psqm) Rent: 5 years at 200 psqm Rent: 160 sqm to 240 psqm in steps Proforma Budget Proposed Terms n n 0 60, , , , , , , , , , , ,000 Total 200,000 Total 200,000 Int = 10.00% Int = 10.00% NPV = 83,301 NPV = 80,684 IRR = 60.38% IRR = 54.30%

36 Impact of % Turnover Rents The prospect of % Turnover Rent has no impact on value only actual % [Turnover] Rent received... An Anonymous Auditor Should % turnover rent be in our forecasts? Pro: Adds value if accurately forecast Con: Difficult to forecast turnover & growth How to build % Turnover Rent into our forecast? Need estimated sales (corroborate with evidence from elsewhere). Sales growth rate estimates (based on time series data). How do you deal with a turnover only rent?

37 Financial Effects of Tenant Allowances, % Turnover Rents Top-ups & Service Charge Caps / Exclusions Simply put, cash out for tenants allowances is likely to decrease short term value In Zero Year every out reduces value but payment may be necessary. % turnover rent top-ups are less risky for the landlord. % turnover rent may or may not actually accrue! Service charge caps / exclusions Every not recovered from tenant is value lost (multiplier effect of cap rate)

38 Issues with Key Tenant Deals Higher tenant allowances (psqm) Lower base rent; lower % turnover rent. Hard cost control measures: Caps on extras/service charges Token marketing contribution; possibly none Co-tenancy requirements; anchor & key retailers All of these have an impact on value!

39 The Economics of Buyouts, Relocations and Take-backs Buyout: A party seeks to buy their way out of a current lease obligation. May be initiated by either the landlord or tenant (usually the landlord) Relocation: A landlord seeks to move an existing tenant from one location to another prior to expiration of term Take-backs: A landlord agrees to take back a portion of an existing tenant space. May be initiated by either landlord or tenant

40 Concerns of the Tenant To be Treated Fairly To know who is paying whom for: Tenant Improvements / Landlord Work Downtime, Moving & Storage Releasing, Legal Work, Commissions Occupancy cost ratio; the all-in cost All pertinent points need to be addressed in a binding legal document

41 Tenant Buyouts Tenant Buyouts Cost is always the key issue Difference if tenant is doing well versus tenant doing badly Tenant relationship will be crucial opportunities elsewhere in portfolio

42 Relocation Relocation Leverage depends upon lease terms Cost of moving tenant A must be part of zero year expense to get tenant B Is landlord building new store for A? Capital cost ( )? Unique expenses: moving & storage Who pays for what is a function of lease terms and how much landlord needs the space

43 Take-backs Take-backs: Can be landlord needs the space to get tenant B, for an expansion, etc... Can be tenant wants to downsize. Unique expenses: re-demise of space Who pays for what often depends upon who initiated the discussion

44 Section III: Appraisals & Leasing Development Appraisals & the Role of Leasing

45 What is a Development Appraisal? Best guess of the outcome of an activity but an informed guess! Based on market information, cost estimates, pre-lets/ervs and perceived risks Income x Capitalisation Rate = Value Less (Development Costs) = Costs = Profit

46 Value Projected Rental Income Less Non-Recoverable Outgoings = Net Rental Income ( pa) X Cap Rate = Capital Value ( ) plus any Capital Receipts = Total Capital Value ( )

47 Capitalisation Rate Yield (Pricing) Based on transactions (Judgement) Reflects perception of risk / value Consider long term yield

48 Development Costs Land Costs Planning / Survey / Preparation Costs Construction Related Costs Construction Contract Fees & Expenses Leasing / Marketing Costs Financing Costs

49 Profit Measures of Profit Capital Profit (Developers Profit) Percentage Profit IRR Development Yield

50 Bottom Line Combination of facts / estimates / best guess and judgement Does the answer look right?! Sensitivity Analysis to assess risk Know what is critical to the bottom line

51 The Role of Leasing in the Development Appraisal Process The Leasing Team should be involved early & throughout the development process Will separate fantasy from reality (but be careful of the easy option) Constantly ask, what if? Get Leasing s input on the rental projections: Does the appraisal drive Leasing Strategy or does Leasing Strategy drive the appraisal? Be farsighted: See the opportunity Make leasing decisions accordingly Stick to the plan but constantly re-evaluate

52 Incremental Income / Commercialisation The potential has never been greater: Utilities: Resale, Production, Controlled Environment Kiosks & RMU s Sponsorships & Strategic Alliances Vendor Leasebacks Antennas, Storage, Others...? If you create income, you create value

53 Re - cap Value is the right to receive income (current and future). Value is driven by the quantum & perceived quality of the income. Cashflow is the receipt of income, not just the right to receive income. Cost is cost not VALUE! Income is generated by leasing activity! Good leasing in shopping centres is about the creation of high quality income - in the context of the right tenant mix (adjacencies matter).