Consider a retail culinary space available for lease in a high foot$-$traffic area $($shopping centre$).$ A contract currently being negotiated that has not yet been signed is a $7-$year net lease, starting at $$520/$m$2$ in arrears, graduated at $7\%.$ Operating expenses are estimated to be $23\%$ of gross rent. The tenant applicate wishes to include a tenant improvement of refitting the space with better ventilation, which is expected to cost $$160/$m$2,$ to be completed as soon as the contract is signed and to be paid by the landlord. The landlords discount rate is $15\%.$

From the perspective of the Landlord, what is the effective rent of this agreement with tenant improvement? $(2$ marks$)$

$(2)$ From the perspective of the Tenant, what is the effective rent of this agreement with tenant improvement? The tenants discount rate is $23\%.(2$ marks$)$

$(3)$ In exchange for the tenant improvements, the landlord wishes to include an option to change rent structure from graduated at $7\%$ to indexed at inflation after year $2.$

Forecasts at the end of year $2$ show there is:

$30\%$ probability inflation will be at $5\mathrm{.}5\%$

$40\%$ probability inflation will be at $7\mathrm{.}5\%$

$30\%$ probability inflation will be at $9\mathrm{.}0\%$

From the perspective of the Landlord, what is the effective rent of this agreement with option? What is the price of the option? $(6$ marks$)$

$(4)$ Assuming the tenant values the option the same as the landlord, is the tenant better off agreeing to the customised lease, or removing both the improvements and option? $(2$ marks$)$

$(5)$ Define inter$-$lease risk and discuss whether they tend to extend or shorten tenant and landlord consideration of the lease term, if both are risk$-$averse.$(3$ marks$)$