INTERNATIONAL REAL ESTATE TRANSACTIONS

30 November exam (6-8- questions, short 1 o 2 paragraphs, about topics of class)

Topics covered in this course: international market for investing real state assets, who are the major
players of these markets, what is the flow of a typical transaction, what are the international
standards, how are the standard agreements structured...

TOPIC 1: COMMERCIAL REAL ESTATES

What are the commercial real estates?

Commercial real estate (CRE / inmuebles comerciales) is property used exclusively for business-related
purposes or to provide a work space rather than a living space, which would instead constitute
residential real estate. Most often, commercial real estate is leased to tenants to conduct income-
generating activities. This broad category of real estate can include everything from a single storefront
to a huge shopping center.

The traditional commercial real estates assets are related to:

o Retails
o Industrial / factories
o Hotel / entertainment / theme park
o Apartment/Residential: mundu guzik alokatzen baditto eraikiñek, aldittozo erabili
commercial real state transaction bezala. It has become so important that investors were
investing into residential buildings more than in offices.
o Student housing / senior housing
o Land
o Offices
o Others

The asset of course has a life cycle, that could be summarized as follows:

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The life cycle is important to understand because it drives the behavior of the investors. Depending
on which part of the cycle we are, different strategies are used to collect as much profit as possible.
The parts of the cycle are the followings:
1- Everything starts with a concept or feasibility of something. You collect the capital required
2- Acquisition: you buy the building or whatever. You want to see the characteristics for the
pricing.
o You want to address the information asymmetry of the parties in the transaction.
The seller has more information than the buyer, and the buyer wants to have a good
picture of what it is buying. Here law has a role to play. In many countries if it doesn't
fulfill the conditions you can have the seller repare the car. Then the thing is to
investigate in the local law or the local practice, which will state how these type of
problems are solved. The seller will normally be punished if it is hiding some kind of
information.
3- Design / construction
4- Leasing /Management: building is finally used. 15-20 years without changing anything, just
collecting rents. You will have however operating expenses: reparations and all that
5- Redevelopment / repositioning: there are new offers, so you will face how to react to the
new options for buyers that are better than yours (you might choose to do some vertical
integration).
6- Sale /demolition: if you are a pure investor you would jump the last step and go directly
here.

This cycle is not isolated from the market. The market has its own cycle. Economies are going
through phases of expansion and the contrary. And it’s both situations combined which determine
the strategy used by the investors.

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Commercial real states rely on tenancy, on companies, on individuals, and so on.
 So if the economy is recovering, the demand of commercial real states will increase. Companies
are winning more, so they might want to enter a new country, get new factories…During
recovery the owners of commercial real states will see there is an increased demand, but in this
first phase you are not that certain about the recovery.
 If the recovery is strong enough, you will enter a phase of expansion in which more a more
commercial real states investors will think it’s time for new constructions. It cannot be predicted
how long the phase will last, but the creation of constructions takes a lot of time, so it cannot
react quickly to changes in demand.
 In the recession there is a decreasing demand, companies are not making that much moeny and
they do not have money to spend. The commercial real state owner maybe ends now the
construction but there is no demand anymore. Tienes que bajar los precios, las rents serán
lower, o igual nisiqueira hay demand. Therefore it is a very risky thing, because you have to time
your development on how the economy is doing. The perfect case for the developer would be to
end the construction right up in the line before the recession but timing that well is almost
impossible.
 In the recession there is a decreasing demand, so the developer will have no rent or lower rent.
Owners will not be able to rent the whole building, so the developers will stop with any
construction or development that were being done until now. The up and down regulates how
buildings in the city are being done. After recession there is always going to be a recovery but
we dont know how long it will last.

The players of the commercial real estate transactions are the followings (using the example of
the office building).

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  The most important player is the tenant, the user of the space, because it is the only one
putting money into the system (playing a rent). The rest of players are making a profit out of
that rent.

 A financing party (bank): diversify and lower the risk if you take a lot of assets so you might
prefer to buy 10 assets with the help of the bank instead of 1 with your money. Also if you
collect the money of 10 properties, even if you gotta pay the loan you will have higher
income. Whenever you are buying real state, some part of it will be to pay the interests of
the bank, but you will keep the rest, so depending on the market situation you are more
keen on earning money.

 Facility Manager: he takes care of the cleaning and security or whatever of the building
 Property manager: he manages the tenant in a daily basis. Operating buildings. Taking
complaints of tenants, making sure everyone is paying the rent, etc.
 Architects & Contractors: giving certain services and get a fee for that
 Suppliers: giving certain services and getting a fee for that.
 Landlord: the owner of the offices or whatever we are buying.

TOPIC 2: VALUATION OF COMMERCIAL REAL ESTATES AND THE ASSET MARKET

“Don’t wait to buy real estate. Buy real estate and wait” Will Rogers, actor and humorist

Parts of the topic:

 Valuation of Commercial Real Estates
 The Asset Market

Valuation of Commercial Real Estates

What factors determine the value of a real estate?

This is going to be different depending if we are talking about residential or commercial estate. The
special characteristics are valued differently.
The different methods that we can use are sales comparison, cost approach and income approach

1) Sales comparison

This method consists basically on looking at comps in the local market to determine value.
o The market value is the value that the market establishes for a given article in the
present. If you are selling something you want to get the market value. If you re
collecting data of the past those data reflect some economic circumstance and etc. of
that time in the past (look at energy prices). Now we have another situation which leads
to another price.

However, it might be hard to find comparable in commercial estates, or there might be no

comparison data available. There are in fact two challenges when getting the correct data set:

o How should we define the geographical area? Should it be widened if there is not
enough data?
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 If we are looking at residential real estate in us there can be a street where on the
right side prices are substantially higher because of local circumstance (technical
condition, infrastructure, external factors like light or noise, demand (how many
people are coming to buy real estate), income (in places where there is a lot of
money, en esos sitios los pisos son muy caros), school district. There can be a lot of
things. A smaller geographical area is more accurate.

o The other challenge that we might find related to gathering information is that there
are some markets in which sales prices are not tracked.

Therefore, if there are not enough sales to use as a dataset, what can we do? To broaden the
comparison data it is not realistic anymore. Then what should we do? This shows drawbacks of this
method.

In consequence, this methos is heavily used in residential real estates, but it is less frequently used
in commercial real estate, because there could be a lot of differences between comparisons.

2) Cost approach

This approach consist of calculating the cost that it would take to rebuild the property from
scratch. It accounts in fact for the current cost of the land, as well as the construction materials,
labor costs, and all other costs that would be associated with replacing the commercial property’s
existing structure.
o It should be noted that you are getting a cost, that is probably different of the one 5
years ago. By adjusting the present value of the building, you can screw it up.
Therefore,
Property value = land value + (cost to build new + accumulated depreciation)

Depreciation should be mentioned at this point. It represents how much of an asset’s value has
been used. Companies indeed depreciate long-term assets for both tax and accounting purposes
(e.g. leased offices can be depreciated over 39 years in the US and 20 years in Hungary).
This can of situations can derive into differences between the seller and the buyer, and they can be
solve by agreement or by going to a third party. Parties will try to agree as a dispute resolution
solution, as going to a third expert costs money.

Cost approach is used a last resort in the case of factories, industrial and buildings.

3) Income approach

This approach is based on how much income a property is expected to generate in the future.

- Imagine you are an investor. You can buy Spanish government bonds, at 4%. You are
investing 1000 euros. You have a nice office building that gives you 5,5% yield (interest). I
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 can invest in Milan building with more. You can also put your money in a bank that gives you
3%. When you know the different interest, which one you decide to go for? You will
probably look at the price of the offices. Therefore, how much you pay for the building will
be determined by the income it will generate to you.

In this scenario there are two important terms to be explained.

- NOI (Net operating income) = Effective Gross Income – Operating Expenses

If we look at the income statement of any company, you have different items, you will have
the income stream (in the case of the office building is the rent, payments, etc. ). And then
we have all the operating expenses related to operating the building. When you do one
minus the other you get the net operating income, which goes to the “pocket” as an
investor (even so there will be taxes to be paid and so on). That is the return you will get in
your investment.

- Cap rate = the owner’s annual anticipated return on investment before capital costs, debt
service and taxes. This is basically the ratio taking into account the price and income. “Every
year the income is 5,5% of the purchase price”.

For the purpose of pricing, from the perspective of the buyer, the bonds are giving 4% and
the banc 3%. I can make a calculation of the price I want to pay depending on what the
capitalization rate is. NOI is the income and the capitalizacion rate is what I get.

- The property value will be NOI/Cap rate. The is the price I am willing to pay.
If I accept a 4,5% of capitalizacion rate, I will pay more. Si quiero ganar un 5% tengo que
comprarlo más bajo, si quiero ganar un 4,5% me conformo con menos y entonces estoy
dispuesta a pagar más, porque aunque pague más llegaré a que me genere un 4,5%.

But risk has to be taken into account. Maybe I cannot maintain the NOI I’m winninn, or the building
might be destroyed. In the income rents, there is a risk of you not being able to get tenants for the
building and the occupation number declines. Maybe the price changes, changes in the market
which will make the price go down. Or the operating expenses go up, the NOI is influenced by the
cost and there could be new taxes or whatever.
Also country risks: risks associated with a country, how likely is that new regulations will come into
force. Countries are different political systems, and it differs how much taxes you are wanting to
pay, or changes regulations so that everything is green. Country risks are also the expectation
around market liquidity (how easy it is to send a piece of asset). Real estate is inliquid, difficult to
find someone to send it to. Liquidity is related to country risks.
That will be reflected in the rate of return expectation (capitalization rate) → if the risk is higher
the expectation should be higher and therefore you are willing to pay less.
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This method is the most accurate one. Moreover, it allows for the comparison of different type of
properties, you can compare with this method different real estate assets.
But one big limitation is that it relies in the calculation of the NOI. In other words, it is very
sensitive to inaccuracies in the calculation of the NOI. As a seller you want the NOI to be very high,
so that you can set a higher price. Maybe you will be optimistic with the income streams and the
costs, because it has a huge effect on the price. As a buyer you want the NOI to be low.

As an example, we will put the case in which there is a NOI = EUR 100/ year. The cap rate is 5%, and
the value is 2000 euros.
I’ll pay 2000 euros today to acquire an annual cash flows of 100 euros in the future.

The funds can take different form: open fund (investors free to come and invest and then leave it at
a certain date), close-end fund (make thsi fund for x years and then no oportunity for investors to
leave).

Asset market

For investors, there are a lot of alternatives they can invest on. Some of them are stocks, bonds,
saving accounts, commodities, arts, mutual funds, foreign currencies, cryptocurrencies, loan notes
and real estate (residential or commercial)
- Funds: collection of assets. Several investors. Each of them gives 100 euros to the fund and
they receive a unit which represents their investment (like a share). The difference: in the
shares you can vote the planning and dividends payment, go to the meetings, and other
rights as right to information or whatever. In the case of the fund, you have the investors
who made their investment but the fund will have a fund manager (a professional financial
service) whose job is to make all the investment decisions of the fund. The manager is also
representative of the fund when signing agreements and so on. The investment policy is
published for investors.
As an investors you are entitled to receive the proportion of profit of the fund, and in certain
cases, even some limited rights to vote to change the manager, but normally it is the
manager who has the great control over the fund and the investors don’t really exercise too
many rights.
The funds can take different forms: open fund (investors are free to come and invest and
then leave it at a certain date), close-end fund (make the fund for x years and then no
opportunity for investors to leave).

If we look at the investment strategy of the fund, we could have some categories:
o Private equity fund: starts-up in which they see potential and they are financial
investors.
o Real estate funds: dedicated to real estate investments
o Funds without single focus but mixed strategies looking at different tools

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In any case, investors have money to invest, but they don’t want to look after them. That is why
there will be other market players in the market who will do the management part of the
investments.

When investing into CRE (commercial real estates) there might be some pros and cons that have to
be taken into account:

PROS
- Income potential/appreciation potential: the historical prices of real estate follow inflation.
That means that they are a good stable investment in the long term (even if in the short
term prices go down.
Moreover, we know that the price of the building is NOI/Yield (being that one a lot of things,
investors view of the market, the country, etc.). Is there any way to increase the value of the
building, so that when we sell it its value will be higher for sure? Yes, by increasing the NOI.
That can be done by increasing the rents (limitation of agreements with former owner) or
bringing down operations costs.
It is important at this point to understand the difference between CAPEX and OPEX:
 OPEX are the operation expenses in a daily basis of the building (lightining,
water, etc.). CAPEX is the investments that you can make in the building to
make it more efficient (energy efficient, for example). As an investor, I want
to make a balance: is there a difference in the OPEX if I invest in the CAPEX?
Maybe if I put solar panels (+ CAPEX) y decrease the operating expenses.
 In commercial Real Estate the OPEX is paid by the tenants (the owner records
it and charges it to the tenants). So the owner is not actually paying the
OPEX, so what would it like to invest in the CAPEX?
 The building is not isolated in the market, and when compiting for tenants,
the owner wants to be as competitive as possible. Tenants look at the rents,
but also the operating costs they are going to be paying. So for the owner
even if he/she is not retaining any benefit out of the investment in CAPEX,
the building becomes more competitive, and people are willing to pay more
for the rent (lo que se ahorran de pagar en el opex, al final).
 However, when deciding to invest in the CAPEX, other factors should be
taken into account. Like the location of the building (maybe pointless to
improve building if it is in a very bad part of the city).

- Control over the asset, investor is in the driving seat

- Long term leases
- Tripple net leases
- Stable cash flow: investors can rely on it.
- Regulatory environment is stable compared to other industries.

CONS
- Time commitment: to manage investment you need to devote time.
- Need for expert advisers: to help treating income tax calculation, technical advices, etc.
- Financing
- Stable cash flow

When looking at who the investors of these commercial real estate assets are, we get to the
following list:
o Wealthy private individuals

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 o Mutual funds

o REITs: Real Estate Investment Trust (in USA). A REIT is a real estate investment,
organized in the following way: there is a commercial real estate, that will generate
income, so the REIT will collect those rents, and out of those profits collected, the
investors will receive a part and pay individual taxes. The tax is paid by investors, not
by REIT. Changes going on: now it is possible to have a private REIT without the need
to register it to the stock exchange.

o Pension funds: it is a fund that deals with retirement. For employers, they tell the
workers to do some investments on the pension fund so that they collect periodical
payment when they retire (even obliged to do so in Switzerland, but the can choose
which fund). When you are retired you get money from it.

o Insurance companies: they way of working is to make people pay a small fee per
month, and if someone has an accident, you get it repaired (they basically spread
risk). The challenge of this model is the risk calculation and how likely it is that all the
people crash their cars, as they wouldn’t have the money (liquidity issue). As there
are some patterns (winter more accidents) they know when they need more
liquidity, but they have to be able to change investment into liquidity fast.

o Developers: typical to develop a value add strategy (making a “D” type of building
become an “A”in a “A” type of neightbourhood).

Which are the Global CRE investment flows happening nowadays?

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What can be read behind this image is that:
- The middle east is sending investments to other regions of the world, but they are not
getting anything. Reasons for that are there are some regulations there to establish a
company, by which it is not allowed to establish them as a sore owner or to buy the whole of
shares, you need someone local (which limits the number of investors).
- USA is investing a lot in Europe
- Europe is the biggest destination of the investments.
- Some investors invest in Singapur or Hong kong because of language easiness (English as
former English colonies).

Inside Europe, the countries that are receiving more investments are United Kingdom, Germany,
and France. The first two increased in 2021 from 2021, while France decreased a little bit. They are
followed by northern countries, Netherlands and Spain. Moreover, historically UK has always been
the main place to invest.

Related to the yields accepted (rendimientos), it can be seen that in the past years markets have
become quite competitive, and investors even accept yields that are similar to those offered by the
state bonds. Therefore, there has been a decrease in the yields offered.

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 TOPIC 3: COMMERCIAL LEASE AGREEMENTS

What are we going to cover?

- Type of commercial lease agreements
- Main commercial and legal terms

Type of commercial lease agreements

There are various types of leases that can be done.

According to the activity that will be carried out, it can be office, retail (shop, shopping center),
logistics or an hotel.
According to the degree of readiness of the building before the contract, it can be:
- Regular lease: there is an already existing building, and they just look for the tentant
- Built-to-suit (BTS) lease: a type of commercial real estate agreement between a developer
and a landlord to contract and later lease a commercial building that meets specific and/or
unique tenant needs.
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Finally, related to the taxes that tenant pay, we can classify:
- Single net: the tenant is required to pay only the property taxes
- Double net: the tenant is required to pay plus the property taxes the insurance premiums.
- Triple net (NNN): the tenant pays all the expenses of the property: property taxes, insurance
premium and the maintenance.

The main parties are the lessor (or the landlord) and the lessee (or the tenant).
In the case of consultas, advisers, etc. they are typically involved:
- Leasing agents, brokers
- Lawyers
- Technical staff (designers, contractors, project managers).

Main commercial and legal terms

Related to the rents that have to be paid because of this agreement, we can mention the following
things:
- The rent can consist of the base rent, a turnover rent (a percentage rent) or a rent that is
composed by the two of them.
- There are some rent incentives :
o Nominal rent (“headline rent”) / effective rent
o Rent-free periods
o Fit-out contribution as rent incentive
- In order to carry out rent adjustments or indexation, we can consider the HICP or MUICP, as
well as some negative index or capped adjustment.

Apart from the rent, there are also some fees that has to be dealt with, in concrete:
- The service charge can involve different things:
o Triple net (NNN) concept /items to be excluded
o Service charge advance payment -to be determined each year
o Annual reconciliation, SC audit – actual service charge to pay

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 - The management fee is normally included in the service charge
- The marketing fee is typical for certain retail leases (shopping centers).
- The metered consumption (public utilities of the leased premises)

We are also going to mention the security for non-payment or damages that there are. The tenant
security consists of back guarantee, parent company guarantee and the cash deposit. The insurance
is also a form of security.

The tenant has come unilateral rights that can enforce, such as:
- The expansion right -> partial hand bank right a.k.a. contraction right
- The right of first refusal (ROFR)
- The extension and break option
- The non-compete right.

When it comes to repair and maintenance, alterations, etc.

How does a commercial lease agreement work in practice?

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The takeaways from this chapter are:
- Various types of leases
- Consultants, advicers involved
- Rent (base, turnover, minimum, indexation)
- Service charge (triple net model=
- Tenant security
- Termination rights

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