Problem 9-1

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 49 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.

Data Input Box:

Interest Ra 10% Step Amount 1 per year
Net Lease 15 Percent CPI Adj. 0.03
Net with C 16 Net rent increase 1.5 per year
Gross Leas 30 Expenses 9
Gross with 22 Expense Growth 1 per year
Expense Stop 9

NET LEASE with STEPS:

Year 1 2 3 4 5
Net Rent 15.00 16.50 18.00 19.50 21.00
Average Rent 18.00
Present Value $67.15
Effective Rent $17.72

NET LEASE with CPI ADJUSTMENT:

Year 1 2 3 4 5
Expected CPI 3.00% 3.00% 3.00% 3.00%
Net Rent 16.00 16.48 16.97 17.48 18.01
Average Rent 16.99
Present Value $64.04
Effective Rent $16.89
 GROSS LEASE:
Year 1 2 3 4 5
Gross Rent 30.00 30.00 30.00 30.00 30.00
Less Expen 9.00 10.00 11.00 12.00 13.00
Net Rent 21.00 20.00 19.00 18.00 17.00
Average Rent 19.00
Present Value $72.74
Effective Rent $19.19

GROSS LEASE with EXPENSE STOP and CPI ADJUSTMENT:

Year 1 2 3 4 5
Expected CPI 3.00% 3.00% 3.00% 3.00%
Gross Rent 22.00 22.66 23.34 24.04 24.76
Less Expen 9.00 10.00 11.00 12.00 13.00
Plus Reim - 1.00 2.00 3.00 4.00
Net Rent 13.00 13.66 14.34 15.04 15.76
Average Rent $ 14.36
Present Value $53.94
Effective Rent $14.23

b. How would you rank the alternatives in terms of risk to the pr

As the property owner the ranking of the property should be the

following: Gross Lease with Expense Stop and CPI Adjustments, Net
Lease with CPI Adjustments, Net Lease with Steps and Gross Lease. That
is: 4<2<1<3.

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

As a rentee I would choose Gross lease with expense stop and CPI
adjustment, but on the other hand if I am the owner then I would choose
gross lease because I would be earning more. With net lease with steps
and net lease with CPI adjustment, these are just average options for
both owner and renters. The effective rents ranking should be rank the
same way on b answer 4<2<1<3