This is probably an elementary topic for most, but when you are comparing leases with different terms to decide which one is more Accretive, do you mainly look at the net effective rate, or do you forecast out so the two leases have the same term and then take the NPV of the cash flows?
If you do look at the net effective rate, please explain your calculation. I think I am correct compared to someone else in my office, and would like another opinion.
Punch one lease into the Argus file. Run the IRR
Punch the other lease into the same Argus file. Run the IRR
You could do it all in excel if there are probabilistic functions (e.g., termination options)
yeah I do argus lease NPV
I'd rather do it out in Excel, which I have done but wanted to see how others would do it. For the people I am explaining to, I want to show the work out and not say a "because Argus says so" type of answer.
I generally show both, however, NPV is probably stronger (taking time into account) especially if you have significant variations in your rent over the terms of the lease.
Would you agree that taking the PMT of the NPV of the cash flows with the same discount rate and period gives you equal payments that will yield the same value, therefore taking time into account as well?
If you have a ten year lease and a 5 year lease, an NPV of the 10 will obviously be higher due to the term length. The above will make both equal in terms of comparison.
You might be over-thinking it, just compare two, 10-year cash flows from each lease. In your NPV cash flow for the shorter lease, you don't stop at Year 5. You just have zero rent coming in for the downtime. Then it leases up at market rates.
The 10-year lease could be below market, thus hurting you more than downtime (6 to 9 months), tenant improvements ($X) and leasing commissions (Y%).
Right, I think there's two ways to look at it. To do what you said, which includes guessing what market will be (included with TI's, LC, downtime, etc.) and have the same term. The other way is what I was talking about above, so you can compare two different terms - it's the only way I can think of to compare the two if you didn't want to add in future leases and decide what "market" will be in 5 years.
I agree with Gene, you just need to put a probability on them staying vs. leaving and the other leasing assumptions he mentioned. Argus FTW!
There are other factors that go into this analysis that you are holding constant, such as credit worthiness of the tenant.
EDIT - If the tenants are of equal credit, then I would assume the same discount rate. For the shorter term lease, I agree with modeling the 2nd generation terms and taking an equal number of years to compare side by side against the larger lease. I would keep it simple and assume rents & TI's grow at 3.0% annually for your future lease. If you assume the tenant rolls to market, ARGUS will handle all the blending of downtime, TI's, & rents (when new & renew terms are different). After this, you just see what generates the larger NPV.
You could also use and IRR instead to mitigate the impact of differing term lengths. I guess I was assuming that the difference in results of NPV and NER were related to the timing of the CFs (flat rate vs. large rent bumps or drops)
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