Office Building Cash Flow
An office building has three floors of rentable space with a single tenant on each floor. The first floor Tenant A has 20,000 square feet of rentable space and is currently renting for $15 per square foot. Three years remain on the lease. The lease has an expense stop at $4 per square foot. The tenant will renew its lease at the conclusion of the initial term at the market rate with a new expense stop. The second floor has 15,000 square feet of rentable space and is leasing for $15.50 per square foot and has four years remaining on the lease. This lease has an expense stop at $4.50 per square foot. The tenant will renew its lease at the conclusion of the initial term at the market rate with a new expense stop. The third floor has 15,000 square feet of leasable space and a lease just signed for the next six years at a rental rate of $17 per square foot, which is the current market rate. The expense stop is $5 per square foot, which is what expenses per square foot are estimated to be during the year one (excluding management). Each lease also has a CPI adjustment that provides for the base rent to increase at half the increase (50%) in the CPI. The CPI is projected to be 3 percent per year. The market rental rate at which leases are expected to be renewed is also projected to increase 3 percent per year.
Assume that when the initial lease expires, the tenant will immediately release the space at the prevailing market rate. Assume renewed leases are for five years. When a lease is renewed the base expense stop is revised to the current expenses for that year. Also, note that the CPI will adjust so that there will be $-0- of CPI rent during the first year of the renewed lease term.
Management expenses are expected to be 5 percent of effective gross income and are not included in the expense stop. Estimated operating expenses, $5.00psf, for year 1 are included in the template.
All expenses are projected to increase 3 percent per year. When a lease is renewed, it will have an expense stop equal to operating expenses per square foot during the first year of the renewed lease term. To account for any time that may be necessary to find new tenants after the first leases expire, vacancy is estimated to be 10 percent of EGI for the last two years (years 4,5 and 6).
You have been offered to buy the building at a price of $5,000,000. You are also seeking financing to acquire the property. Assuming the price is the value, you can obtain financing up to 65% of the price at a rate of 8.5%, 30-year, monthly pay, fully amortizing with a ten year term. You anticipate selling the property on the last day of year 5 based on year 6’s NOI capped at 11%. However, you will have to pay a prepayment premium of 5% of the
outstanding balance at that time. There will also be selling expenses equal to 3% of the selling price.
- Prepare a 6-year cash flow statement
- What is the IRR without leverage?
- What is the IRR with leverage?
- Assuming you wish a return of 14%, what is the price that you would pay for the building? Use the goal seek function