Question

An owner of a Downtown Covina office building (“Lessor”) is currently negotiating a six-year lease with Chernobai Corporation (“Lessee”) for 20,000 rentable square feet of space. Chernobai Corporation’s offer: Chernobai Corporation would like a base rent of $24 per square foot per year with step-ups of $2 per square foot per year beginning the second year. Downtown Covina Office Building owner would provide full service under the lease terms. Downtown Covina office building’s owner’s counter-offer: The owner of Downtown Covina Office Building believes that the $24 lease is too low and is trying to offer a counter-offer which includes a base rent of $30 per square foot per year with the same step-ups. Under this counter-offer the Downtown Covina Office Building owner would also provide Chernobai Corporation with immediate $50,000 move-in allowance and immediate $100,000 in tenant improvements (TIs) if the lease at $30 per square foot is signed.

a. Assuming that Downtown Covina Office Building owner believes that his required rate of return on investment should be 12 percent per year, is the counter-offer a better proposal for the building owner? What about for Chernobai Corporation? Show and explain all calculations.

b. Chernobai Corporation’s counter-counter-offer: Chernobai Corporation informs Downtown Covina Office Building owner that it has 1 year remaining on its existing 20,000-square-foot lease in an older building at $18 per square foot per year. Chernobai Corporation is therefore proposing a counter-counter-offer: it is willing to pay Downtown Covina Office Building owner $29 per square foot per year with the step-ups (same as above) on the new lease, but is demanding that the Downtown Covina Office Building owner “buy out” the old lease in lieu of the moving allowance and TIs. Should Downtown Covina Office Building owner agree to this lease buyout counter-counter-offer, or insist on the lease at $30 per square foot per year with the step-ups, move-in allowance and TIs? In other words, which one of the two is better for the building owner? Show and explain all calculations.  

Answer 1

		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate=Required rate of return=12%=0.12
		N=Year of Cash Flow
		Cash Flow of Lessor on Chernobai Corporation’s offer:
		Rent of year 1=20000*24=	$        480,000
		Rent of year 2=20000*(24+2)	$        520,000
		Rent of Year (N+1)=2*20000+Rent of year (N)
		Assuming , the Rentalpaid at the beginning of year
	N	Year	0	1	2	3	4	5
	R	Rent	$        480,000	$ 520,000	$ 560,000	$    600,000	$ 640,000	$ 680,000	SUM of PVs
	PV=R/(1.12^N)	Present Value (PV) of Cash Flow:	$        480,000	428571.43	414540.82	398596.939	381310.85	363153.19	$      2,466,173
		Net Present Value	$    2,466,173
		Cash Flow of Lessor on Counter offer:
		Rent of year 1=20000*30=	$        600,000
		Rent of Year (N+1)=2*20000+Rent of year (N)
	N	Year	0	1	2	3	4	5	6
	A	Move in allowance and tenant improvement	($150,000)
	R	Rent	$        600,000	$ 640,000	$ 680,000	$    720,000	$ 760,000	$ 800,000
	CF	Net Cash Flow	$        450,000	$ 640,000	$ 680,000	$    720,000	$ 760,000	$ 800,000	SUM of PVs
	PV=R/(1.12^N)	Present Value (PV) of Cash Flow:	$        450,000	535714.29	510204.08	484010.569	457573.02	431244.41	$      2,868,746
		Net Present Value	$    2,868,746
	a	Yes,Counter offer is a better proposal for the building owner
		The Net present Value of Cash flow is higher for counter proposal
		Cash Flow of Lessor on Counter Counter offer:
		Rent of year 1=20000*29=	$        580,000
		Rent of Year (N+1)=2*20000+Rent of year (N)
	N	Year	0	1	2	3	4	5	6
	A	Cash flowfor buying out old lease	($360,000)
	R	Rent	$        580,000	$ 620,000	$ 660,000	$    700,000	$ 740,000	$ 780,000
	CF	Net Cash Flow	$        220,000	$ 620,000	$ 660,000	$    700,000	$ 740,000	$ 780,000	SUM of PVs
	PV=R/(1.12^N)	Present Value (PV) of Cash Flow:	$        220,000	517857.14	494260.2	469774.964	444862.65	419895.87	$      2,566,651
		Net Present Value	$    2,566,651
		The Counter Counter Offer should not be accepted
		Counter offer with move in allowance and tenant improvement