Quick question: Are termination fees relevant to compute net effective rent?
Hi everyone,

I am working on a model in which I have different lease options with multiple tenants, each with different rents, lease terms, tenant improvements, etc. I must base my decision on the net effective rent that each option yields. There is one scenario in which one tenant terminates the contract early and has to pay a termination fee. 

My question is: should I factor that in the equation to get the Net Effective Rent of that option? Or should I take it into account as a a relevant factor but not include it directly in the NER? 

Also, just to know if I'm doing correctly the NER, with a very simple example: 

NRA: 100,000 SF

Option 1

Tenant 1: 25,000 @ 15/SF, 

Tenant 2: 25,000 @ 13.5/SF, 

Tenant 3: 50,000 @ 10/SF,

To compute the Net Annual Effective Rate/SF for this option, what I'm doing is:

15\*(25,000/100,000)+13.5\*(25,000/100,000)+10\*(50,000/100,000)= $12.125

Is that correct? In this example, there are no TI or LC or free months of rent, so NER/SF coincides with Gross Rent/SF, but just to see if this is the way to do it. As you might guess, I'm a newbie ;)

Thanks in advance!
[{"id": "iuf0aii", "text": "Net effective rent is the result of taking the PMT using the discount rate, NPV you calculate from a completed DCF, and the holding period I believe. That tells you what revenue in annuity terms is actually coming in. \n\nThis may be incorrect but that\u2019s how I remember calculating it. Please correct me if so. I can check my old sheets later.", "replies": [{"id": "iuf85z8", "text": "Hi! Thanks for your comment. In the model, I am given some assumptions and those do not include the discount rate, and I\u2019m supposed to get the NER without using it. Only thing related is, for several tenants, I know their credit rating. At first I thought of discounting the future cash flows with the corresponding corporate bond yield (for instance the average 10 year AAA yield is 5%), but again I am not supposed to look for any info available online. It\u2019s true that not considering the time value of money feels wrong, especially since the lease terms are different for all tenants. What could I do?", "replies": [{"id": "iuf8j3g", "text": "So you would take their cost of capital (corporate bond rate) and add a market risk premium (MRP)to derive the discount rate. I would top that 5% with a 3-4% MRP for a discount rate of 8-9%", "replies": [{"id": "iuf9kex", "text": "Ok, thank you!!", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "iufzyrj", "text": "Your formula looks to be calculating a weighted average rent for the building, which is helpful, but I\u2019m not sure that it\u2019s really relevant in comparing lease options to each other.\n\nWhen I\u2019m comparing leases that have a termination option, I typically run two scenarios. 1 as if the tenant does not terminate and 1 assuming they do. I\u2019ll run the NER, NPV, etc for each and see how they compare to each other and how they match up to our budget or underwriting assumptions. Your NER should be different on each scenario since your lease term is changing.\n\nI calculate NER by taking the total gross rents less opex (if it is a gross lease), free rent, and TI, divided by lease term.  I find that these formulas are calculated slightly differently person to person, so I could be off base a little lol.  Hopefully this is somewhat helpful!", "replies": [{"id": "iuho26t", "text": "Hi! Thanks for your input. \n\nWhat I'm doing is computing  the NER for the total building, considering all tenants, because in each scenario tenants have different rental rates, lease terms, etc., \n\nSo what I do is first compute the NER for each tenant and then do the weighted-average to get the \"total\" NER for scenario 1. Then, for scenario 2, I would compute the NER for each tenant (with the new lease terms) and again do the weighted-average so that the NER of tenants renting more space has more impact on the \"total\" NER, and now I can compare it to scenario 1. Does this make any sense? What you say seems correct but only considers one tenant, that's why I incorporate the weighted-average to my formula. \n\nBy the way, just to be sure, when the tenant terminates, the fee you get will certainly affect the NPV, but you do not include to get the NER, correct? Because, as you said, NER= total gross rents less opex (if it is a gross lease), free rent, and TI, divided by lease term.\n\nThanks again!", "replies": [], "depth": 2}], "depth": 1}, {"id": "iuh51m2", "text": "No. I model term fees as other income.", "replies": [{"id": "iuhoamn", "text": "Hi! Thanks for your answer. \n\nYeah, that seems reasonable.", "replies": [], "depth": 2}], "depth": 1}]