User Decision Analysis for Commercial Investment Real Estate
What is being tested
User decision analysis takes the occupier's point of view: should this business lease, buy, build, renew, relocate, or expand? The answer comes from comparing alternatives that deliver the same space program over the same time horizon, on a present-value basis.
Concepts to master
- Occupancy cost: rent plus operating expenses and taxes paid by the user, plus ownership costs (financing, capital, maintenance), less tax benefits and residual value.
- Lease economics: base rent, escalations, expense stops, free rent, tenant improvement allowances, and effective rent.
- Ownership economics: equity requirement, loan terms, depreciation, capital events, and net sale proceeds.
- Sale-leaseback: converting owned real estate into working capital while retaining occupancy, at the cost of flexibility and future appreciation.
- Discounting at the user's cost of capital or borrowing rate; after-tax treatment when tax position differs among alternatives.
- Incremental analysis for expansions and short-term versus long-term commitments.
Traps
- Comparing a five-year lease with a twenty-year ownership without matching horizons or crediting residual value.
- Summing undiscounted costs; the timing of TI, moving costs, and escalations matters.
- Using the property's projected IRR as the user's discount rate instead of the company's cost of capital.
- Omitting transaction costs, double rent during relocation overlap, and restoration costs on the old space.
- Treating sunk costs (existing improvements, prior studies) as relevant.
- Ignoring flexibility and option value when the business is growing or volatile.
Worked example
Face rent is $25.00/SF per year on a five-year lease with twelve months free and a $30.00/SF TI allowance. Total rent is $125.00/SF; subtract free rent ($25.00) and TI ($30.00) to get $70.00/SF over five years, an effective rent of $14.00/SF per year - a 44% discount to the face rate.
Rule of thumb: when two alternatives are close in present value, the more flexible one wins; flexibility has value a static model misses.