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Importance of Trade Area Analysis for Commercial Sites/Properties

Trade area analysis defines the characteristics of the area around a particular commercial site/property. Defining a trade area is an important step in any market analysis because it outlines the boundaries that will serve as the basis for additional analysis. A trade area is the topographical area from which a site/property generates most of its customers. This helps businesses identify the opportunities to develop the site/property knowing where their customers are coming from as well as the area for new potential customers. Trade areas are affected by factors such as population density, driving distance, competition, demographic factors, economic factors, sociological and geographical boundaries, and other similar factors. This information provides important insight into the community’s customer base and allows for the analysis of demand for types of development and uses.

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Property Development: Demand & Supply

In a “For-Sale” Property Development Project, the developer usually has some idea of the end customer anticipated from the early stages of the development process. The law of demand and supply is an economic principle that explains the relationship between demand and supply for a good or service (property, in this case) and how the interaction of the two affect the price of that good/service. In simple terms, the law of demand and supply simply states that when there is high demand for a product, the price of the product will naturally rise and if there is over-supply of that product, without sufficient demand to cover it, then the price naturals falls. In real estate, the four-quadrant model (DiPasquale and Wheaton) is a widely used tool which explains the factors connecting markets of value, space market for rents, construction and stock adjustment (e.g. the effect of demand growth in space market or asset market). In relation to the property development sector, simply put, if construction increases then the supply of assets increase and, if this supply exceeds demand, then prices and rents will naturally be driven downwards.

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Landlord & Tenant “Re-Leasing Costs.”

A main issue affecting both the landlord and tenant in the commercial property sector is the issue of “Re-Leasing Costs”. From the landlord`s point of view, this includes the vacancy period and possible costs to undertake between the period of a lease termination up until a new tenancy agreement is signed with a new tenant. From the tenant`s perspective, this includes re-location costs of moving which affects both business operations and actual costs of moving. “Long-Term Leases” can help avoid these issues although rent expectations need to be considered in long-term agreements, both from the landlord`s and tenant`s side. Tenants will usually try to persuade the landlord of low absorption in the market, high availability of similar space and future security of rental payment (i.e. risk to the owner). Landlords will try to persuade tenants of high absorption, minimal supply of similar space and increase in rents and costs to move a business. In any case, both Landlords and Tenants need to consider various factors before entering into a long-term lease.

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Property Lease Types

Gross Lease: Rent is all-inclusive. Tenant pays a flat amount with the landlord paying all expenses associated with the property (taxes, insurance, utilities, maintenance etc.).

Net Lease: Landlord usually charges a lower `base rent` and tenant pays for the operating expenses. In a Triple Net Lease (or NNN) the tenant will pay the rent and some or all of the property expenses that normally would be paid by the property owner (i.e. operating expenses as well as utilities, taxes, property insurance, maintenance etc.). Landlord therefore receives the rent “net” after the expenses which are passed through to tenants are paid.

Hybrid Lease: Leases which fall somewhere in between a Gross Lease & a Net Lease are considered Hybrid Leases. Landlord and Tenant share the operating expenses according to their contract/agreement. Usually, this is agreed based on charges that can be allocated to a tenant separately and the charges which cannot be allocated separately may be paid by the landlord. The parties may further agree to an “expense stop” approach where tenant may agree to be charged for the extra cost of operating expenses when these are over and above a specified amount.

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Property Investment – Highest & Best Use of Development Properties

When considering an investment in a development property, the Highest & Best Use is an important factor to be determined. Highest & Best Use can be considered as the legal use of a property that yields the highest Present Value. Zoning laws which determine the legally permitted uses and physical possibilities of a property must therefore be assessed, while considering the physical characteristics of the property. A feasibility study of all permissible uses of the property can then be examined with the financially feasible use producing the highest financial return being considered as the Highest & Best Use. A financially feasible use of a property will mean that the proposed use of a property should generate adequate revenue to justify the construction costs and include a developers profit while generally considering risk/return and finance factors.