Alternatives for Leasing Space in Office Building
What are the different alternatives for leasing space in the office building?
A property owner is evaluating the following alternatives for leasing space in his 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 $1.90 per square foot each year until the end of the lease. All operating expenses will be paid by the tenant. Calculate the effective rent to the owner (after expenses) for the lease using a 10 percent discount rate.
Effective Rent Calculation for Leasing Space
The effective rent to the owner, after expenses, for the lease is $16.25 per square foot.
To calculate the effective rent, we need to take into account the annual increase in rent and the discount rate. The net lease with steps starts at $15 per square foot in the first year and increases by $1.90 per square foot each year. We will calculate the present value of these cash flows over the five-year lease period using a 10 percent discount rate.
In the first year, the rent is $15 per square foot, which will be discounted by 10 percent. The present value of this cash flow is $15 / (1 + 0.10) = $13.64 per square foot.
In the second year, the rent increases to $15 + $1.90 = $16.90 per square foot. Again, we discount this amount by 10 percent to get the present value. The present value of the second-year cash flow is $16.90 / (1 + 0.10)^2 = $13.33 per square foot.
We repeat this process for each subsequent year, calculating the present value of the increasing rents. The present values for the third, fourth, and fifth years are $12.94, $12.58, and $12.26 per square foot, respectively.
Finally, we sum up the present values of all the cash flows over the five-year lease period and divide it by the total number of square feet. The effective rent to the owner, after expenses, is the average of these present values, which is ($13.64 + $13.33 + $12.94 + $12.58 + $12.26) / 5 = $16.25 per square foot.