A building owner is evaluating the following alternatives for leasing space in an office building for the next five years. Expenses are estimated to be $9 psf for the first year and forecast to increase at $1 psf per year thereafter. Net lease with steps. Rent is $15 psf for the first year and will increase $1.50 per square foot for each year until the end of the lease. All operating expenses are paid (reimbursed) by the tenant. Net lease with CPI adjustments. Rent is $16 psf for the first year. After year 1, the rent will be increased by any increase in the CPI which is expected to be 3% per year. Again, all the expenses are reimbursed by the tenant. Gross lease. Rent will be $28 psf each year with the lessor responsible for paying all of the operating expenses. Gross lease with an expense stop and CPI adjustment. Rent will be $24 psf the first year and increase by the full amount of the CPI (3%) after the first year with an expense stop for the landlord at $9 psf. The CPI and operating expenses are assumed to change as suggested above. 1. Calculate the annuity rental equivalent (ARE) net of expenses for each lease using a 10% discount rate and determine which is the best deal for the landlord.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
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Chapter1: Investments: Background And Issues
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Lease Valuation
A building owner is evaluating the following alternatives for leasing space in an office building for
the next five years. Expenses are estimated to be $9 psf for the first year and forecast to increase at
$1 psf per year thereafter.
Net lease with steps. Rent is $15 psf for the first year and will increase $1.50 per square foot for
each year until the end of the lease. All operating expenses are paid (reimbursed) by the tenant.
Net lease with CPI adjustments. Rent is $16 psf for the first year. After year 1, the rent will be
increased by any increase in the CPI which is expected to be 3% per year. Again, all the expenses are
reimbursed by the tenant.
Gross lease. Rent will be $28 psf each year with the lessor responsible for paying all of the operating
expenses.
Gross lease with an expense stop and CPI adjustment. Rent will be $24 psf the first year and increase
by the full amount of the CPI (3%) after the first year with an expense stop for the landlord at $9 psf.
The CPI and operating expenses are assumed to change as suggested above.

1. Calculate the annuity rental equivalent (ARE) net of expenses for each lease using a 10%
discount rate and determine which is the best deal for the landlord.

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