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Terms of a commercial office lease

How shall we respond to a request to modify proposed terms of a commercial office lease?

What factors should be a part of our consideration and how confident are we in the estimates we make?

Problem:

We have a schedule of asking rents and terms for spaces in our commercial office building all predicated on earning a 10% annual return on investment. A prospective tenant would like to rent space in our building, but she does not wish to be limited to the five-year term at \$18 per square foot per year that we have proposed. In particular, she does not wish to move or renegotiate at the end of five years, but would rather extend the term to ten years for a rent of \$20 per square foot per year with a resetting of the operating expense base year in year 6 of the lease to the actual pro rata share of operating expenses incurred in year 5.

You are willing to consider this extension but must first analyze the situation to determine what rent to charge and what other conditions might be added to the lease to produce a net present value to you for the ten years similar, if not identical, to the net present value to you for the five years at \$18 per square foot plus a subsequent lease for the same space for an additional five years.

Your best estimate of the annual rate of increase of market rents is 3% but you have yet to estimate other possible variables related to tenant rollover. These estimates will be part of your analysis.

Your assignment is to examine this problem. Identify the variables that should be considered when “pricing” the lease for a 10-year term rather than for a 5-year term. Quantify, to the extent possible, each variable in your pricing model or express as likely ranges reasonable quantities for each variable. Develop a spreadsheet model that would equate the monthly or annual rent for the 10-year term that would equate to your expected rental value to be achieved from the 5-year lease plus an additional 5-year lease to the same or to a new tenant.

Present your analysis in the form of a spreadsheet that includes the variables you deem important, the expected values for these variables, and the way in which the variables fit together to “price” the 10-year lease embedded in equations in the appropriate cells of your model.

Lastly, be sure an say whether or not you would be willing to accept the counteroffer made by the prospective tenant and what gross rental rate would equate the 10-year lease with the two 5-year leases according to your best estimates of the variables involved.

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