Trending prime rents up on the scarcity thesis, or flat lining them for ten years

My company is a service business, and I'm the one signing office leases as a tenant, so from that seat: face rent is a negotiating fiction and everybody in the room knows it. Last renewal I signed, the landlord would not move the number on the page because it feeds their appraisal and their lender. He gave me six months free and $55/sf of improvement allowance on a five year term instead. Do the arithmetic on that and my effective rent went down.

So if Deal A is trending face rent 3.5 percent with a fixed TI assumption, that model is showing you my landlord's press release, not my check.

Underwrite net effective and the two deals stop looking different in kind. They just look differently priced.

The thing that stops me on Deal A isn't the growth rate. It's that 60 percent of the return sits in the residual. I'm looking for income and a model where more than half the answer arrives on the last page is a model where I find out in year ten whether I was right.

keystone, what does Deal A pay in cash years one through five if you flatten the rent curve entirely? If the answer is 4 percent and change, that's the real product being sold and the growth is optional upside. If the answer is nothing, then the scarcity thesis isn't an assumption in the model, it is the model.

I'd sign the flat one and argue about the price, and I say that as someone currently in a lease-up that's running eleven months behind.

But cobalt, flat isn't automatically conservative either. Deal B holds $27/sf nominal for ten years on a 61 percent leased commodity building. That's not a conservative assumption, that's a bet that commodity space stops losing ground, and the delinquency number says commodity space is where all the pain is concentrated. Nominal flat over ten years with 2 to 3 percent inflation is a real rent decline, which is arguably right for that asset, so at least the sponsor isn't pretending. The thing I'd push on is the lease-up pace and the cost per square foot to get the vacant 39 percent occupied. That number moves the deal more than any rent line.

What broke on my small portfolio was never the growth rate, it was the timing of the spend. Two suites went dark in the same quarter once and I learned that models spread capex smoothly and reality delivers it in lumps.

So my vote is net effective, and then a second pass where I put every re-tenant cost in the year the lease actually expires rather than averaged. On a 210,000 sf building with 88 percent leased, keystone, I'd want the expiration schedule stacked against the loan maturity on one page before I cared about 3.5 versus zero. If a big chunk of the roll lands within a year of the maturity, the rent assumption is a rounding error next to that.