Question

Show excel work, please. I rate

An owner of the Atrium Tower Office Building is currently negotiating a five-year lease with ACME Consolidated Corp. for 20,000 rentable square feet of office space. ACME would like a base rent of $20 per square foot with step-ups of $1 per year beginning one year from now.

a. What is the present value of cash flows to ATRIUM under the above lease terms? (Assume a 10% discount rate.)

b. The owner of ATRIUM believes that base rent of $20 PSF in (a) is too low and wants to raise that amount to $24 with the same $1 step ups. However, now ATRIUM would provide ACME a $50,000 moving allowance and $100,000 in tenant improvements (TIs). What would be the present value of this alternative to ATRIUM?

c. ACME informs ATRIUM that it is willing to consider a $23 PSF with the $1 annual stepups. However, under this proposal, ACME would require ATRIUM to buyout the one year remaining on its existing lease in another building. That lease is $15 PSF for 20,000 SF per year. If ATRIUM buys out ACME’s old lease, ACME will not require a moving allowance or TIs. What would be the present value of this proposal to ATRIUM? How does it compare with the alternative in (b)?

Answer 1

We see that the step-up applies from one year from now. This means Atrium receives the next year's rent today. Hence the rent cash flow occurs at years 0,1,2,3 and 4

We calculate each year's rent rate by adjusting it to the necessary step up and compute cash outflow by multiplying the rent rate by the rentable area.
Then we discount each year's cash flows with the given discount rate to arrive at PV of a particular year's cash flow
Then we sum them all to arrive at PV of all the cash flows

Following table shows the calculation in Excel

Rentable are	20,000
Base rent PSF	$                  20
Step up	1
Discount rate	10%
Year	0	1	2	3	4
Rent rate	20	21	22	23	24
Rent	$       400,000	$   420,000	$   440,000	$   460,000	$   480,000
PV of rent	$       400,000	$   381,818	$   363,636	$   345,605	$   327,846
NPV	$   1,818,906

PV of this alternative is $1,818,906

b.

In this case, Atrium provides a moving allowance worth $50,000 and tenant improvements worth $100,000. This will be a cash outflow today and we change the above table in excel to accommodate these two cash flows as follows

Rentable are	20,000
Base rent PSF	$                  24
Step up	1
Discount rate	10%
Year	0	1	2	3	4
Rent rate	24	25	26	27	28
Rent	$       480,000	$   500,000	$   520,000	$   540,000	$   560,000
Moving allowance	$       (50,000)
Tenant improvement	$     (100,000)
Net cash flow	$       330,000	$   500,000	$   520,000	$   540,000	$   560,000
PV of rent	$       330,000	$   454,545	$   429,752	$   405,710	$   382,488
NPV	$   2,002,495

Hence PV of this alternative is $2,002,495

c.

In this option, we take out moving allowance and tenant improvements. Instead, Atrium buys out Acme's existing lease @$15 for 20,000 square feet.
Hence Atrium pays $15 x 20,000 = $300,000 today to buyout Acme's existing lease.

We make the changes in Excel to compute PV of cash flows from this option as follows

Rentable are	20,000
Base rent PSF	$                  23
Step up	1
Discount rate	10%
Year	0	1	2	3	4
Rent rate	23	24	25	26	27
Rent	$       460,000	$   480,000	$   500,000	$   520,000	$   540,000
Buyout lease	$     (300,000)
Net cash flow	$       160,000	$   480,000	$   500,000	$   520,000	$   540,000
PV of rent	$       160,000	$   436,364	$   413,223	$   390,684	$   368,827
NPV	$   1,769,098

Hence PV of this alternative is $1,769,098

As we compare this with alternative b, we realize alternative b is beneficial for Atrium as it has a higher PV of cash flows.