In residential properties the sources of funds take place simultaneously with the utilization of funds as residential properties are generally sold while in commercial properties the risk is much more as:

1. The commercial properties are generally leased.

2. The tenants cannot be ascertained at the beginning of construction.

3. The returns on the property come over the period of lease which may vary from 3 to 20 years.

Thus the risks being high, the developer needs to take care while entering into leasing agreements. Some of the important aspects that a developer needs to keep in mind as listed below.

Leasing Characteristics: ( Revenue for a Developer )

A typical commercial premise being a leased one, the owner will set out his terms and conditions of ,lease which will include details like signage requirement, hours of operation, product lines offered / business carried on etc, apart from the crucial element Rent, which depends on the supply and demand and not the cost of development alone. If the rent is lower than the cost of developing and running the property, the property will not be built .If it is already built and the rent doe not cover the cost, then the business will eventually close down.

Terms of lease agreement are not fixed but negotiable. These will differ depending upon the types of tenants (office, retail) whether the tenant already has an established business, and if he is an Anchor tenant. Depending on the bargaining power of the landlord and the prevailing market conditions, he may enter into any of the following type lease.

1. Gross lease: the landlord pays all expenses except remodeling costs and non structural maintenance costs in the tenant area, i.e. insurance, taxes , utilities etc. whereas the tenant pays a fixed rent for the life of the lease

2. Net lease: Gross lease + Pro rata sharing of property taxes.

3. Double net lease: Net Lease + Pro rata sharing of insurance costs.

4. Triple net lease: Double Net lease + sharing of building maintenance expenses based on super built up are occupied.

5. Triple net lease with Percentage: Triple Net lease + a rent that includes a percentage of gross sales (over and above the minimum rent)

6. Triple Net lease with Ups: triple net lease, where the underlying / the minimum rent is indexed to some bench mark.

Thus it is obvious that the gross lease is the worst bargain for a landlord and he gets a better deal with each passing lease in the list.

Finance for the developer:
Current real estate and retail boom in India has made it easier for real estate developers to raise finance from financial institutions. However the developer has to market to ensure that major retailers are aware of the projects and be able to attract atleast one or two anchor clients. The future of the project depends upon these clients as FII’s finance readily because of them as their risks are reduced.

The landlord or the developer has to accept a charge on their property being constructed

Institutional finance:
Financial institutions have developed new products in tandem with the market conditions which are:

1. Rupee term loan / project finance

Here the financial institution gets the first charge of the premises being constructed and the landlord gives collateral, guarantees. Before disbursal of the loan, the builder is required to obtain all the necessary statutory approvals and the Loan to be secured by mortgage of the property of the proposed project which should have a clean title and should be easily marketable. All the receivables of the company will have the exclusive charge of the lender. Additional collateral in the form of additional property with its development right assigned in the favour of lender and the personal guarantee of the promoters may be obtained by the lender. Usually an undertaking for minimum price as incorporated in the cash flows is provided by the builder. Loan repayment depends on the sale of property. the developer may be given the possession of the land o the basis of the guarantee of the Financial Institution or on purchase of land, after disbursal, depending on the agreement between the land owner and the developer.

2. Line of credit is like Cash credit in which the lending institution specifies for a particular amount upto which the borrower can withdraw at any point of time and deposit back whenever he has funds. It is like working capital.

3. Lease discount rentals

In this new product, the loan amount sanctioned does not depend on the borrowers repaying capacity but on the future rent/ income that the property will earn. The future cash flows (Future rent receivables) are discounted at the current interest rates to arrive at the loan amount. The financer will go through the rent agreement between the lesser and the lessee to understand any escalation / cash flows. He will also enter into an agreement with the lessee to pay the rent directly to him thereby safeguarding his loan. Though the maximum term is flexible, the finance is generally restricted to 7-8 years. The net rent received (i.e. gross rent - tax) is considered for calculating the loan amount.

This loan is availed not for acquisition or for construction, as most of the space is allotted only after the construction is completed. So the general practice is to avail loan on the pre leasing agreement, begin construction, and in the last phase, when most of the space is let, obtain LDR and pay back the original loan.