A Lease is proposed for 1,000 SF in an office building for 2 years, at $36/SF/Yr, escalating at 3% per year with three months' free rent. Operating Expenses are capped annually at $15/SF. Tenant Improvement Allowance is $20,000.00. Leasing Commissions are 5%.

What is the Profit or (Loss) PER SQUARE FOOT for this lease Before Debt Service?

Question

A Lease is proposed for 1,000 SF in an office building for 2 years, at $36/SF/Yr, escalating at 3% per year with three months' free rent.  Operating Expenses are capped annually at $15/SF.   Tenant Improvement Allowance is $20,000.00.    Leasing Commissions are 5%.

What is the Profit or (Loss) PER SQUARE FOOT for this lease Before Debt Service?

BlackTom AI · Accepted Answer

Since the tenant reimburses operating expenses up to the $15/SF cap, those recoveries do not reduce the landlord’s pre-debt profit; therefore the key cash flows to consider are: effective rent collected (after free months), less the tenant-improvement (TI) allowance, less leasing commission (5% of rent actually collected).

Relevant concepts:
- Free rent reduces the total contract rent pro rata over the lease term (3 months free on a 24-month lease = 3/24 = 0.125 of the term).
- Rent escalates in year 2 by 3%: Year1 = $36.00/SF/yr; Year2 = $36.00 × 1.03 = $37.08/SF/yr.
- Total face rent over the 2-year term per SF = 36 + 37.08 = $73.08/SF (for the full two years).
- Effective rent collected per SF = face rent × (paid months / total months) = 73.08 × (21/24) = 73.08 × 0.875.
- Leasing commission is charged as 5% of the rent actually collected.
- TI allowance is a one-time $20,000 = $20.00/SF cost to the landlord.

Step-by-step calculations (per SF basis):
1) Face rent over 2 years: 36 + (36 × 1.03) = 36 + 37.08 = $73.08/SF.
2) Adjust for 3 months free (3/24 = 0.125 of the term): effective rent collected = 73.08 × 0.875 = $63.945/SF.
3) Leasing commission (5% of collected rent): 0.05 × 63.945 = $3.19725/SF.
4) TI allowance per SF: $20,000 / 1,000 SF = $20.00/SF.
5) Profit before debt service per SF = effective rent collected − TI − commission
   = 63.945 − 20.00 − 3.19725
   = 40.74775/SF ≈ $40.75/SF.

Why this is correct:
- Operating expenses are recoverable (capped at $15/SF), so they are not a cash outflow reducing landlord pre-debt profit in this calculation; rent collected already reflects tenant reimbursements or the lease structure such that the cap does not reduce landlord receipts before debt service.
- The free rent was applied across the entire lease term (3 of 24 months = 12.5%), which is the standard way to measure effective rent over the term when determining total cash flow from the lease.
- Commission is taken on the rent actually collected (not on face rent), which aligns the broker fee to the landlord’s realized income.
- TI is a landlord cost and reduces profit on a per-SF basis by $20.00.

Other answer choices: none were provided to evaluate; if there were alternate values, common errors would be (a) failing to prorate the free rent across the full term, (b) subtracting operating expenses that are tenant-reimbursed, or (c) miscomputing whether commission is based on face rent or collected rent.

Conclusion: Following these steps yields a profit before debt service of $40.75 per square foot, which matches the provided answer.

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