1. **Problem Statement:** TM Supermarkets currently have a lease with 3 years remaining at a rent of 220000 per annum. The market rent is 270000 per annum, and the landlord wants to grant a new 10-year lease with 5-year rent reviews. We need to advise on an acceptable rent level if the current lease is surrendered and a new lease granted. 2. **Key Information and Assumptions:** - Current lease rent: $220000$ p.a. with 3 years left, no review. - Market rent: $270000$ p.a. - New lease term: 10 years with rent reviews every 5 years. - Capitalisation rate for freehold interests: $10\%$. - Rent reviews imply rent can adjust to market rent every 5 years. 3. **Valuation from Landlord's Perspective:** The landlord values the lease based on the present value of future rents. - Present lease value (3 years at $220000$): $$PV_{current} = 220000 \times \frac{1 - (1+0.10)^{-3}}{0.10}$$ Calculate: $$PV_{current} = 220000 \times \frac{1 - (1.10)^{-3}}{0.10} = 220000 \times 2.4869 = 547118$$ - New lease value (10 years with rent reviews at year 5): Assuming rent is $R$ for first 5 years and adjusts to market rent $270000$ for next 5 years. Present value of first 5 years at rent $R$: $$PV_1 = R \times \frac{1 - (1+0.10)^{-5}}{0.10} = R \times 3.7908$$ Present value of next 5 years at $270000$ discounted back 5 years: $$PV_2 = 270000 \times \frac{1 - (1+0.10)^{-5}}{0.10} \times (1+0.10)^{-5} = 270000 \times 3.7908 \times 0.6209 = 636000$$ Total present value of new lease: $$PV_{new} = PV_1 + PV_2 = 3.7908 R + 636000$$ 4. **Valuation from Tenant's Perspective:** The tenant currently pays $220000$ p.a. for 3 years, then market rent $270000$ p.a. thereafter. Present value of current lease and market rent after 3 years: - Value of current lease (3 years at $220000$): same as landlord, $547118$. - Value of market rent from year 4 to 10 (7 years at $270000$): $$PV_{market} = 270000 \times \frac{1 - (1+0.10)^{-7}}{0.10} \times (1+0.10)^{-3} = 270000 \times 4.8684 \times 0.7513 = 987000$$ Total value to tenant: $$PV_{tenant} = 547118 + 987000 = 1,534,118$$ 5. **Determining Acceptable Rent $R$ for New Lease:** The landlord wants the new lease value to be at least equal to the current lease value plus the value of the market rent after 3 years (tenant's perspective), so: $$3.7908 R + 636000 \geq 1,534,118$$ Solve for $R$: $$3.7908 R \geq 1,534,118 - 636,000 = 898,118$$ $$R \geq \frac{898,118}{3.7908} = 236,900$$ 6. **Recommended Course of Action:** - The landlord should set the initial rent $R$ at approximately $236,900$ per annum for the first 5 years. - This rent is higher than the current $220,000$ but lower than the market rent $270,000$, reflecting a fair compromise. - Rent reviews every 5 years ensure rent aligns with market conditions, protecting landlord's income. - Assumptions include stable market rent and capitalisation rate. This approach balances landlord's income expectations and tenant's ability to pay, making the lease attractive and fair.