What is the difference between contract rent and

12. What is the difference between contract rent and market rent? Why is this distinction
more important for investors purchasing existing office buildings than for investors
purchasing existing apartment complexes?
13. Estimate the market value of the following small office building. The property has
10,500 square feet of leasable space that was leased to a single tenant on January 1,
four years ago. Terms of the lease call for rent payments of $9,525 per month for the
first five years, and rent payments of $11,325 per month for the next five years. The
tenant must pay all operating expenses.
During the remaining term of the lease, there will be no vacancy and collection
losses; however, upon termination of the lease it is expected that the property will be
vacant for three months. When the property is released under short-term leases, with
tenants paying all operating expenses, a vacancy and collection loss allowance of 8
percent per year is anticipated.
The current market rental for properties of this type under triple net leases is $11 per
square foot, and this rate has been increasing at a rate of 3 percent per year. The
market discount rate for similar properties is about 11 percent, the "going-in" cap rate
is about 9 percent, and terminal cap rates are typically 1 percentage point above
going-in cap rates.
Prepare a spreadsheet showing the rental income, expense reimbursements, NOI s, and
the net proceeds from the sale of the property at the end of an 8-year holding period.
Then use the information provided to estimate the market value of the property.
Solution : The fifth year of the 10-year lease is the first year of analysis. The problem
calls for an 8-year analysis--one for the last year of the 1st 5-year period, five for the
second 5-year period, one to allow the vacancy and collection loss to achieve a
normal level, and one at the normal level for calculating the property's value (sale
price) at that time. Assume vacancy and collections losses in year 7 are 25 percent,
which reflects 100 percent vacancy for three months and no vacancy for 9 months.
Assume the “normal” vacancy rate of 8 percent will apply in year 8 of the analysis
and beyond.
Yr. 1 Yr. 2 Yr. 3 Yr. 4 Yr. 5 Yr. 6 Yr. 7 Yr. 8 Yr. 9
Contract Rent 114,300 135,900 135,900 135,900 135,900 135,900

9
Market Rent 115,500 118,965 122,534 126,210 129,996 133,896 137,913 142,050 146,311
Less: VC 0 0 0 0 0 0 34,478 11,364 11,705
Effective Gross Inc. 114,300 135,900 135,900 135,900 135,900 135,900 103,435 130,686 134,606
Less: Operating Exps 0 0 0 0 0 0 0 0 0
Net Operating Inc. 114,300 135,900 135,900 135,900 135,900 135,900 103,435 130,686 134,606
Sale price at the end of Yr. 8: = [NOI (yr9) / Terminal cap rate]
= $134,606 / 0.10
= $1,346,060
Cash Flows: CF
1
= 114,300
CF
2
= 135,900
CF
3
= 135,900
CF
4
= 135,900
CF
5
= 135,900
CF
6
= 135,900
CF
7
= 103,435
CF
8
= 1,476,746 (130,686+1,346,060)
PV of Cash Flows @ 11 percent = $1,246,090