Lease vs. Buy Mini Case 2021 (AMAZON)
alec.delgado
LeasevsbuySAMPLES.pdf
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Lease vs. Buy Mini Case Darden Restaurants Inc.
Prepared by: Mitch O’Reilly Georgio Kwok May 7, 2013
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10505 NW 112th Avenue, Miami, FL 33178
Darden Restaurants The purpose of this project is to determine whether Darden Restaurants should purchase or lease a property of 150,000 square feet of office space near the Turnpike and Northwest 96th Street for a regional headquarters in Miami, Florida. The company is located and headquartered in Orlando, Florida and is looking to expand its regional expertise into the South Florida market. Darden’s investment horizon is a six-year holding period. Our analysis showed that Darden Restaurants should purchase the property. The company would realize an internal rate of return on after-tax cash flows of 19.70% and a net present value of $7,771,554. Required Return on Equity According to the Bloomberg terminals, the 2-year beta for Darden Restaurants was 0.832 and is 16.8% less risky than the benchmark index such as the S&P 500. The bonds chosen to determine the cost of borrowing had maturity dates of 10/15/2021 and 11/1/2022, which were long than the expected holding period of 2018 for this analysis. Averaging the callable bond yields from Bloomberg, the long-term cost of borrowing was 3.47%. However, since these bonds are redeemable prior to 2018, they have a higher yield than non-callable bonds; thus, we deducted 50 basis points from the 3.47% to arrive at 2.97% as the long-term cost of borrowing.
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Using the capital asset pricing model (CAPM), the required return on equity for Darden Restaurants was calculated to be 8.35%. The risk free rate (Rf) was found by averaging the 10- Year Treasury rate from the past 10 years, which yielded an average rate of 3.53%.1
1 Federal Reserve Economic Data. http://research.stlouisfed.org/fred2/
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Date 10-Year Treasury Rate 1-Jan-13 1.91% 1-Jan-12 1.97% 1-Jan-11 3.39% 1-Jan-10 3.73% 1-Jan-09 2.52% 1-Jan-08 3.74% 1-Jan-07 4.76% 1-Jan-06 4.42% 1-Jan-05 4.22% 1-Jan-04 4.15% 1-Jan-03 4.05% Average 3.53% The implied equity risk premium was taken from Damodaran’s website and for the month of April 2013 the risk premium was 5.79%.2 Re = Rf + β (Rm – Rf) .0353 + (.832 * .0579) = 8.35% Using the Capital Asset Pricing Model, the required return on equity is 8.35%. This important measure is reflected in the recommendation to Darden’s Restaurants. Assumptions and Givens The following parameters were provided:
The property can be purchased for a total of $32,000,000, of which $27,000,000 is building value
60% of the value of the property can be financed if purchased, for 10 years, with 30 year amortization
The firm is in the 35% tax bracket, the depreciation recapture is taxed at 25%, and long term capital gains are taxed at 15%
For the assumption of the annual average appreciate rate, we used the Zillow Home Price Expectations Survey where the economists predicted that home values would appreciate 4.05% annually through 2017.3 Taking a conservative approach, 100 basis points were deducted from the economists’ projections to arrive at annual appreciate rate of 3.05%. The adjustment was necessary since the demand for office space is generally weaker than the residential real estate market. The 3.05% rate is also more indicative of the current inflation rate in the US. Using Costar, we collected data on several properties with similar features and amenities located within a 3-mile radius of the site. Most of the office buildings were recently built or renovated and all were near 150,000 square feet in net rentable area. Averaging the eight 2 Implied Equity Risk Premium. Aswath Damodaran. http://people.stern.nyu.edu/adamodar/ 3 Zillow Real Estate Research. http://www.zillowblog.com/research/2013/03/19/zillow-home-price- expectations-survey-predicts-home-value-appreciation-through-2017-to-exceed-pre-bubble-norms/
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comparable properties below, we determined Darden’s potential triple net lease rate to be $23.24 per square foot. Address NRA
(SF) Lease Type Lease Rate
($/SF) Operating Exp ($/SF)
Total Rent ($/SF)
Year
8750 NW 36th St 140,600 NNN $12.25 $10.34 $22.59 1991 9100 NW 36th St 246,917 FS $18.64 N/A $18.64 1980 9250 NW 36th St 187,321 FS $25.00 N/A $25.00 1984 9850 NW 41st St 133,117 NNN $13.25 $10.18 $23.43 2006 9725 NW 117th Ave 114,287 FS $24.50 N/A $24.50 2006 10452 NW 117th Ave 118,723 FS $24.50 N/A $24.50 2007 3895 NW 107th Ave 80,000 FS $24.04 N/A $24.04 2014 3885 NW 107th Ave 133,117 FS $23.75 N/A $23.75 2012 Average 144,260 $20.31 $23.24
Sensitivity Analysis The sensitivity analysis below shows Darden’s after-tax IRR at various future selling prices and at different borrowing rates. For example, if the property had future selling price of $32,000,000 (0% appreciation) instead of the assumed value of $38,320,000 and if the interest rates on the borrowed funds was 4.5% or 1.5% more than forecasted rate, then the after-tax IRR would be 13.55%. While this value is much lower than the predicted 19.3% return, it is still greater than 8.35%, so even under these pessimistic assumptions, the best option would be for Darden to acquire the property. Moreover, the triple net lease rate would have to be less than $7 before Darden would be indifferent between buying or leasing the property. Since Darden can borrow money cheaply and because the company’s required return on equity is relatively low, in most instances the
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best financial decision would be for Darden to purchase this property. However, this recommendation could change if the company anticipated a longer holding period than 6 years. Loan Rate Summary Decision Based on the assumptions for this project as well as the appreciation and lease rates from our research, our recommendation is for Darden Restaurants to buy this office building rather than to lease it. If the firm decides to purchase the property, it would receive a 19.70% internal rate of return on after-tax cash flows, which is substantially higher than the required return on equity investment of 8.35%. In addition, the company would receive a positive net present value of $7,771,554 after the 6 years with a future selling price of $38,321,099 using an appreciation rate of 3.05%. Finally, as the sensitivity analysis revealed, this recommendation would not change under the assumed worst case scenarios.
After-Tax IRR Future Selling Price 19.70% 40,000,000 38,000,000 36,000,000 34,000,000 32,000,000 2.50% 21.12% 19.78% 18.35% 16.82% 15.15% 3.00% 20.81% 19.45% 18.01% 16.45% 14.77% 3.50% 20.48% 19.12% 17.65% 16.08% 14.37% 4.00% 20.15% 18.77% 17.29% 15.70% 13.97% 4.50% 19.81% 18.41% 16.92% 15.31% 13.55%
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Exhibit 1: After-Tax Incremental Lease vs. Buy Analysis 2013 2014 2015 2016 2017 2018
Corporate Tax Bracket 35%
Required After-Tax Return 8.35%
Annual After-Tax Incremental Cash Flow to Owning
Depreciation Tax Shelter (TB * Dep.) $242,308 $242,308 $242,308 $242,308 $242,308 $242,308
Interest on an After-Tax Basis (Int * (1-TB)) ($370,094) ($362,272) ($354,217) ($345,924) ($337,384) ($328,591)
After-Tax Lease Payment SAVED (Lease * (1-TB)) $2,265,900 $2,311,218 $2,357,442 $2,404,591 $2,452,683 $2,501,737
Loan Principal Paid ($405,830) ($417,865) ($430,257) ($443,016) ($456,154) ($469,681)
Net Annual After-Tax Incremental Cash Flow to Owning $1,732,283 $1,773,389 $1,815,276 $1,857,959 $1,901,453 $1,945,772
Ending After-Tax Incremental Cash Flow to Owning $19,757,276
Net After-Tax Incremental Cash Flow to Owning $1,732,283 $1,773,389 $1,815,276 $1,857,959 $1,901,453 $21,703,048
Present Value of Incremental Ownership Cash Flows $20,571,554
Purchase Price ($32,000,000)
Loan $19,200,000
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Owner's Initial Equity Contribution ($12,800,000)
NPV of Incremental Decision to Own INSTEAD of Lease $7,771,554
Decision Buy, positive NPV
After-Tax IRR on Decision to Own INSTEAD of Lease 2013 2014 2015 2016 2017 2018
After-Tax Owning Cash Flows: ($12,800,000) $1,732,283 $1,773,389 $1,815,276 $1,857,959 $1,901,453 $21,703,048
IRR on After-Tax Cash Flows 19.70%
Compare to Required Return on Equity Investment 8.35%
Decision Buy, IRR on an after-tax basis is greater than the required return on equity investment
Maximum lease rate before leasing becomes better $6.59
Mini Case 2: Lease vs. Buy Analysis
Property Description: 150,000 square feet warehouse/office building in West Miami. Decision: Buy. Rationale:
1. UPS’s low cost of debt 2. UPS’s low required return of equity invested.
Decision Sensitivity: Stable even under variation in the required return on equity (Re) and cost of debt (Rd), as well as variation in the NNN rent rates.
Core Competency: Logistics.
Analysts: Pavel Egiyan & Daniel Fornes T: (305) 890-7475 T: (786)-506-0355 E: [email protected] E: [email protected]
Key Metrics Discussed • IRR: 17.17% • Re: 7.67% • Rd: 2.50% • NPV: $6,563,050
7 May 2013 │ 20 pages
7 May 2013 │ 20 pages
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Contents: +
Executive Summary ...................................... 3 Opportunity Defined ..................................... 4 Property Description .................................... 5 Company Beta .............................................. 7 Cost of Debt .................................................. 8 Risk-Free Rate ............................................... 9 Equity Risk Premium ..................................... 9 Required Return on Equity .......................... 10 Comparable rents and properties .............. 11 Lease vs. Buy Analysis ................................ 14 Appreciation Assumptions .......................... 15 Decision Sensitivity Analysis ....................... 16 Appendix .................................................... 17
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Executive Summary: This report includes a Lease vs. Buy analysis in regards to an office/warehouse expansion opportunity that, based on our economic rationale, should be beneficial to UPS.
The analysis employs four key performance metrics (company beta, cost of debt, risk-free rate, and equity risk premium) used in the Capital Asset Pricing Model (CAPM) to calculate the required rate of return on equity to be compared to the Internal Rate of Return associated with either leasing the office/warehouse space or owning it.
Our analysis suggest that UPS should buy the office/warehouse space in question because of a combination of factors, such as UPS’s low cost of debt and low required return of equity invested. As our sensitivity analysis suggests, the current decision is quite stable even under some variation in the required return on equity (Re) and cost of debt (Rd), as well as variation in the NNN rent rates. Therefore, UPS should buy the building!
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A Great Opportunity for UPS
With its Latin America headquarters in Miami, located at 3401 NW 67th Avenue, Bld. 805, and continually growing volumes of international trade and commerce between the USA and Latin America, office space expansion seems to fit this path of growth in the economy.
Based on this premise, we concluded that UPS would benefit from a larger distribution/warehouse with an office/showroom/distribution in the same region, which would allow UPS to further capitalize on its proximity to the nearby Miami International Airport and Port of Miami infrastructures.
This map displays the distance between UPS’s Latin America headquarters in Miami (A) and the new office space located close to the Miami International Airport (B). The new warehouse/office building is only 10.8 miles or 20 minutes away from the currently leased UPS office and is truly direct to every airport, seaport and railway system in both Miami-Dade and Broward counties and can be easily accessed through the Florida Turnpike.
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Property Description
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Property Description (cont.)
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UPS' Beta
In our Lease vs. Buy analysis, we referred to Bloomberg Equity resource to determine the degree of UPS’s non-diversifiable firm-specific risk relative the risk-return trade-off in the economy, as measured by the Equity Risk Premium (ERP). We discovered that the Raw Beta of UPS averages at 0.885 over a 10-year period from 2003 to 2010. This score means that UPS is 11.5% less risky than the market, such as the S&P 500.
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UPS’s Cost of Debt
We also referred to Bloomberg to estimate UPS’s long-term cost of borrowing. As of May 7, 2013, UPS has three bonds outstanding, as shown on Bloomberg printout below. Two of the three outstanding issuances are callable bonds, which indicates the company’s uncertainty about future long-term interest rates and serves as a means of protection against interest rates fluctuations. The remaining bond is a bullet bond and, therefore, in not callable.
Based on the decision period in question (10 years), we looked at UPS’s bonds that would have their maturity dates as close to the end of our investment horizon as possible (year 2023), as well as offer relatively comparable risk-return tradeoff. The only UPS bond that fit our criteria was the first bond on the list, which matures in 2020 (three years off) and offers 2.333% Ask Yield to Maturity. Therefore, we concluded that the appropriate cost of debt for UPS is the Ask Yield to Maturity of around 2.50% (where the extra 0.167% is a risk premium we associated with the additional three years of uncertainty in UPS’s returns as views by potential investors/lenders.
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Bloomberg Equity output
Excel output
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Risk-free Rate As can be seen from the 10-Year Treasury Constant Maturity Rate chart below, the average rate of return over the last 10-year investment horizon is approximately 3.5%. This rate will be used next as a risk-free rate (Rf) in the Capital Asset Pricing Model (CAPM) equation to compute the required rate of return (Re) that UPS investors/lenders would demand.
Chart source: http://research.stlouisfed.org/fred2/graph/?s[ 1][id]=WGS10YR#
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Equity Risk Premium Based on a widely used source of implied equity risk premiums, such as Aswath Damodaran’s website (http://people.stern.nyu.edu/adamodar/), we obtained the average Equity Risk Premium over the past ten years is approximately 4.71%. This rate indicates that investors have been demanding a 4.71% premium to entice them to invest in higher risk equities instead of risk-free T-Bills.
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Capital Asset Pricing Model (CAMP)
Applying the Capital Asset Pricing Model’s formula Re = Rf + β(Rm – Rf), we calculated that the required return on equity with which UPS’s investors/ lenders will be content is 7.67%
Required Return on Equity +
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Comparable 1 8333 NW 53rd St Class Type: A RBA: 150,00 Rent/SF: 20.00 Year Built: 2010 Lease Type: NNN
Comparables Using Costar, we collected information on NNN lease rents on new and nice (not extravagant) large properties in
Medley/Hialeah office market. The comparables we obtained are as follows:
Comparable 2 9675 NW 117th Ave Class Type: A RBA: 150,350 Rent/SF: 24.50 Year Built: 2009 Lease Type: NNN
Comparable 3 9725 NW 111th Ave Class Type: A RBA: 118,287 Rent/SF: 24.50 Year Built: 2007 Lease Type: NNN
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+ Comparables (cont.)
When looking at the market statistical data for office space we decided to go with the Medley/ Hialeah Market due to the proximity to Flagler Station. We felt that using the statistical data for office space in Miami-Dade County would have been a broader look at the market and not represented the office market around Flagler Station.
According to CoStar’s First quarter report for 2013 the Medley/ Hialeah quoted rates are $24.44, when compared to Miami-Dade County quoted rates which are $28.36, it is clear to see that the Medley/Hialeah market is at the lower end of the Miami-Dade Office market. The lowest quoted rates were Miami-Dade Central County for $17.83 and the Highest were in Brickell for $38.52. It is important to not that these quoted rates are a blend of Class A, B, and C Office space for their respective area.
Medley/Hialeah Office Market
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+ Comparables (cont.) Historical Analysis for All Cases
Historically quoted rental rates in the Medley/Hialeah Market have been on a decline going as far back as the 4th quarter of 2009 for the blend quoted rate.
Historically absorption rates since 2009 have been negative with blended vacancy rates maintain themselves at 12%.
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Assumptions:
1. Property Appreciation Rate We assumed an annual average appreciation rate of 2.5% to hold for 6 years until 2018. We based this assumption on average rate of US inflation, which has been around 2-2.5% over the last ten years.
2. NNN Rent Based on our CoStar research of competitive properties in the area, we have determined that a $20 psf NNN rent rate should be appropriate for this analysis.
Chart source: http://www.tradingeconomics.com/united-states/inflation-cpi
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Sensitivity Analysis: In regards to its office/warehouse space expansion, the most advantageous decision for UPS is to buy the building instead of renting it.
This decision rests on a combination of factors, such as UPS’s low cost of debt and low required return of equity invested. As the tables below suggest, the current decision is quite stable even under some variation in the required return on equity (Re) and cost of debt (Rd), as well as variation in the NNN rent rates. Therefore, UPS should buy the building!
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Appendix
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Comparable 1
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Comparable 2
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Comparable 3
Office Depot. (ODP) 7 May 2013
P a g e | 1
University of Miami
*Sources: Bloomberg unless otherwise stated
Office Depot (ODP)
University of Miami
7 May 2013 │ 14 pages
North America │ United States
Lease vs. Buy Analysis
Core Business Line o Office Supplier
Building - 150,000 square foot office building in West Miami
Low Rental Rates – improve the benefits of leasing rather than
buying. Low rates help decrease the opportunity cost supported
through buying.
High Required Cost of Debt – makes buying the less advantageous
option as interest expense consumes a large amount of Cash Flow.
High Required Cost of Equity – as shown through the CAPM
discounts Cash Flow at over 15%, which is higher than the IRR of
13.88%
Decision – Rent rather than Buy
Analysts Covering:
Jeremy Mizraji & Eric Krieger
T: (973)-650-8814
T: (954)-483-4105
Important Metrics o IRR: 13.88%
o Re: 15.48%
o Rd: 6.00%
o NPV: ($844,875)
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Contents Opportunities for Office Depot ..................................................................................................................... 3
Cost of Debt ................................................................................................... Error! Bookmark not defined.
Beta ................................................................................................................ Error! Bookmark not defined.
Risk-Free Rate ............................................................................................................................................... 6
Equity Risk Premium ..................................................................................................................................... 7
Capital Asset Pricing Model .......................................................................................................................... 8
Comparable Area .......................................................................................................................................... 9
Comparable Office Rents ....................................................................................................................... 10-11
Net Absorption & Average Rent ................................................................................................................. 12
Appreciation ................................................................................................................................................ 13
Conclusion ...................................................................................................... Error! Bookmark not defined.
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Opportunities for Office Depot
With its global headquarters in Boca Raton, we gathered that Office Depot would benefit from
a logistics and storage facility in the region. This would further capitalize on the nearby port
and airport infrastructure at PortMiami and Miami International Airport. There is a plethora of
large warehouse and office structures in the Doral and Hialeah areas of northwestern Miami-
Dade County that fit the aforementioned criteria. Moreover, we believe that Office Depot’s
present merger with Office Max necessitates a more modern and streamlined distribution
center.
The map displays the distance between Office Depot’s global headquarters in Boca Raton (A)
and the new distribution facility located near Miami International Airport (B). Even though the
locations are 45 minutes away, they are both easily accessible through highway and rail.
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Cost of Debt
Three outstanding issuances appeared after searching Bloomberg for Office Depot’s
outstanding debt. Unfortunately, all three issuances were callable. After further researching
comparable companies’ bond issuances, we determined that the office supply industry only
issues callable bonds as a means of protecting against interest rate inconsistency. Also, one of
the issuances had a maturity time within 2013, so we did not include the 6.25% coupon bond in
our analysis. After comparing the two remaining USD, fixed, callable bonds with a TTM of
3/15/19, we concluded that the appropriate cost of debt is the ask yield to maturity of
approximately 6.00%.
Amortization Schedule 2013 2014 2015 2016 2017 2018
LTV 60%
Loan Amount ($19,200,000)
Loan Rate 6.00%
Amortization Term 30
Loan Life 6
Loan Payment $1,394,859
Beginning Balance ($19,200,000) ($18,957,141) ($18,699,710) ($18,426,834) ($18,137,585) ($17,830,981)
Interest ($1,152,000) ($1,137,428) ($1,121,983) ($1,105,610) ($1,088,255) ($1,069,859)
Principal $242,859 $257,431 $272,876 $289,249 $306,604 $325,000
Ending Balance ($18,957,141) ($18,699,710) ($18,426,834) ($18,137,585) ($17,830,981) ($17,505,980)
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Beta
We utilized Bloomberg Equity information to determine Office Depot’s Raw Beta of
approximately 2.084. Office Depot is approximately 208.4% riskier than the Market (S&P 500).
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Risk-Free Rate
The 10-Year Treasury Constant Maturity Rate has averaged approximately 3.5% over the last
ten years. This rate will suffice as our risk-free rate within our CAPM equation.
http://research.stlouisfed.org/fred2/graph/?s[1][id]=WGS10YR
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Equity Risk Premium
According to Aswath Damodaran’s website, the average Equity Risk Premium over the past five
years is approximately 5.75%. Investors have been demanding a 5.75% premium when
deciding to invest in higher risk equities rather than risk-free treasury bills.
http://people.stern.nyu.edu/adamodar/
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Capital Asset Pricing Model
Re = Rf + B(ERP)
Through FRED’s 10-Year Treasury Constant Maturity Rate, we have calculated the Risk-Free
Rate to be 3.5%.
Re = 3.5% + B*(ERP)
After consulting Damodaran’s website, we have determined that the average Equity Risk
Premium over the past five years is approximately 5.75%.
Re = 3.5% + B*(5.75%)
We utilized Bloomberg to derive a Raw Beta of 2.084.
Re = 3.5% + 2.084(5.75%)
Re = 15.48%
After-Tax Incremental Lease vs. Buy Analysis 2013 2014 2015 2016 2017 2018
Corporate Tax Bracket 35%
Required After-Tax Return on Corporate Equity Invested in Real Estate 15.48%
Annual After-Tax Incremental Cash Flow to Owning
Depreciation Tax Shelter (TB * Dep.) $242,308 $242,308 $242,308 $242,308 $242,308 $242,308
Interest on an After-Tax Basis (Int * (1-TB)) ($748,800) ($739,328) ($729,289) ($718,647) ($707,366) ($695,408)
After-Tax Lease Payment SAVED (Lease * (1-TB)) $1,950,000 $1,998,750 $2,048,719 $2,099,937 $2,152,435 $2,206,246
Loan Principal Paid ($242,859) ($257,431) ($272,876) ($289,249) ($306,604) ($325,000)
Net Annual After-Tax Incremental Cash Flow to Owning $1,200,649 $1,244,299 $1,288,861 $1,334,349 $1,380,773 $1,428,145
Ending After-Tax Incremental Cash Flow to Owning $16,887,176
Net After-Tax Incremental Cash Flow to Owning $1,200,649 $1,244,299 $1,288,861 $1,334,349 $1,380,773 $18,315,321
Present Value of Incremental Ownership Cash Flows $11,955,125
Purchase Price ($32,000,000)
Loan $19,200,000
Owner's Initial Equity Contribution ($12,800,000)
NPV of Incremental Decision to Own INSTEAD of Lease ($844,875)
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Comparable Area
In order to determine our comparable properties, we chose a range of office and industrial
properties with a close proximity to Miami International Airport. The yellow square above
displays the main target area of our search. We also further refined our search to only include
properties built after 2000 and within 100,000 and 200,000 square feet.
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Comparable Office Rents
Office Building RBA/GLA SF
Available Rent/SF/Year Year Built
A - Royal Palm Offices at Doral 122,000 23,553 21.00 1972/2007
B - Palmetto West Park Phase III 108,668 75,673 15.61 2007
C - 8333 Downtown Doral 150,000 51,431 20.00 2010
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Palmetto West Park Phase III seems to be the third phase of a larger development where the
first two phases have been completely leased out. For some reason this building is far from
fully leased and thus skews the comparable rents in this submarket. For this reason we have
chosen an average rent that is closer to comparable properties A and C, which results in a
weighted average rent of approximately $20.00 PSF.
(Tenant Improvements were not included as they would only further progress the decision to rent).
Office Building Rent/SF/Year Weight Royal Palm Offices at Doral 21.00 45%
Palmetto West Park Phase III 15.61 10%
8333 Downtown Doral 20.00 45%
Total $20.01 100%
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Net Absorption & Average Rent
Apparently, a substantial amount of office and industrial space was delivered onto the market
surrounding the airport around 2010. After much of this space was absorbed, the vacancy rate
for this submarket has remained around 14% for the last year.
Office rents have grown towards the upper $20’s range in this submarket.
Office Depot. (ODP) 7 May 2013
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University of Miami
*Sources: Bloomberg unless otherwise stated
Conclusion
Office Depot should choose to lease rather than buy the 150,000 square foot office building in
West Miami. This decision can be attributed to a combination of fairly low rental rates, a high
cost of debt, as well as a high required cost of equity capital. As displayed in the charts above,
buying does not become the appropriate course of action until extreme assumptions are
extrapolated. For now, Office Depot should choose to rent.
After-Tax IRR on Decision to Own INSTEAD of Lease 2013 2014 2015 2016 2017 2018
After-Tax Owning Cash Flows: ($12,800,000) $1,200,649 $1,244,299 $1,288,861 $1,334,349 $1,380,773 $18,315,321
IRR on After-Tax Cash Flows 13.88%
Compare to Required Return on Equity Investment 15.48%
NPV ($844,875) $14 $17 $20 $23 $26
13.48% ($2,213,819) ($996,493) $220,834 $1,438,161 $2,655,488
14.48% ($2,694,557) ($1,510,854) ($327,152) $856,551 $2,040,254
15.48% ($3,147,950) ($1,996,412) ($844,875) $306,663 $1,458,200
16.48% ($3,575,797) ($2,455,047) ($1,334,297) ($213,547) $907,204
17.48% ($3,979,766) ($2,888,501) ($1,797,235) ($705,970) $385,296
Decision: More Likely to Lease
Rent Rate
Re
IRR 13.88% 4.00% 5.00% 6.00% 7.00% 8.00%
25.00% 16.63% 15.74% 14.83% 13.90% 12.94%
30.00% 16.02% 15.20% 14.36% 13.48% 12.59%
35.00% 15.41% 14.66% 13.88% 13.07% 12.24%
40.00% 14.80% 14.11% 13.40% 12.66% 11.90%
45.00% 14.19% 13.57% 12.92% 12.24% 11.55%
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