A real estate company is considering four lease terms for five years for an office property. Figures for the four lease terms are estimated and provided as follows:

Year 1 Rent Adjustments

Net Lease with Steps £20,000 Step Amount £1000 per year

Net with CPI Adj. £21,000 CPI 2.5% per year

Gross Lease £33,000 Year 1 Expenses £8,000

Gross with Exp. Stop £31,000 Expense Growth 12.0% per year

Expense Stop £9,000

The required annual rate of return is 13%.

Calculate the PV of the expected net rental income from each of the four lease terms.

(5 marks)

Solve for the effective rent from each of the four lease terms and recommend the preferred lease term.

(5 marks)

Suppose you are a mortgage advisor advising your client on choosing between a 25-year CPM loan and a 25-year CAM loan. The loan amount is £300,000. The annual percentage rate is 8% initially and kept unchanged until the end of year 10. The annual percentage rate drops to 6% from the beginning of year 11 that lasts to the end of the loan.

What would be the loan’s balance at the beginning of year 11, interest payment in January of year 11 and amortisation in January of year 11 for CPM and CAM respectively?

(2 marks)

What would be the total payment, principal repayment and interest costs, of CPM and CAM respectively? Which is higher and why?

(2 marks)

What would be the effective cost of CPM and CAM respectively? Which is higher and why?

(3 marks)

Contrast the two mortgage products with your results obtained above, with regard to the features of CPMs and CAMs. Advise your client accordingly. If the client can switch from CPM to CAM or from CAM to CPM at the beginning of year 11, how would you advise?

(8 marks)