I could use some assistance. Anyone have experience in valuing subleases? The methods for valuing a traditional office/retail lease are probably applicable as well.
Here is the situation: About to enter into a lease and then going to subsequently sublet it to another tenant. We will have an upfront outlay of capital (all equity) to complete tenant improvements prior to the subtenant taking over the lease. You could essentially think of this situation as flipping a lease for profit.
Now...the lease is relatively short-term (just a few years)...and there will be no residual value. We will still be responsible for the monthly lease payments and OpEx. However...the incoming revenue from the sublease will generate a monthly profit. And we will recoup the cost for the initial capital improvements within a few months due to the high sublease rate.
I have completed a full cash flow model. So...I have all the numbers and know the income...expenses...and therefore the NOI. My challenge is attempting to determine the key financial metrics with which to analyze the investment...along with reconciling two months' worth of negative cash flow. I added the total amount of the NOI deficit (from the first two months) to the overall initial capital cost under an operations reserve line item. I believe that is the proper method.
The short-term nature of the lease...coupled with the fact there is no residual value has me a bit baffled on how to apply key metrics to the situation. There will be an equity payback period (which I know)...and suppose that I can run a NPV calculation? I do run an IRR calculation...although it looks a bit funky to me.
What about computing an equity multiple? The monthly lease payments create a liability (which obviously diminishes over time) and I have included them as an operating expense above the NOI. Would an equity multiple be determined against an NOI that excludes the lease payments...or against to the total distributable cash flow over the course of the deal...or against the NPV at the beginning of the lease?
It seems equally plausible that I have this figured out the fullest extend possible (and it is just a unique situation in which typical metics do not provide much insight)...or I might be completely off the mark and thinking about this in all the wrong ways. I honestly have no clue.
Anyway...I would be grateful to have anyone with insights to direct message me...and perhaps take a look at my cash flow model and provide feedback. I am happy to provide some information in exchange. Most of what I have is development based (lots of info on development costs...financing...construction...capital stacks...yields...etc). You could tell me what kind of info might be helpful to you and I can let you know if I can help you out.
Tagging onto my own post...
How do you determine the discount rate for a deal on an all cash basis...and have no set return target to use as a comparison? You plug in some random number...use current treasury rate...or just say that there is no purpose in running a DCF model?
It's real estate so we don't use WACC.
I've had an EVP of AM say to use 5% and a Controller say to use 8%
The discount rate is essentially your WACC. I would recommend using your company's pref before splits on deals which I am guessing is between 7 to 9%, you want that to analyze the cashflows. If you want to get aggressive, use the market cap rate for the asset which I am guessing will be closer to 5%.
You are on the right track of NPVing the cash flow stream at the disount rate that makes sense, if greater than zero then it's a good deal with your return being the discount rate or WACC. if you have the stream of cashflows already, you can also use goalseek to know your exact return, this is also the IRR so you can justify your analysis from two different angles.
if you message me, i am happy to take a look and explain in more detail. good luck!
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