A 1,000 square foot office space is leased at $15.00 per square foot during the first year with $2.00 step-up provisions each of the following years.The lease is gross with an expense stop set at $6.65 per square foot,and yearly expenses per square foot are as follows: $6.00,$6.65,and $7.05.The lease provides for two months of free rent at the end of the lease term.If the lease term is three years and the discount rate is 10%,what is the effective rent per square foot?

Question

Quizplus · Accepted Answer

To find the effective rent per square foot, we need to first calculate the total cost of the lease over the three-year term, including any free rent and expenses covered by the tenant. Then we will discount this total cost to present value using the given discount rate and divide by the total square footage leased.

First, let's find the total cost of the leased space over three years:

- Year 1: 1,000 sq ft x $15.00/sq ft = $15,000
- Year 2: 1,000 sq ft x ($15.00 + $2.00)/sq ft = $17,000
- Year 3: 1,000 sq ft x ($15.00 + 2*$2.00)/sq ft = $19,000

We also need to add in yearly expenses, up to the expense stop:

- Year 1: $6.00/sq ft x 1,000 sq ft = $6,000 (covered by tenant)
- Year 2: $6.65/sq ft x 1,000 sq ft = $6,650 (covered by tenant)
- Year 3: $7.05/sq ft x 1,000 sq ft = $7,050 (covered by tenant up to expense stop of $6.65/sq ft, so tenant pays $6.65/sq ft x 1,000 sq ft = $6,650 and landlord covers the rest, which is $7.05/sq ft - $6.65/sq ft = $0.40/sq ft, for a total of $400)

The total lease cost over three years is: 
$15,000 + $17,000 + $19,000 + $6,000 + $6,650 + $6,650 + $400 = $71,700

Two months of free rent for a three-year lease is equal to 2/36 of a year's rent, or about 5.6% of the total cost of the lease. We subtract this from the total lease cost to get the net present value (NPV):

NPV = -$71,700/(1+0.10)^0 + $71,700/(1+0.10)^1 + $71,700/(1+0.10)^2 - $71,700/(1+0.10)^3 + $71,700/(1+0.10)^3 x 0.056
NPV = -$57,021.29

Finally, we divide the NPV by the total square footage leased and add back in the yearly expenses covered by the tenant to get the effective rent per square foot:

Effective Rent = ($57,021.29/1,000) - ($6.00 + $6.65 + $6.65)/sq ft 
Effective Rent = $44.85/sq ft - $19.30/sq ft 
Effective Rent = $25.55/sq ft

Rounded to the nearest cent, the effective rent per square foot is $25.55, which is closest to answer choice B ($9.50).

A 1,000 Square Foot Office Space Is Leased at $15