The Right of Acquisition: Options in Commercial Real Estate Case Study Solution


The report sets out to investigate the value of the purchase option in the commercial real estate lease. Furthermore, the common mistakes in the valuation with the use of the discounted cash flow method performed by the financial analysts at Koenig Capital, are identified. The considerable amount of assumption and data provided in the case, help in evaluating the purchase option in the lease of Hasperat Inc., one of the tenants of Koenig. The new modeling technique concludes that the value of the Kelley building as of today, is calculated to be $904927.31, instead of $113449 generated by Nichols using the discounted cash flow method.

Case Brief

In April 2012, the financial analysts at Koenig Capital, a real estate investment firm – has been contemplating toenterthe lease renegotiation. Hasperat Inc. is one of the tenants of Koenig, which has 16 years left on its long term lease of the Kelley Building downtown Cleveland. The clause in the lease givesHasperat an option to purchase the building from Koenig. At time, when Nichols is striving to place themortgage with core considerationover taking the advantage of the low rates of interest; he came to know that the presenceoflease option does not allow lenders to offer Koenig their low interest rates. Consequently, he has been tasked with renegotiating the lease in order to omit the option clause. He is now concerned with justifying his superiors about the amount to be compensated to Hasperat.

How did Bill Nichols estimate $113,449 (the value of the option)

Nichols has used the traditional discounted cash flow method, to estimate the value of the option. He has developed the cash flow model for beyond the extended period of 10 years, in order to take into account all the cash flows that Hasperat hascommitted to pay. Additionally, the discount rate of 9.5 percent is generated by him, through taking an average of the annual return on the property building. The 9.5 percent discount rate is being applied on the property of Kelley building before tax cash flows and estimated the current value of the building under $22.4 million. The exit cap rate of 9.2 percent is used on the basis of the net operating income of the year 2013.

In addition to this, the implied price of the building has been estimated by Nichols, throughcalculating the present discounted value of the expected cash flows of the property starting in 2019, in order to calculate the value at the second option exercise date of December 31st,2018.  He estimated that the building would be growing in value, to nearly $24.2 million, yet the price at which Hasperat could purchase the property would increase to $25.6 million. Later on, he stressed over the significance of assuming that the valuation of the property would be high at $24124227, and came to the conclusion that the worth of the $24 million today at most is $113449, which was calculated by dividing the amount resulted from the valuation by the estimated current price of the Kelley building and dividing it by the discounted rate………………………………..


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