Assignment task: 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 $2.20 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 $17 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 $31 per square foot each year with the lessor responsible for payment of all operating expenses. Expenses are estimated to be $8 during the first year and increase by $1 per year thereafter.
Gross lease with expense stop and CPI adjustment. Rent will be $29 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.
Required:
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?