Problem 2

A property owner is evaluating the following alternatives for leasing space and his office building for the next five years:

Net lease with steps. Rent will be $15 per square foot for the first year and will increase by $1.50 per square foot each year until the end of the lease. All operating expenses will be paid by the tenant.

Net lease with CPI adjustments. The rent will be $16 per square foot for the first year. After the first year, the rent will increase by the amount of increase in the CPI. The CPI is expected to increase 3% per year.

Gross lease. Rent will be $30 per square foot each year with the lesser responsible for payment of all operating expenses. Expenses are estimated to be $9 psf during the first-year increase by $1 per year thereafter.

Gross lease with expense stop and CPI adjustment. Rent will be $22 the first year and increase by the full amount of any change in the CPI after the first year with an expense stop at $9 per square foot. The CPI and operating expenses are assumed to change by the same amount as outlined above. (CPI at 3% and expenses at $1psf per year)

1. Calculate the effective rent to the owner (after expenses) for each lease alternative using a 10# discount rate.

2. How would you rant the alternatives in terms of risk to the property owner?

3. Considering your answers to a) and b), how would you compare the four alternatives?