Question 3.

You are appointed by the owner of an office building, Monument Tower, as the property manager. You are currently negotiating a 5-year lease with an IT company, Extreme Vision, for 2,000 square metres of rentable space. After careful market/property analysis, you estimate that the base rent should be $250 per square metre per year. Monument Tower offers full service to all its tenants as a policy. Rent is due at the beginning of each year. 

Extreme Vision indicates to you that they are willing to pay $220 per square metre with step-ups of $10 per square metre each year beginning one year from now. You think that a price of $220 is too low to degrade the reputation of Monument Tower. The owner will certainly reject this price. You come up with two alternative proposals. 

• Option A: Monument Tower offers Extreme Vision a move-in allowance of $50,000 plus tenant improvements (fitouts) worth $50,000 subject to Extreme Vision signing the lease at a flat rent of $250 for a term of 5 years.

• Option B: Monument Tower offers Extreme Vision to buy out its existing lease in another building. The existing lease of Extreme Vision has 1 year remaining. Its space in the other building is 2,000 square metres and the price is $200 per square metre per year. The lease agreement between Extreme Vision and its existing landlord specifies that Extreme Vision should pay 50% of the remaining rent due in a buyout. Extreme Vision signs the new lease at $250 with step-ups of $5 per square metre each year starting one year from now.

(1) Using discounted cash flow method, calculate the present values and effective rents of the three options: the original proposed rent schedule from Extreme Vision, option A, and option B. The discount rate is 10%, which is the required return by the owner. Show your workings by copying the table here and state the formulas if necessary. Explain concisely.

(2) Should you recommend option A or option B to the owner? What are the benefits and costs of the three options?

(3) If you propose the selected option in part (2) to Extreme Vision, will it accept it? How could you convince them to accept the offer? Please propose another set of lease terms to make it attractive to the potential tenant while satisfying the requirement of the owner.