For a medium-sized accounting firm expanding its footprint by leasing office space in a new city, choosing the right lease can make a significant financial difference. Even with similar rental rates among options, understanding the total costs associated with leasing can help conserve capital. This is where comparative lease analysis comes into play. This article guides you through the process of analyzing leases systematically to determine which one will be less costly in the long run.
What is Comparative Lease Analysis?
At its core, comparative lease analysis involves examining all cash flows linked to lease agreements and discounting them back to their present value. This method enables firms to assess the financial implications of various lease options accurately. The principle behind this analysis rests on the time value of money, which asserts that a dollar today holds more value than a dollar in the future, mainly due to its potential to earn interest.
How to Conduct Comparative Lease Analysis
There are two primary steps in performing comparative lease analysis:
- Identify Cash Flows: Gather detailed information on lease payments, including any additional costs or economic concessions.
- Calculate Net Present Value (NPV): The cash flows identified are discounted back to the present value using a selected discount rate. From the present value, you can compute the net effective rent by dividing the total gross rent by the duration of the lease in months.
These steps offer a structured approach to discerning the total costs associated with each lease, ultimately allowing for an informed financial decision.
Simple Comparative Lease Analysis Example
To illustrate the comparative lease analysis, let’s consider a scenario where a company decides between two leases for a 10,000 square foot commercial property. Each lease term lasts for three years, with no free rent or extra fees for operating expenses.
Lease A
- Base Rent: $20 per square foot (increasing $1 each year)
- Year 1: $20 PSF
- Year 2: $21 PSF
- Year 3: $22 PSF
Lease B
- Base Rent: $19 per square foot (increasing $1.50 each year)
- Year 1: $19 PSF
- Year 2: $20.50 PSF
- Year 3: $22 PSF
Assuming a discount rate of 10%, the Net Present Value (NPV) calculations could yield $52.07 for Lease A and $50.74 for Lease B, indicating that Lease B appears to be the less expensive option upon first glance.
Calculating Effective Rent
To get the effective rent, we use the NPV results in a formula utilizing spreadsheet functions to compute an equivalent level annuity:
- Rate: 10.00%
- Number of Periods: 3
- Future Value: $0
- Present Value: NPV of Lease Payments
The effective rent results in $20.94 for Lease A and $20.40 for Lease B. Therefore, from a financial standpoint, Lease B presents a more cost-effective option.
Advanced Comparative Lease Analysis Example
In a more complex example, we analyze two leases with additional variables added.
Lease Option 1
- Base Rent: $20 PSF (increasing 3% annually)
- Operating Expenses: $5 PSF (increasing 4% annually)
- Parking Fees: $1.50 PSF
- Moving Expenses: $4,000
- Required Tenant Improvements: $15,000
- Tenant Improvement Allowance: $10,000
- Term: 3 Years
The first lease analysis would look something like this: Year 0 costs totaling $9,000 after factoring in the tenant improvement costs, with increases in outflows each subsequent year based on terms.
Lease Option 2
- Base Rent: $19 PSF (increasing $0.50 each year)
- Operating Expenses: $6 PSF (increasing 4% annually)
- Moving Expenses: $6,000
- Required Tenant Improvements: $17,500
- Tenant Improvement Allowance: $12,000
- Term: 3 Years
A thorough analysis of both options would reveal Year 0 cash outflows, with total costs calculated for comparison.
Summary of Lease Comparison
In summary, the comparative lease analysis method provides an insightful view into the monetary implications of leasing decisions. Although Lease 2 proves to be less expensive based on the figures, other qualitative factors could sway the final choice for the tenant—such as location, amenities, or lease flexibility.
Ultimately, comparative lease analysis serves as a foundational framework to guide tenants in analyzing and selecting their leasing options properly. The financial calculations reveal vital insights, yet understanding the full context should influence the final decision.
Disclaimer: This article aims to inform potential tenants about comparative lease analysis. It is essential to consult with real estate professionals for specific circumstances and more tailored advice.
