Common Fee Calculations for Early Termination Options
I'm reviewing a proposal for a 10 year downsized lease renewal with the following early termination clause: "Tenant shall have a onetime right to terminate the Lease at the end of year seven (7). Tenant shall provide twelve (12) months prior written notice and pay an early termination fee at the time of submitting written notice. The early termination fee shall be equal to six (6) months of Rent based on the gross monthly rent due for month 85 plus the unamortized tenant improvement allowance and commissions discounted at an annual rate of 7.5%. The option is personal to Tenant and non-transferable."
Can someone explain how I should go about calculating this?
When it says the unamortized TI & LC discounted at 7.5%, I take that to mean the following steps: A) take the nominal TI+LC amount [for an example we'll say TI's of $50 & LC's of $2.25/Yr = $75/SF total for the 10 year term] 2) allocate the costs over 10 years [$75/10yrs => allocate $7.50 per year] 3) take the allocation from each year 8-10 and discount it by 7.50%. So the TI & LC portion of the fee would be NPV( rate=7.5% , Y1=$7.50 , Y2=$7.50 , Y3=$7.50). 4) the total fee would be the NPV of the TI&LC's and add the 6 months of rent using the Month 85 rental rate.
I've never heard of a termination fee calculated like this so I'm assuming I don't understand. And if it correct, then it doesn't seem fair because the TVM is only applied to help the tenant and at the expense of the landlord.
Appreciate any help! This has me stumped.
Create an amortization schedule with the initial TI/LC and the stated amortization rate, find the termination month, take the Ending Balance (Outstanding Principal) in that month – that's what the tenant owes you (ie the "unamortized portion"). + 6 month termination fee.
DCF analysis might get you there but sounds complicated.
Edit: my understanding about the "discount" part is that the "discount rate" they provide you is just the interest rate for the amortization. Doesn't seem to make sense to further discount the TI/LC balance that I'm no longer amortizing because of the tenant's termination...
Thank you! Your approach makes a lot more sense that the route I was going lol.
Attached a screenshot below. Assuming assumptions/formulas are correct, is this kind of what your talking about for the TI/LC portion of the fee?
Yeah that looks right. It's just the outstanding balance from the TI/LC you had spent that the tenant needs to reimburse you for if they want to early terminate. Benefit for you is that you get to keep the improvements for a fraction of the cost and hopefully re-use them for your next tenant.
Great, thank you. That totally make sense. I think I was thrown off when the lease was talk about nonamortize TI/LC and applying a discounting.
Appreciate your help!
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