Question

An owner of the Atrium Tower Office Building is currently negotiating a five-year lease with ACME Consolidated Corp. for 20,000 rentable square feet of office space. ACME would like a base rent of $20 per square foot with step-ups of $1 per year beginning one year from now.

a) What is the present value of cash flows to ATRIUM under the above lease terms? (Assume a 10% discount rate)

b) The owner of ATRIUM believes that base rent of $20 PSF in (a) is too low and wants to raise that amount to $24 with the same $1 step ups. However, now ATRIUM would provide ACME a $50,000 moving allowance and $100,000 in tenant improvements (TIs). What would be the present value of this alternative to ATRIUM?

c) ACME informs ATRIUM that it is willing to consider a $23 PSF with the $1 annual step-ups. However, under this proposal, ACME would require ATRIUM to buyout the one year remaining on its existing lease in another building. That lease is $15 PSF for 20,000 SF per year. If ATRIUM buys out ACME's old lease, ACME will not require a moving allowance or TIs. What would be the present value of this proposal to ATRIUM? How does it compare with the alternative in (b)?

Answer 1

a) The annual lease payment will be made at the beginning of each year

Year	Area in sq foot	Rent per sq foot	Total Rent = Area * Rent per sq foot	Discount factor	Present value = Total rent * discount factor
0	20000	$                     20	$ 400,000	1/(1+10%)^0 =1	400000*1 = $    400,000
1	20000	$                     21	$ 420,000	1/(1+10%)^1 = 0.909091	420,000*0.9091 = $381,818
2	20000	$                     22	$ 440,000	0.826446	$    363,636
3	20000	$                     23	$ 460,000	0.751315	$    345,605
4	20000	$                     24	$ 480,000	0.683013	$    327,846
Sum of all present values				$ 1,818,906

(b)

Year	Area in sq foot	Rent per sq foot	Rent	Discount factor	Present value
0	20000	$                     24	$ 480,000	1	$    480,000
1	20000	$                     25	$ 500,000	0.909091	$    454,545
2	20000	$                     26	$ 520,000	0.826446	$    429,752
3	20000	$                     27	$ 540,000	0.751315	$    405,710
4	20000	$                     28	$ 560,000	0.683013	$    382,488
Sum of all present values				$ 2,152,495
Present value of benefits				$    150,000
Present valuet of this alternative			2152495-150000 = $ 2,002,495

(c)

Year	Area in sq foot	Rent per sq foot	Rent	Discount factor	Present value
0	20000	$                     23	$ 460,000	1	$    460,000
1	20000	$                     24	$ 480,000	0.909091	$    436,364
2	20000	$                     25	$ 500,000	0.826446	$    413,223
3	20000	$                     26	$ 520,000	0.751315	$    390,684
4	20000	$                     27	$ 540,000	0.683013	$    368,827
Sum of all present values				$ 2,069,098
Cost of 1 year remaining lease			$    300,000
Present valuet of this alternative			2069098+300000 = $ 2,369,098

Option c is more costly as compared to option b