Consider a 100,000 square foot retail outlet leased to a single tenant (say Walgreens). Assume that Walgreens entered into a 5 year triple net lease for all 100,000 sq. ft. of space 2 years ago, so the remaining lease term is 3 years. In year one of the remaining term Walgreens pays $8/ft, base rent which jumps to $8.50 for the other 2 years. Assume there is no other source of revenue (no percentage rents or ancillary income) other than expense reimbursements. Use simple market estimates of current (year 1) costs, expressed per sq. ft.: (Common Area Maintenance Charges) CAM = $2.50/ft./yr., property taxes = $1.50/ft./yr., insurance = $.15/ft./yr. Further suppose that non-reimbursable capital expenditures are $.15/ft./yr. Assume that all of these costs inflate at 3%/yr. over the remainder of the forecasting period.

a) Construct a 5 year cash flow pro forma assuming that there is a 100% chance of retaining Walgreens, that the rent under the new lease will be the prevailing market rent at that time, and that Walgreens gets $2/ft. in tenant improvement allowance at the beginning of the new lease. Assume that the current market rent (year 1 in your forecast) is $8/ft./yr. and inflate that at the prevailing inflation rate (3%/yr.) to get the end of lease market rent. You can assume that the new lease will have a 5 yr. term and that rent is fixed over the term. Assume that the exit cap rate is 7%. Assume that there will be a 3% brokerage commission paid on the sale, so the net sale proceeds will be 97% of the sale price.

b) With the 5 year cash forecast in place, discount cash flow back to the present to find the estimated value of the property. Do this using a range of discount rates; 9%, 10%, 11%.

c) Reconstruct your cash flow pro forma assuming that there is a 75% chance of retaining Walgreens and a 25% chance of having to find a new tenant. In the new tenant scenario, assume that all 100,000 is leased, that $6 ft. is the tenant improvement cost (incurred at the end of the current lease) and that the space is vacant for 6 months (no rent during this period). For the second lease, use the same lease rate as in problem 1).

d) Find the value of the property for the range of discount rates in part b)