Previous question:

A 150,000-SF office building has a triple-net lease providing a constant rent of $20/SF per year. (With a triple-net lease, you can assume the rent equals the net operating cash flow.) The lease has five years before it expires (i.e., assume the next payment comes in one year, and there are four more annual payments after that under the present lease). Rents on similar leases being signed today are $22/SF. You expect rents on new leases to grow at 2.5% per year for existing buildings. You expect to release the building in year 6 after the current lease expires, but only after experiencing an expected vacancy of six months, and after spending $10/SF in tenant improvements (TIs). After 10 years, you expect to sell the building at a price equal to 10 times the then-prevailing rent in new triple-net leases. Based on survey information about typical going-in IRRs prevailing currently in the market for this type of property, you think the market would require a 12% expected return for this building.

a. What is the NPV of an investment in this property if the price is $30 million? Should you do the deal?

b. What will be the IRR at that price?

c. What is the cap rate at the $30 million price?

---

Consider the building described in the previous question. Suppose everything is the same except that, since the time the current lease was signed, the market for office space has softened. Rents on new leases are lower now and will be only $18/SF next year instead of the $20/SF that prevailed when the current lease was signed. Furthermore, suppose that the current lease has only one more year until it expires, instead of five. You expect to release in year 2, and again in year 7, with six months of vacancy and $10 in capital expenditures each time, as before. You still expect growth of 2.5% per year in new-lease rental rates, starting from the expected year-1 level of $18.

a. What is the value of the property under the required return assumption of Question 11.14?

b. What would be the NPV of the deal from the buyers perspective if the owner wants to sell the building at a cap rate of 10% based on the existing lease?

c. What would be the cap rate for this building at the zero-NPV price?

d. Why is the market value cap rate so different in this case than in the case presented in the previous question?