Question

A building owner is evaluating the following alternatives for leasing space in an office building for the next five years (using a 5% discount rate):

I.Net lease with steps. Rent will be $10/ square foot the first year and will increase by $1.50 per square foot each year until the end of the lease.

II. Net lease with CPI adjustments. The rent will be $12 /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 4% per year.

III. Gross lease. Rent will be $28/square foot each year with the lessor responsible for payment of all operating expense. Expenses are estimated to be $10 during the first year and increase by $1 per year thereafter.

IV. Gross lease with expense stop and CPI adjustment. Rent will be $20 the first year and increase by the full amount of any change in the CPI after the first year with an expense stop at $10/square foot. The CPI and operating expenses are assumed to change by the same amount as outlined in II and III.

Which of the following is True?

Group of answer choices

a) For option I, the property owner has no unexpected change in operating expense risk.
b) For option I, the property owner has no inflation risk.
c) For option III, the property owner has no unexpected change in operating expense risk.
d) For option III, the property owner has no inflation risk.

Answer 1

Option a) is true because the operating expenses are not beard by the lessor and hence no unexpected changes can affect him. Any unexpected is been beared by Tennant.

Option b&d are false because there is a inflation risk. They have not factored in.

Option c). Yet they have decided that operating expenses cost but as operating expenses are bared by lessor, the unexpected cost is also been beared by him.

Advice:-

If you have this question where we have limited time to work on, kindly look at the options first. You can observe they have just asked us to look for 2 situation, in this case I, III only. But in question they have given us the 4 situation. So to optimize the time, we can just look at required scenario only.