Lease Analysis: Definition & Process

Instructor: Eileen Cappelloni

Eileen worked for the Orange County Asssociation of Realtors for 31 years. She has written real estate courses and exams for other publishing companies

This lesson will explain what a lease analysis means and what it can and should accomplish. It will also explain the steps used in the income approach to property valuation.

To Rent or to Buy?

Let's say you own a small business that you're operating from home at the present time. You're doing well, but it's getting a little crowded since you share your office space with your family space. So, you're thinking about buying or renting separate office space.

In order to make an intelligent business decision, you need to have a great deal of information available to you. You not only need to determine what your needs are now, but you should also be able to somewhat predict what your future needs might be. Sounds like renting might be easier, right? Well, that's not necessarily the case. Buy or lease? Not always a clear-cut decision. Let's talk about leasing.

Types of Leases

There are many different kinds of leases:

  • A gross lease is where the tenant pays a fixed rental amount, and the landlord pays all expenses related to the property.
  • A ground lease is where all the expenses of the property remain the responsibility of the tenant.
  • A net lease is where the tenant pays a fixed rent plus all or a portion of the operating costs.
  • A percentage lease is where the tenant pays a monthly base rent plus a percentage of the goods sold at the location.
  • A lease option contains an option to buy the property, generally within a certain period of time.

Lease Analysis

So, ultimately, you've decided not to purchase a property right away. You decide, instead, to lease property. Sounds a lot simpler, doesn't it? Well, in reality, before you lease a property, you should conduct, or hire someone to conduct, a lease analysis. A lease analysis uses various tools and procedures to gather and organize economic and financial data that will help in determining what type of lease would be most advantageous for you and acceptable to the lessor, who is the party that receives payment from the lessee (that would be the renter, in this case, you).

What is going to be considered when weighing the advantages or disadvantages of a particular lease? This may be something you may want an expert to analyze for you. Here's a partial list of items to consider:

  • The base rent
  • Does the base rent escalate?
  • Is there a cap on operating expense escalations?
  • Is there a separate parking space charge for your business?
  • Is the building already compliant with Federal Fair Housing laws?
  • Will you be paying individually for your utility charges or is it a percentage of the entire building's fees?
  • Will the landlord and municipal regulations allow you to erect signage?

These are just a few of the factors that will need to be considered before you should be signing on the dotted line!

Income Approach to Value

The income approach to value is an appraisal method that permits investors to approximate the value of a property based on the income the property generates. This approach is one of three main methods that appraisers use to determine the value of a property. It is typically used on income-producing properties, such as apartment houses.

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