Question

A building owner is evaluating the following alternatives for leasing space in an office building for the next five years: Net lease with steps. Rent will be $15 per square foot 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 the first year. After the first year, the rent will be increased by the amount of any increase in the CPI. The CPI is expected to increase 3 percent per year. Gross lease. Rent will be $30 per square foot each year with the lessor responsible for payment of all operating expenses. Expenses are estimated to be $9 during the first year and 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.

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

b. How would you rank the alternatives in terms of risk to the property owner?

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

Answer 1

Soln : Alternative 1 : Net lease with steps

Year	0	1	2	3	4	5
Rent		15	16.5	18	19.5	21
Operating expense		0	0	0	0	0
Discount rate =1/1.1^t		0.909	0.826	0.751	0.683	0.621
PV		13.64	13.64	13.52	13.32	13.04
NPV	67.15

Alternative 2: Net Lease with CPI Adjustments

Year	0	1	2	3	4	5
Rent		16	16.48	16.9744	17.48363	18.00814
Operating expense		0	0	0	0	0
Discount rate =1/1.1^t		0.909	0.826	0.751	0.683	0.621
PV		14.55	13.62	12.75	11.94	11.18
NPV	64.04

Alternative 3: Gross Lease

Year	0	1	2	3	4	5
Rent		30	30	30	30	30
Operating expense		9	10	11	12	13
Net		21	20	19	18	17
Discount rate =1/1.1^t		0.909	0.826	0.751	0.683	0.621
PV		19.09	16.53	14.27	12.29	10.56
NPV	72.74

Alternative 4: Gross Lease with CPI and expense stop

Year	0	1	2	3	4	5
Rent		22	22.66	23.34	24.04	24.76
Operating expense		9	9	9	9	9
Net		13	13.66	14.3398	15.03999	15.76119
Discount rate =1/1.1^t		0.909	0.826	0.751	0.683	0.621
PV		11.82	11.29	10.77	10.27	9.79
NPV	53.94

(b) Based on the risk Alternative 3 is most risky as income is sa,e but cost is increasing yearly.

Alternative 3 is riskier than 1 &2 but low risk compare to 4. As Revenue is increasing at CPI but expense is also paid by owner.

Alternative 2 is more risky than 1 but at low risk than 3 & 4 , as revenue is dependent upon the CPI index. So, if it is negative income will decrease.

Alternative 1 is least risky, as revenue is increasing at fixed rate and no cost . So no risk.

c) When we will compare the alternative, we will see the maxmum revenue having low risk compare to others.

Like here best alternative is Alternative 3 , with less risky but highest NPV value.