I am currently building a model where a business enters into a long term NNN lease (10 year) and then subsequently leases out the entire space to a tenant. How would I think about pricing a sublease of different lengths in this scenario (2 year, 4 year, 6 year)? Would I target an unlevered free cash flow yield based on assumed opex?
In a scenario where the land is purchased, I would look at the IRR. In this case, there isn't necessarily a capital outlay assuming the Tenant Improvements are priced into the lease - therefore an IRR analysis would work, correct?
Thanks for helping me think about this.
From whose perspective are you attempting to model?
It's not immediately clear if you are modeling from the actual owner's perspective or the primary lessee's perspective.
From owner's perspective, all you're really doing is modeling the 10 year cash flows. For a true absolute net transaction, it's just like buying a bond. The risk premium the owner is paid depends on credit quality of primary lessee.
If modeling from primary lessee's perspective, you're modeling the cash flow projections basically like a normal transaction except there is probably no major cash outlay up front associated with the building purchase. You are primarily capturing the spread between the the primary and the sublease. If you project a TI, factor it in.
As far as what metric to use to consider value - yes you can derive an IRR from both sides of the transaction as presumably there are cash flows underpinning the transaction. You can derive an NOI off the sublease because you have income. By making reasonable projections for expenses and subtracting from income, the spread one captures is basically an NOI - the real caveat being that technically for the instrument to exist, it is predicated on paying someone else to play. And unlike normal property-level cash flows, the primary rent (debt) payment would have to be above the line as a normal operating expense.
To be honest I don't know if I answered your question, but I hope this helps shape your thinking.
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