Consider a 100,000 square foot office building with one tenant and an additional lease in hand. The current tenant leases 50,000 square feet at market rent, which is $12/ft./yr. fixed, and the lease has a remaining term of 4 years. The lease in hand is a binding commitment to lease 35,000 square feet at $14/ft./yr. fixed for 5 years with the lease starting in exactly 2 years (first rent payment at the end of year 3). Average (market) rent is currently 13/ft./yr., and historically has increased at 2% per year.

A) Ignoring operating and capital costs and assuming that rent is paid at the end of the year, use DCF over a 5 year investment window to find the value of the property. Assume that the property currently under lease is re-let at the same rent at the end of the current lease, the discount rate is 9% and the expected cap rate for the property at the end of 5 years is the current stabilized cap rate of 7%. Using the price you derive from DCF, what is the propertys current cap rate? Why isnt it the current market cap rate of 7%?

B) Now suppose that the leases in part a) are triple nets under which operating costs (CAM, insurance, and property taxes) are reimbursed by the tenant on a pro rata basis. (Each tenants share of the expenses is the % of the total leasable space that it leases.) CAM, real estate taxes, and insurance are estimated to be $1.50/ft./yr., $2.50/ft./yr., and $.15/ft./yr., respectively. As the owner you pay all capital costs, which are estimated as a reserve of $.25/ft./yr. You also pay $5/ft. in tenant improvement at the start of the second lease (end of year 2), $2/ft. in TI when the first lease rolls over, and you pay lease commissions of 6% of all base rent revenue over the life of the second lease at the end of year 2. Find the value of the property using DCF. Discount at 9% as above. (Best to do this in a spreadsheet.)