A retail lease for 10,000 square feet of rentable space is being negotiated for a five-year term. Option A calls for a base rent of $25 per square foot for the coming year with step-ups of $1 per year each year thereafter. CAM charges are expected to be $3 for the coming year and are forecasted to increase by 6 percent at the end of each year thereafter. Option B calls for a lower base rent of $23 per square foot with the same step-ups and CAM charges, but the tenant must pay overage rents based on a percentage lease clause.
The clause specifies that the tenant must pay 8 percent on gross sales over a breakpoint level of $900,000 per year. The owner believes that the tenant's gross sales will be $850,000 during the first year but should increase at a rate of 10 percent per year each year thereafter.
a. If the property owner believes that a 12 percent rate of return should be earned annually on this real estate investment, which option is best?
b. What if sales are expected to increase by 20 percent per year?