rent escalation clause

[Christine Marie]

am working on a complex assignment, and the one of the subjects tenants has a rental agreement in place that is $1500 this year, $1600 next year, etc. all the way up to $1900 for the fifth year.

ignore the future, and base this as of the effective date on the $1500 is my gut... anyone care to rebut? or add to my narrowistic way of thinking in the box...

 

[Otis Key]

Commercial property? (I doubt it) The current rent is $1,500 but I'd sure comment on the escalation clause - most commercial leases have an increase statement that's tied to the CPI increases, from what I remember when I leased office space. If I'm wrong, someone will chime in - they always do.

 

[DB]

If this is a commercial property, this clause is quite common, particularly for start ups. When Opry Mills opened in Nashville, my job was to make sure that Gibson had a presence there. The lease agreement they signed was for an anchor position (one of the 4 corners) and a 10 year agreement started at one fee and escalated each year up to a cap. After talking with several other owners/managers, just about all of them signed the same agreement and one even told me that it was the Mills, Corp. way of doing things, particularly on start ups.

I agree with Otis ... do it as of the date of the appraisal and comment on the escalating agreement.

 

[Christine Marie]

Thanks Otis, will wait for the chimers..

it is a somewhat significant percieved value difference, in my opinion? just don't know what to do with it, for sure!

thanks Dougie... appreciate the input...

 

[Howard Klahr]

what type of property is this? How many tenants?

 

[Christine Marie]

typical row building in the historic district, has office tenants [below on street level] and apartment dweller's above on second floor... total of 4 tenants...

 

[ccooper]

IMHO what it is worth today is what the rents are today. First, there is no guarantee that those future rents will be paid. Tenant could move out and market rent may not support the higher rents. I wouldn't use any Yield Cap analysis on this one.

 

[Christine Marie]

thanks for the input, Coop

 

[Howard Klahr]

I don't want to over complicte the issue but here is the formula for calculating the present value of a cash flow (annuity) that changes at a straight line (Constant) amount. (i.e. $100 annual increase in rental rate). Another approach is to adjust your capitalization rate to reflect the future increasing income. However, since your subject represents mixed uses that produce revenue in different ways, discounting the contract rent is probably the simplest method.

Hope this helps

Straight Line Changes
To obtain the present value of an annuity that has a starting income of d at the end of the first period and increases h dollars per period for n periods:
PV = (d + hn) aSFF– [h (n – aSFF)]/i
To obtain the present value of an annuity that has a starting income of d at the end of the first period and decreases h dollars per period for n periods, simply treat h as a negative quantity in the foregoing formula.


Subscripts:
PV = Present Value
CF = Cash Flow
Y = Yield Rate
R = Capitalization Rate
= Change
a = Annualizer
SFF= Sinking Fund Factor
1/n = 1/Projection Period
CR = Compound Rate of Change
V = Value
n = Projection Period
O = Overall Property
I = Income

 

[Mountain Man]

Are you doing a discounted cash flow, or using a cap rate?
With a discounted cash flow, you show the rents as they escalate through out the lease term.
Cap rate, you built your EGI based on today's rent rate.