Question

A building owner is evaluating the following option for leasing space in an office building for the next five years (using a 5% discount rate): 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 is expected to increase 4% per year. Expenses are estimated to be $10 /square foot during the first year and increase by $1 per year thereafter. What is the effective rent to the owner (after expenses)?

Answer 1

Solution:

First year rent per square foot = $20

Operating cost = $10

Operating cost increase per year = $1

Year	1	2	3	4	5
Rent	20	20	20	20	20
Less: Operating cost	10	11	12	13	14
Net Cash flow/rent	10	9	8	7	6

Present value of rent = 10/1.05 + 9/1.05^2 + 8/1.05^3 + 7/1.05^4 + 6/1.05^5

Present value of rent = $35.06

The effective rent, R is calculated as follows

Present value of rent = R (PVIFA @ i, n)

$35.06 = R (PVIFA @ 5%, 5)

$35.06 = R [(1.05^5 - 1)/ (0.05*1.05^5)]

$35.06 = R (4.3295)

R = $8.10

Hence, the effective rent to the owner (after expenses) is $8.10.