Valuation of a Lease Proposal

Valuation of a prospect to lease space can be difficult. Say they offer to lease the space at 10% less than the asking price. What is the effect? Maybe one questions to ponder is how time is a factor on leasing the property. The difference between $22/sf and $20/sf is (drum roll...); $2/sf. $2/sf for 2,000sf over a term of five years is equal to a total aggregate value of $20,000. Rent today is equal to how much rent tomorrow? What is the break even of time on the market to reach the higher rent.

$20,000/3,333 (the monthly rent proposed) = 6 months.

So, if you don't secure a tenant at full price within six months, the offer at the lower rate is a better decision.

What if the landlord felt like $21/sf is a more reasonable rate?

$1 x 2,000sf x 5 years = $10,000 aggregate value of the difference.

$10,000/3,333 (monthly rent proposed) = 3 months.

Clear as mud? As we analyze lease proposals, we advise our client/landlords of the activity level. If the market activity level is high, then the landlord might want to roll the dice and try for higher rental rate. However, if the activity level is low, then he or she would be advised to take the tenant with a lower rate and start collecting rent sooner.

There are many other things to consider including the impact of lower rent on the value of the property. Say the market year one return for the subject property is 8% and the property would likely be evaluated purely as a stream of income. The impact of $10,000 of additional rent is equal to $80,000 ($10,000/.08).