Question

1. A tenant would like to lease 4,000 square feet of space over the next ten years, and is evaluating the following alternatives:
   173533634. 1: Gross lease with base rent of $16 psf each year.   
   173533634. 2: Gross lease with base rent of $15 psf with rent rising by $0.50 psf every other year; the first year of adjustment is year 3.
   173533634. 3: Absolutely net lease with base rent of $12 psf, increasing to $14 psf starting in year 6.        
   3045494042897. expenses for the space are expected to be $2.50 psf in the first year; these expenses are expected to increase at the same rate as overall inflation, which is expected to be 3 percent per year.    
                  1. Calculate the tenant’s effective rent (after expenses) for each lease alternative using a 12 percent discount rate.
                  2. How would you rank the alternatives in terms of risk to the tenant?
                  3. Considering your answers to parts (a) and (b), which option would you choose if you were the tenant? Explain your reasoning briefly.

Answer 1

		1: Gross lease with base rent of $16 psf each year
		Annual cost to the tenant	$64,000	(4000*16)
		2: Gross lease with base rent of $15 psf with rent rising by $0.50 psf every other year; the first year of adjustment is year 3.
		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate=12%=0.12
		N=Year of Cash Flow
		cost for tenant in the first year	$60,000	(15*4000)
		cost in the third year	$62,000	(15+0.5)*4000
		cost in the year 5	$64,000	(15.5+0.5)*4000
		cost in the year 7	$66,000	(16+0.5)*4000
		cost in the year 9	$68,000	(16.5+0.5)*4000
	N	Year	1	2	3	4	5	6	7	8	9	10
	A	Annual cost to the tenant	$60,000	$60,000	$62,000	$62,000	$64,000	$64,000	$66,000	$66,000	$68,000	$68,000	SUM
	B=A/(1.12^N)	Present Value of annual cost	$53,571	$47,832	$44,130	$39,402	$36,315	$32,424	$29,855	$26,656	$24,521	$21,894	$356,602
		Present Value of total cost	$356,602
		Equvalant Annual Cost to the tenant	$63,113	(Using PMT function of excelwithRate=12%, Nper=10, PV=-356602)
		Absolutely net lease with base rent of $12 psf, increasing to $14 psf starting in year 6.
		Annual Lease in year 1to5	$48,000	(12*4000)
		Annual Lease in year 6to10	$56,000	(14*4000)
		Annualexpense in year 1	$10,000	(2.5*4000)
		Annualexpense in year 2	$10,300	(10000*1.03)
		Annualexpense year (N+1)=1.03*Annual expense year (N)
	N	Year	1	2	3	4	5	6	7	8	9	10
	A	Annual Lease to the tenant	$48,000	$48,000	$48,000	$48,000	$48,000	$56,000	$56,000	$56,000	$56,000	$56,000
	B	Annual expenses for tenant	$10,000	$10,300	$10,609	$10,927	$11,255	$11,593	$11,941	$12,299	$12,668	$13,048
	C=A+B	Annual Cost to the tenant	$58,000	$58,300	$58,609	$58,927	$59,255	$67,593	$67,941	$68,299	$68,668	$69,048	SUM
	D=C/(1.12^N)	Present Value of annual cost	$51,786	$46,476	$41,717	$37,449	$33,623	$34,245	$30,733	$27,585	$24,762	$22,232	$350,607
		Present Value of total cost	$350,607
		Equvalant Annual Cost to the tenant	$62,052	(Using PMT function of exce lwith Rate=12%, Nper=10, PV=-350607)
		Tenant's Effective Rent for alternative 1	$64,000
		Tenant's Effective Rent for alternative 2	$63,113
		Tenant's Effective Rent for alternative 3	$62,052
		Alternative 1 has least Risk
		Alternative 2 has Risk higher than 1
		Alternative 3 has highest Risk
		Risk due to change in inflation rate
		Better to Choose Alternative 1
		Considering risk and low difference in    effective cost