what index might be used to adjust lease rate over ten years

In Leasing Property - Asked by Rick S. - Feb 22, 2011
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Answer(s)

David L.
Broker/Agent
Newport, RI

Rick,
As I'm sure you know there are literally hundreds of indecies to align your lease appreciation with. I feel the most popular is CPI, or Consumer Price Index, which is the Federal Reserve's measure for inflation. But as an investor, you know that simply hedging against inflation isn't enough of a return knowing the potential return you could receive from other investments.
A great benchmark to your lease increases could be the considered benchmark for mortgages: the 10 Year Note. It is currently yielding %3.65 according to Bloomberg.com. By using the 10 year note instead of CPI, you'll not only hedge against inflation, which the market are already covers in the yield. Also, you know that in the same duration of 10 years, you can achieve the same level of return risk free.
In conclusion, many people immediately jump to inflation as dictating their Lease Appreciation, when as an intelligent investor, you need to take opportunity cost into the equation, making the 10 year note a better choice.
Thank you for your time and I hope this helps!

Feb 22, 2011
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Rob B.
Chandler, AZ

David had a good answer for CPI, which normally always is presented as applied to a specific area of the country, since the items that go into CPI do vary from region to region. However, I found David's answer, while being a brainteaser a bit complicated for general usage. I did a spreadsheet with some assumptions of the change in the 10-year note over the past five years. There has been about a 200 basis point swing over this period. I then compared that to a simple CPI clause that would have a floor of 3% in it. (The rent never to be less than a three percent increase over the past year, or CPI, whichever is higher). I found over the past ten years if I calculated correctly I believe that using the 10-year note would not have been the better choice.
I believe that a CPI index with a minimum 3% annual increase remains acceptable in the market. While national credit tenants will not go for this, most other tenants will. The national credit tenant may state that you are allowed to increase the rate by 10% every five years, which is somewhat typical for a credit-tenant, NNN lease. However, for a gross or modified gross lease, you will want the minimum 3% annually for certain. Sometimes if there is a floor the tenant will demand a ceiling as well. I would likely start out by making the ceiling 7% or 8%, with perhaps a 6 % negotiated agreement in the final draft of the lease.
Again, I commend David for stimulating my brain with another alternative. I would personally not be able to use his suggestion effectively without further explanation to the wording of the full clause; and the mechanics on how it would be applied. Even then, I believe it may likely be unacceptable to the common tenant in a lease, no matter how sophisticated he or she may be.
Good luck Rick... Rob Baird, CA RE License #544165 (One of the oldest, active licenses in CA) 951 515-5855 Email: robertbaird@NewportCpC.com

Feb 22, 2011
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Steve J.
Owner/Investor
Irvine, CA

Rob is correct. Generally most leases will have lease bumps based upon CPI. Usually it will be stated as the greater of CPI or 3% (in the past few years many tenants have been negotiating 1.5 or 2% instead of 3%). Many tenants will also request a clause, not to exceed 5%.

Feb 24, 2011
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D D.
Broker/Agent
Irvine, CA

The answers that Dave, Rob and Steve gave are all accurate and well based.
The key issue that drives these darned things though is market acceptance and there are many ways to skin the cat so to speak.
Dependant upon the actual lease structure (NNN, Gross, Modified Gross, ETC.) you can simultaneously get some operational cost relief while at the same time growing your lease value.
There used to be some acceptance of even a NNNN lease format which allowed pass through of increased debt costs to the tenant as well and this could be a factor in longer terms leases that start in these very low debt cost times.
Lease growth is a complicated matter that can be quite overwhelming if managed aggressively in accordance to a well written document.

Feb 25, 2011
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