When analyzing the NPV of a long term lease, what discount rate do you generally use?
I am negotiating a lease renewal with a large national tenant and this would be helpful in comparing their current lease with the proposed one.
[{"id": "db7qvoo", "text": "If they're public, look in their 10-K for an indication of their cost of capital. That's what I usually do (but if I'm wrong, somebody else please let me know if you wouldn't mind).", "replies": [{"id": "db7u09w", "text": "Wouldn't I want to use my cost of capital as a hurdle rate rather than theirs since I am the landlord in this situation?", "replies": [{"id": "db7yexs", "text": "My mistake -- I thought you were trying to look at it from their perspective (that is, to see how it affected their books). You're right.", "replies": [{"id": "db8i9nb", "text": "why would you use cost of capital and not something like a cap rate? When you're doing NPV, isn't the time value of money supposed to take into account the opportunity cost of putting the money to use somewhere else instead of not having the money at all? ", "replies": [{"id": "db998ug", "text": "I was going with the risk free rate of a 10YTB at &lt;3% plus the risk premium of a corporate tenant at roughly 4.5% so 7.5%.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "db84adg", "text": "I typically stick with cost of capital and just bear in mind it is a floor. \n\nYour cost of capital would be a factor in whatever you decided to be your discount rate, but to approach this truly as a project, there would be many other factors at play. If you are in a safe, low competitive area your discount rate would be higher than in a shady, hyper competitive area.   It is very difficult, as you recognize, to derive a discount rate for NPV with real estate. \n\nIn the end, it doesn't matter if you are comparing options in the same property as long as you are consistent and at or above your cost of capital. \n\nIf you are figuring out investment return, be sure to account for the tax free appreciation of the underlying property.\n\n", "replies": [{"id": "db85ra8", "text": "Wouldn't your discount rate be lower in a safe area since your risk premium over the risk free rate is lower? In other words, your denominator is smaller and npv is higher for a less volatile cash flow stream ", "replies": [], "depth": 4}, {"id": "db99eu6", "text": "Yes, I originally ran it at my refi loan rate of 5%.  Tenant is arguing that 8% is better but that makes their lower rent on their proposed new lease look like less of a hit to me over the long term.  I'll probably give in just because the favorable loan with the 10 year commitment before options from the tenant saves me about $200k.  I just hate giving up $500k over 40 year with discount rate of 8%.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}]