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15

Advances in Business Research

2010, Vol. 1, No. 1, 15-25

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 !!"#$%$&'()#*+,(#&-(.$%/(01(2033,"4$#*( %%,5%6(75"#5$18$&'(59,(:0-$;,-(<&5,"&#*(.#5,(01(

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In comparative project valuations, there is an assumption of equality of risk across investments. Two commercial 

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1((!5"1),!%1("+$.0%&$#%+.2!0"$#0:%;3+0%515!#%5#!0!."0%1%"!(3.+<*!%"31"%!.31.(!0%"3!%'.1,%+.2!0" !."%-!(+0+$.%5#$(!00:%

=5!(+'(1,,>9% "3+0%515!#%5$0+"0% "31"9%0*5!#+$#% "$% "3!%?."!#.1,%@1"!%$&%@!"*#.%A?@@B9%0"#1"+&>+./% "3!%C$-+'!-%?."!#.1,%

@1"!%$&%@!"*#.%AC?@@B%5#$2+-!0%1.$"3!#%,1>!#%$&%#+0D%1.1,>0+0%"31"%&1(+,+"1"!0%5#$E!("%($ 51#+0$.0%!2!.%F3!#!%$"3!#%

"!(3.+<*!0%312!%,!-%"$%($.G+("+./%#!0*,"0:

In making commercial real estate valuation decisions, the process of analyzing competitive locations is based 
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return, and the degree of risk associated with each of the capital projects. This paper posits that with the appraisal of 
the value of commercial assets, real options exist for an investor. It compares the existence of a European Put Option 
>.(2(*2()(23!0$*)#85(*?-2033*3(88!$-*62!<(@*<#$*0<<52*0$84*#'*'.(*($%*0=*'.(*8(#3(*'(29*#$%*#$*A9(2!<#$*/5'*B6'!0$*
>.(2(*2()(23!0$*<#$*.#66($*#'*#$4*'!9(*%52!$-*'.(*.08%!$-*6(2!0%C*&6(<!D<#884+*!'E3*'.(*62(3($<(*0=*:0'.*'.(*F5206(#$*
and American Put Options that gives the investor the right but not the obligation to make a sell decision.  Just like 
>!'.*D$#$<!#8*06'!0$3+*'.(*)#85(*0=*'.(*2(#8*06'!0$*!3*<0$'!$-($'*0$*=5'52(*()($'?3@*35<.*#3*$('*8(#3(*2()($5(*2(<(!6'3*
and the expected future re-sale value.  

G.(*)#85(*0=* 2(#8*(3'#'(*620H(<'3*#2(* 8!I(84* '0*"5<'5#'(*3'0<.#3'!<#884*#$%* '.(* !$)(3'02*>!88*<.003(* '0*(;(2<!3(*
'.(*06'!0$+*'.(2(*!3*$0*0:8!-#'!0$+*>.($*!'*!3*6(2<(!)(%*'0*:(*J!$K'.(K90$(4E*?L!;!'*#$%*/!$%4<I+*MNNO@C*G.!3*6#6(2*
recognizes and supports prior works which state that investors have the choice to make net capital expenditures with 
02*>!'.05'* '.(*#:!8!'4*'0*#:#$%0$*02*3(88K0==* '.(*620H(<'C*P'*=0<53(3+*:#3(%*0$*#<'5#8*2(#8*(3'#'(*%#'#+*0$*#*36(<!D<*
95'5#884*(;<853!)(*<#3(*:('>(($*'>0*3!9!8#2*0=D<(*:5!8%!$-3*!$*9('20*%0>$'0>$*Q.!<#-0C***

P$*'.(*'2#%!'!0$#8*L!3<05$'(%*Q#3.*R80>*?LQR@*620<(33+*'.(*P$'(2$#8*S#'(*0=*S('52$*?PSS@*!3*$029#884*53(%*'0*
rank the desirability of projects.  In order to determine the relative weights and timing of the various components of 
'.(*2('52$+*'.(*PSS*<#$*:(*6#2'!'!0$(%*?T25(--(9#$*#$%*R!3.(2+*UVVW@C*,0>()(2+*'.(*PSS*!3*35:H(<'*'0*>(#I$(33(3*
35<.*#3*620%5<!$-*958'!68(*2#'(3*0=*2('52$*%(6($%!$-*0$*'.(*3!-$*0=*'.(*<#3.*"0>3+*#$%*'.(*2#'(*!'3(8=*!3*53(%*#3*'.(*
2(!$)(3'9($'*2#'(*0=*2('52$*=02* '.(*620H(<'C*G.!3*6#6(2*#%)0<#'(3* '.(*53(*0=* '.(*X0%!D(%*P$'(2$#8*S#'(*0=*S('52$*
?XPSS@*#3*#$*#8'(2$#'!)(*:(<#53(*!'*>!88*$0'*620%5<(*958'!68(*2#'(3*0=*2('52$*#$%*53(3*'.(*<03'*0=*<#6!'#8*#$%*$0'*
itself as the reinvestment rate of return and offers a more conservative return. In an extension of the literature, 
the stratifying of the MIRR adds another layer to the risk analysis aspect that goes beyond that of the IRR and 
its partitioning. This paper looks at the related real option literature and the source of the data for the analysis, the 
methodology section and the empirical results, and the analysis of the empirical results and the conclusion end the paper.    

.=@ A=B(@<A=. AC.=

The impact of risk and uncertainty on rational decision rules used in the selection of projects to include in a 
<02602#'(*<#6!'#8*:5%-('*.#3*:(($*#*9#H02*D$#$<(*'06!<*=02*%!3<533!0$*#$%*2(3(#2<.C* !$'$(2*?MNYZ@*=05$%*'.#'*'.(*
expected return in a capital budgeting case was an increasing function of the risk-free rate of return, the market price 
of dollar risk, the project’s variance of returns, the aggregate present value of the project and its co-variance with 
(;!3'!$-*#33('3*0=*'.(*D29+*#$%*'.(*<0K)#2!#$<(*0=*'.(*620H(<'*>!'.*0'.(2*620H(<'3*!$<85%(%*!$*'.(*<#6!'#8*:5%-('C*A*
3!'5#'!0$*0=*<(2'#!$'4*(;!3'3*>.($*'.(*!$)(3'02*I$0>3*=02*352(*?MVV[*620:#:!8!'4@*>.#'*.!3*=5'52(*2('52$3*>!88*800I*
8!I(*? ()4*#$%*&#2$#'+*MNWO@C***

 00I!$-*#'*<#6!'#8*:5%-('!$-*5$%(2*5$<(2'#!$'4*?,5#$-*#$%* !'\(9:(2-(2+*MNWW@*#$%*? 5<#3*#$%*/2(3<0''+*MN]M@+*
53!$-*'.(*&.#26(K !$'$(2KT8#<I*90%(8*0=*<#6!'#8*9#2I('*(75!8!:2!59+*R#9#*?MN]]@*=05$%*'.#'*'.(*62(3($'*)#85(*0=*
(;6(<'(%*=5'52(*<#3.*"0>3*%(6($%3*0$*'.(*2!3IK#%H53'(%*%!3<05$'*2#'(3*=02*(#<.*0=*'.(*6(2!0%3*5$'!8*'.(*"0>*0=*=5$%3*
is realized. The discount rate experienced adjustments for risk over the time period due to the possible reassessment 
0=*'.(*=5'52(*<#3.*"0>3C*F)($*'.05-.*'.(*'2#%!'!0$#8*L!3<05$'(%*Q#3.*R80>*?LQR@*9('.0%*'#I(3*!$'0*#<<05$'*'.(*
'!9(*)#85(*0=*90$(4+*343'(9#'!<*<#3.*"0>3+*#$%*'.(*58'!9#'(*2(3#8(*0=*'.(*6206(2'4+*!'*.#3*#*>(#I$(33*!$*'.#'*!'*'($%3*
to be passive and does not capture the ability of the investor to adapt or revise their decisions in response to market 



16

Advances in Business Research

2010, Vol. 1, No. 1, 15-25

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developments. It is generally accepted that investors will follow a set of rigid rules and will not alter a project at any 
36(<!D<*3'#-(*0=*!'3*53(=58*06(2#'!$-*8!=(*?G2!-(02-!3+*MNN @̂+*?G2!-(02-!3*#$%*X#30$+*MNW]@C***

Real options allow investors to take a more strategic approach to decision making as they have the right but not 
'.(*0:8!-#'!0$*'0*9#I(*#$*!$)(3'9($'*%(<!3!0$C*_53'*#3*D$#$<!#8*06'!0$3*%(2!)(*'.(!2*)#85(*=209*'.(*5$%(284!$-*#33('+*
'.(*)#85(*0=*2(#8*06'!0$3*!3*<0$'!$-($'*0$*=5'52(*()($'3*?`!(+*UVVN@C*P$*#*2(<($'*>02I*:4*&'05'+*`!(+*#$%*a!*?UVVW@+*
they create a hypothetical example where the managers of a rental car company are faced with the problem of trying 
'0*%(<!%(*>.('.(2*'0*:54*#*"(('*0=*-#308!$(K60>(2(%*<#23*02*.4:2!%*)(.!<8(3*!$*8!-.'*0=*6($%!$-*$(>*-0)(2$9($'*
regulation. They claim that within this situation is an embedded abandonment option. There is an option to sell the 
-#3K60>(2(%*)(.!<8(*!$*#$4*0$(*4(#2*#'*#*36(<!D<*3#8)#-(*)#85(C*

G.(*75(3'!0$*:(<09(3*.0>*95<.*)#85(*!3*#%%(%*=209*'.(*#:#$%0$9($'*06'!0$*?T0$!$!+*MN]]@C*G.(*#:#$%0$9($'*
06'!0$*!3*#$#80-053*'0*#$*A9(2!<#$*/5'*06'!0$*0$*#*%!)!%($%*6#4!$-*3(<52!'4C*T(2-(2+*B=(I+*#$%*&>#24*?MNNZ@*62(%!<'*
'.#'*9#2I('*)#85(*!3*603!'!)(84*2(8#'(%*'0*8!75!%#'!0$*)#85(*#='(2*<0$'2088!$-*=02*'.(*2(8#'!0$*:('>(($*#*D29E3*9#2I('*
)#85(*#$%*!'3*(;6(<'(%*=5'52(*<#3.*"0>3C*Q0$<(2$(%*>!'.*)#85!$-*620H(<'3*'.#'*.#%*3()(2#8*06'!0$3*#)#!8#:8(*#$%*'.($*
75#$'!=4!$-*'.(!2*!$'(2#<'!0$3+*G2!-(0-!3*?MNN @̂*=05$%*'.#'*'.(*)#85(*0=*2(#8*06'!0$3*9#4*$0'*:(*#%%!'!)(C*b#85!$-*'>0*
06'!0$3*!$*#*'088K20#%*620H(<'*!$*A53'2#8!#+*S03(*?MNNW@*=05$%*'.#'*#'*8(#3'*0$(*0=*'.(*06'!0$3*%!368#4(%*#*3!-$!D<#$'*
)#85(C*G.(*!$'(2#<'!0$*:('>(($*'.(*06'!0$3*!$"5($<(%*'.(*0$(*3!-$!D<#$'*06'!0$*)#85(C*P-$02!$-*(9:(%%(%*06'!0$3*
<058%*2(358'*!$*5$%(2(3'!9#'!$-*'.(*)#85(*0=*#*620H(<'C*G.(*D$%!$-3*0=*'.(3(*8#''(2*'>0*>02I3*!9684*'.#'*'.(*"(;!:!8!'4*
'.#'*#<<25(%* '0*9#$#-(9($'* '.205-.* '.(*2(<0-$!'!0$*0=*#* 2(#8*06'!0$*<058%*:(*#3*(<0$09!<#884*3!-$!D<#$'*#3* '.(*
(;6(<'(%*=5'52(*<#3.*"0>3*0=*'.(*620H(<'C

B#5#(.,D$,E

The data for the comparison of alternative real estate investments is obtained from REIS, Inc. The company 

!3* #*620)!%(2*0=* <099(2<!#8* 2(#8* (3'#'(*6(2=029#$<(*%#'#*#$%*#$#843!3C* P'* 36(<!D<#884* =0<53(3*0$* '.(*9('20* ?<!'4@+*

35:9#2I('*?$(!-.:02.00%@+*#$%*6206(2'4*8()(8C*G.(!2*!$'(2$('*3!'(*!3*www.reis.com. The site offers coverage of 80 U.S. 

9('20608!'#$*#2(#3*#$%*0)(2*U+^VV*35:9#2I('3*=02*'.(*0=D<(+*#6#2'9($'+*2('#!8+*#$%*!$%53'2!#8*3(<'023C*
G.!3* 6#6(2* #$#84\(3* #*95'5#884* (;<853!)(* 3!'5#'!0$* '.#'* 36(<!D<#884* <096#2(3* '>0* %0>$'0>$*Q.!<#-0* 0=D<(*

building investments, Projects Riverside and LaSalle. Their valuations will follow a traditional discounted cash 
"0>*?LQR@*620<(33C*G.(*6.43!<#8*<.#2#<'(2!3'!<3*=02*/20H(<'3*S!)(23!%(*#$%* #&#88(*#2(*62(3($'(%*!$*G#:8(*P*>.!8(*
'.(*6(2'!$($'*%088#2*6(2*375#2(* =00'*%#'#+*53(%* !$* '.(*LQR*90%(8+* =02*(#<.*6206(2'4+* !3* 2(602'(%* !$*G#:8(* PPC*G.(*
initial outlay for Project LaSalle was approximately $108.7 million and the initial outlay for Project Riverside was 
approximately $144.1 million. These are historical purchase prices from 2008 based on data from REIS, Inc.

A#F*,(<6(>98%$4#*(29#"#45,"$%5$4%(10"(>"0G,45%(.$D,"%$-,(#&-(@#7#**,
 

A#F*,(<<6(B0**#"(!,"(7H+#",(I005(J!%1K(B#5#(10"(>"0G,45%(.$D,"%$-,(#&-(@#7#**,(

c0'(3*=02*G#:8(*G>0E3*8!$(*!'(93d

e* A88*6(2*375#2(*=00'*?63=@*D-52(3*#2(*0$*#$*#$$5#8*:#3!3C**

e* c('*S($'#:8(*A2(#*?cSA@*0=*#*:5!8%!$-*!$<85%(%*!$*'.(*'2#$3#<'!0$+*(;62(33(%*!$*375#2(*=(('+*!3*#$*#6620;!9#'!0$*

:#3(%*0$*)(2!D(%*65:8!<*2(<02%3C**

Project Name Project Riverside Project LaSalle 

City Chicago Chicago 

Property Type Multi-Tenant Multi-Tenant 

Building Area (sf) 702,439 621,428 

Buildings/Floors 1/22 1/30 

Year Built/Renovated 1965/1994 1984/not yet 

 

Property Address Project Riverside Project LaSalle 

Net Rentable Area (psf) 702,439 621,428 

Sale Price (psf) $205.00  $175.00 

Average Asking Rent (psf) $27.51 $26.36 

Vacancy Loss Rate (%) 14.40% 9.20% 

Expense Stop (psf) $12.89 $10.91 

Free Rent Concessions (psf) $0.23 $0.25 

Credit Loss (%) 1.00% 1.00% 

Operating Expenses (psf) $14.12 $11.89 

Capital Reserves (psf) $0.10 $0.11 

Going-In-Cap-Rate (%) 5.20% 7.50% 



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Advances in Business Research

2010, Vol. 1, No. 1, 15-25

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e* The potential rent revenue is the product of the building rentable area estimate and the average asking rent which 

is the market rent paid by a potential tenant.

e* &#8(*/2!<(*?63=@*!3*'.(*652<.#3(*62!<(*0=*'.(*6206(2'4*6(2*375#2(*=00'*0=*$('*2($'#:8(*#2(#*?cSA@C*

e* A3I!$-*S($'*=02*0=D<(*6206(2'!(3*!3*#*>(!-.'(%*#)(2#-(*750'(%*#3*#$$5#8*-2033*2($'*6(2*375#2(*=00'C*

e* Vacancy losses are estimated rent losses from unoccupied space and unpaid rents.

e* The Expense Stop creates an upper limit on the amount of operating expenses that the owner will be responsible 

for.  

e* Expense Reimbursement Recovery is the difference between the operating expense psf and the expense stop psf.  

The excess must be paid by the tenant. The recoverable operating expenses are property taxes, insurance, and 

maintenance.  

e* R2((*S($'*Q0$<(33!0$+*'0*!$%5<(*'.(*8(#3(*3!-$!$-+*!3*'.(*0==(2*0=*#*=2((*2($'*6(2!0%*%52!$-*>.!<.*$0*2($'*!3*2(75!2(%*

to be paid. It is the total dollar amount or number of months free rent granted per lease terms.   

e* Q2(%!'* 033*!3*'.(*'0'#8*#905$'*0=*2($'*%5(*'.#'*'.(*8#$%802%*!3*5$#:8(*'0*<088(<'*%5(*'0*'($#$'*%(=#58'C*

e* B6(2#'!$-*F;6($3(3*#2(*'.(*#)(2#-(*#$$5#8*<03'3+*6(2*375#2(*=00'+*0=*06(2#'!$-*:5!8%!$-3*'.#'*!$<85%(*6206(2'4*

taxes, energy, janitorial service, insurance, common area maintenance, and management and leasing fees.

e* Q#6!'#8*S(3(2)(3*!3*#$*#880>#$<(*'.#'*620)!%(3*'.(*6(2!0%!<*2(68#<(9($'*0=*:5!8%!$-*<0960$($'3*'.#'*>(#2*05'*

more rapidly than the building itself. They must be replaced during the economic life of the building.  

e* G.(*2(602'(%*(3'!9#'(%*f0!$-K!$*Q#6!'#8!\#'!0$*S#'(*?Q#6*S#'(@*<#$*:(*<096#2(%*'0*'.(*S(!3*P$%(;(%*X('20*B=-

D<(*Q#6*S#'(*0=*]CO[C*G.(*SFP&*P$%(;(%*X('20*B=D<(*Q#6*S#'(*!3*90%(8(%*#3*#*=5$<'!0$*0=*2!3IK=2((*!$'(2(3'*

rates, metro rent growth expectations, current construction activity, and by running measures of volatility in rents. 

These measures are proxies for capital conditions, income expectations, and risk.

SFP&+*P$<C*#830*<096!8(3*#--2(-#'(*9('20*6206(2'4*%#'#*'.205-.*X('20*A$#843!3+*S($'*Q096#2#:8(3*#$%*&#8(3*
Q096#2#:8(3*2(602'3C*G.(*9('20*02*9('20608!'#$*#2(#*!3*#*-(0-2#6.!<#8*%!)!3!0$*0=*'.(*1$!'(%*&'#'(3*'.#'*!$<85%(3*
#*9#H02*<!'4+*=02*(;#968(+*Q.!<#-0+*#$%*!'3*352205$%!$-*<0995$!'!(3*#$%*<05$'!(3C*G.(3(*X('20*A$#843!3*2(602'3*
offer reasonable property benchmarks for the time frame of the paper’s study. Relevant facts from their analyses are 
presented in Table III below.                                                                                                     

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c0'(3d

e* Vacancy Rate is the amount of available space expressed as a percentage of total inventory.

e*  (#3(*'(29*!3*'.(*#)(2#-(*'(29*<522($'84*:(!$-*750'(%*=02*$(>*8(#3(3+*!$*4(#23C

e*  (#3!$-*Q099!33!0$*!3*#$*#905$'*6#!%*'0*#*2(#8*(3'#'(*:20I(2*!$*(;<.#$-(*=02*:2!$-!$-*'0-('.(2*'.(*6#2'!(3*0=*'.(*

lease agreement.

e* Usually it’s paid in the form of a percentage of the yearly rent.

e* Q0$3'25<'!0$gA:3026'!0$*!3*'.(*<0$3'25<'!0$*02*<0968('!0$3*%52!$-*'.(*'!9(*6(2!0%*%!)!%(%*:4*#:3026'!0$*%52!$-*

the same time period.

e* h&'#:!8!\#'!0$*!3*#<.!()(%*>.($*'.(*#)(2#-(*)#<#$<4*2#'(*0=*'.(*6206(2'!(3*:5!8'*!$*#$4*-!)($*4(#2*(75#83*02*!3*8(33*

'.#$*'.(*X('20E3*#)(2#-(*0)(2#88*)#<#$<4*2#'(*=02*'.(*8#3'*D)(*4(#23C

G.(3(* <099(2<!#8* #33('3* #2(* #<75!2(%* 35:H(<'* '0* (;!3'!$-* 8(#3(3* #3* $0'(%* :4* '.(* 8(#3(* '(293* #$%* 8(#3!$-*
commissions in Table III. Even if this were a new development project, the property lease would be based on typical 
leases in the marketplace. The lease and its terms, such as rent and expense reimbursements, must be accounted for in 
'.(*<#8<58#'!0$*0=*'.(*6206(2'4E3*2(8()#$'*=5'52(*$('*06(2#'!$-*!$<09(*?cBP@*#$%*=5'52(*2()(23!0$*?Sb@*02*3#8(*62!<(C*
G.(*8($-'.*0=*'.(*6206(2'4*8(#3(+*'.!3*3'5%4*53(3*#$*#)(2#-(*D)(*4(#2*6(2!0%+*6853*!'3*0'.(2*36(<!D<*'(293*#==(<'*'.(*
risk and return of the respective projects and cannot be ignored in the determination of the expected future property 
<#3.*"0>3C**

Annualized 5-year Rent Growth 2.1% 

Annualized 5-year Vacancy Rate 17.6% 

Average Lease Term (years) 5.5 

Average Leasing Commissions 4.1% 

Annualized 5-year Construction/Absorption 1.9 

Inflation Rate per www.InflationData.Com 3.85% 

Stabilization Rate* 68.18% 

 



18

Advances in Business Research

:=AN?B?@?OP

P$*02%(2* '0*<0$3!%(2* '.(*<.0!<(*:('>(($*/20H(<'*S!)(23!%(*#$%*/20H(<'* #&#88(+* '.!3*6#6(2*62(3($'3*#*D$#$<!#8*
analysis that enables an investor to assess whether the risk associated with these projects is commensurate with 
their expected returns. The concept of due diligence is critical and is extended by this paper by reviewing the risk-
return tradeoff within an American and European Put Option framework. Within these two real option strategies, 
#*%!3<05$'(%* <#3.*"0>* ?LQR@*9('.0%* !3* =0880>(%* #80$-*>!'.* '.(* <096#2!30$*0=* :0'.* '.(* PSS*#$%*XPSSC*G.!3*
comparison is further enhanced by contrasting the partitioning of the IRR with the stratifying of the MIRR. The 
relevancy of the latter accrues from the overall strengths of the MIRR over the IRR and the ability of an investor to 
%('(29!$(*.0>*95<.*0=*'.(*2('52$*!3*#330<!#'(%*>!'.*'.(*#$$5#8*=5'52(*06(2#'!$-*<#3.*"0>3*0=*'.(*620H(<'*#$%*'.(*
'!9!$-*0=*'.(*(3'!9#'(%*=5'52(*<#3.*"0>*=209*'.(*2(3#8(*0=*'.(*6206(2'4C*P'E3*'.(*>(!-.'3*#330<!#'(%*>!'.*'.(3(*'>0*
36(<!D<*<#3.*"0>*<0960$($'3*'.#'*#880>3*'.(*!$<02602#'!0$*0=*2(8#'!)(*2!3I*>.!<.*($#:8(3*#$*!$)(3'02*'0*<096#2(*
620H(<'3*()($*>.(2(*0'.(2*'(<.$!75(3*.#)(*8(%*'0*<0$"!<'!$-*2(358'3*?/8#'.*#$%*i($$(%4+*MNNO@C*

Regarding the two commercial projects, the appeal of the properties is not for the use or occupancy of the owner, 
they are considered to be income producing assets. Income properties are bought and sold on their ability to generate 
=5'52(*!$<09(*3'2(#93C*G.!3*!$<09(*3'2(#9*!3*#*<#3.*"0>C*13!$-*'.(*%!3<05$'(%*<#3.*"0>*9('.0%*?LQR@+*#$*!$)(3'02*
will capitalize the expected future net operating income associated with the property and determine the asset’s 
(3'!9#'(%*$('*62(3($'*)#85(*?f#88!$(88!*UVVN@C*G.(*LQR*#$#843!3*.(863*'0*%('(29!$(*!=*#*620603(%*620H(<'*<#$*-($(2#'(*
strong enough risk-adjusted returns. It is a standard framework for multi-period real estate investment analysis. For 
/20H(<'3*S!)(23!%(*#$%* #&#88(+*:0'.*62(3($'*<.#$-!$-*2($'*20883*#$%*8(#3(*2($(>#83*#$%*8(#3(*)#2!#:8(3*?!$"#'!0$@*'.#'*
can change the level of gross operating income. Also impacted are the operating expenses and expense reimbursements 
>.!<.*#==(<'*:0'.*'.(*$('*06(2#'!$-*!$<09(*?cBP@*=02*(#<.*4(#2*#$%*'.(*$('*'(29!$#8*)#85(*02*2()(23!0$*?Sb@*?L( !38(+*
UVVN@C*G.(*:#3!<*LQR*90%(8*'0*()#85#'(*'.(*6206(2'4E3*$('*62(3($'*)#85(*?c/b@*!3d

c/b*B=D<(*T5!8%!$-*j*k*cBP
t 
g*?M*l*<#62@t l*Sb'*g*?Ml<#62@t – IO

0

G.(*c/b*!3*(75#8*'0*'.(*62(3($'*)#85(*0=*=5'52(*<#3.*!$"0>3*m*!$!'!#8*!$)(3'9($'+*>.(2(d

cBP*j*(;6(<'(%*$('*06(2#'!$-*!$<09(*?<#3.*"0>3@*=02*'.(*0=D<(*:5!8%!$-
Sb*j*2()(23!0$*?2(3#8(@*)#85(*0=*'.(*6206(2'4n*$('*'(29!$#8*)#85(
IO = initial investment outlay
<#62*j*Q#6!'#8!\#'!0$*S#'(*=02*'.(*0=D<(*:5!8%!$-
'*j*5$!75(*'!9(*6(2!0%*=02*(#<.*0=*'.(*(;6(<'(%*=5'52(*<#3.*"0>3

A#F*,(<)6(>"0G,45,-(Q,5(2#%9(I*0E(1"03(?!,"#5$0&%6(>"0G,45(.$D,"%$-,(

2010, Vol. 1, No. 1, 15-25

 !"#$%

S($'#:8(*A2(#*A33596'!0$*?3=@* ]VU+O^N

Average Asking Rate 3.85% $  27.51 $ 28.57 $ 29.67 $ 30.82 $ 32.00 $ 33.23  

Potential Rent Revenue 3.85% $  19,327,015 $ 20,071,105 $ 20,843,843 $ 21,646,331 $ 22,479,714 $ 23,345,183 

Vacancy Loss 14.40%   2,783,090  2,890,239  3,001,513  3,117,072  3,237,079  3,361,706

Effective Rent Revenue  $  16,543,925 $ 17,180,866 $ 17,842,329 $ 18,529,259 $ 19,242,635 $ 19,983,477

Operating Expense psf 3.85% $  14.12 $ 14.66 $ 15.23 $ 15.81 $ 16.42 $ 17.06

Expense stop psf 3.85%   12.89  13.39  13.90  14.44  14.99  15.57

Expense Reimbursement psf  $  1.23 $ 1.28 $ 1.33 $ 1.38 $ 1.43 $ 1.49

Expense Reimbursement  $  864,00 $ 897,264 $ 931,809 $ 967,683 $ 1,004,939 $ 1,043,629 

R2((*S($'*Q0$<(33!0$3* o**VCU^* * * MYM+ZYM* * MYM+ZYM* * MYM+ZYM* * MYM+ZYM* * MYM+ZYM* * MYM+ZYM* *

Q2(%!'* 033* MCVV[* * * 193,270  200,711  208,438  216,463  224,797  233,452

Effective Gross Revenue  $  17,053,094 $ 17,715,858 $ 18,404,139 $ 19,118,918 $ 19,861,216 $ 20,632,093

Total Operating Expenses  $  9,918,439 $ 10,300,299 $ 10,696,860 $ 11,108,689 $ 11,536,374 $ 11,980,524 

Q#6!'#8*S(3(2)(3* o**VCMV* * * 70,244  70,244  70,244  70,244  70,244  70,244  

Total Expenses  $  9,988,683 $ 10,370,542 $ 10,767,104 $ 11,178,933 $ 11,606,618 $ 12,050,768

c('*B6(2#'!$-*P$<09(*?cBP@*02*c('*Q#3.*R80>* * o* * 7,064,411 $ 7,345,315 $ 7,637,035 $ 7,939,985 $ 8,254,599 $ 8,581,325

hF;6(<'(%*!$"#'!0$*2#'(*!3*^CWZ[

**Other variable % and $ from Table II

P,#"( RSST( RSSU( RSVS( RSVV( RSVR( RSVW

 1 2 3 4 5 6



19

Advances in Business Research

c0'(3*=02*G#:8(3*Pb*#$%*bd

e* G.(*(3'!9#'(%*#)(2#-(*#$$5#8*!$"#'!0$*2#'(*#%H53'9($'*!3*^CWZ[C*G.(*cBP*!$<2(#3(3*(#<.*4(#2*()($*!=*8(#3(3*#2(*

not renewed.

e* Vacancy losses are estimated rent losses from unoccupied space and unpaid rents.

e* Expense Stop creates an upper limit on the amount of operating expenses that the owner will be responsible for.

e* Expense Reimbursement Recovery is the difference between the operating expense psf and the expense stop psf. 

The excess must be paid by the tenant. The recoverable operating expenses are property taxes, insurance, and 

maintenance.

e* R2((*S($'*Q0$<(33!0$+*'0*!$%5<(*'.(*8(#3(*3!-$!$-+*!3*'.(*0==(2*0=*#*=2((*2($'*6(2!0%*%52!$-*>.!<.*$0*2($'*!3*2(75!2(%*

to be paid. It is the total dollar amount or number of months free rent granted per lease terms.

e* Q2(%!'* 033*!3*'.(*'0'#8*#905$'*0=*2($'*%5(*'.#'*'.(*8#$%802%*!3*5$#:8(*'0*<088(<'*%5(*'0*'($#$'*%(=#58'C

e* Effective Gross Revenue is determined as the effective rent income plus the operating expense recoveries less the 

provisions for the free rent period and potential credit losses.

e* B6(2#'!$-*F;6($3(3*#2(*'.(*#)(2#-(*#$$5#8*<03'3+*6(2*375#2(*=00'+*0=*06(2#'!$-*:5!8%!$-3*'.#'*!$<85%(*6206(2'4*

taxes, energy, janitorial service, insurance, common area maintenance, and management and leasing fees.

e* Q#6!'#8*S(3(2)(3*!3*#$*#880>#$<(*'.#'*620)!%(3*'.(*6(2!0%!<*2(68#<(9($'*0=*:5!8%!$-*<0960$($'3*'.#'*>(#2*05'*

more rapidly than the building itself. They must be replaced during the economic life of the building.

e* c('*06(2#'!$-*!$<09(*?cBP@*!3*<#8<58#'(%*#3*'.(*$('*0=*'.(*(==(<'!)(*-2033*2()($5(*#$%*:0'.*'.(*06(2#'!$-*(;6($3(3*

and the provision for future capital outlays.

Even though the worksheet calculates the NOI, the measure is not income as described under generally accepted 
#<<05$'!$-* 62!$<!68(3* ?fAA/@* :5'* !3* <#3.* "0>C* G.(* '(29* cBP* !3* !$'(2<.#$-(#:8(* >!'.* '.(* $('* <#3.* "0>* =209*
operations.

If the appraised value of the project is a function of the income stream and the NOI results from the income stream 
that is generated from the operations of the property, the real estate investment is independent of external factors 
35<.*#3*'#;(3*02*D$#$<!$-C*G.(*!$)(3'02*!3*%(<!%!$-*560$*#*6206(2'4E3*!$<09(*60'($'!#8*$0'*'.(*6206(2'4*!'3(8=C*G.(*
before-tax NOI serves as an objective means of measuring the potential income stream from the property while the 
-0!$-K!$*<#6!'#8!\#'!0$*2#'(*#<'3*#3*#$*!$)(3'02E3*35:H(<'!)(*(3'!9#'(*0=*.0>*>(88*'.(*<#6!'#8*!3*2(75!2(%*'0*6(2=029*
?f#88!$(88!+*UVVO@C*G#;*:($(D'3*#2(*$0'*!-$02(%+*2#'.(2+*'.(*!968!<#'!0$*!3*'.#'*#$*!$)(3'02*>!88*<0$3!%(2*'.(*:(=02(*'#;*
<#3.*"0>3+*5$%(23'#$%!$-*'.#'*#*'#;*:($(D'*>!88*:(*2(#8!\(%*?T25(--(9#$*#$%*R!3.(2+*UVVW@C*

G.(*(;!3'!$-*D$#$<!$-*'(293*#2(*#3359(%*'0*:(*3!9!8#2*=02*:0'.*6206(2'!(3*#$%*#3*35<.+*'.(*(;6(<'(%*2('52$3*=02*
#$4*6#2'!<58#2*-2056*0=*!$)(3'023*3.058%*$0'*:(*!96#<'(%*:4*'.(*D$#$<!$-*0=*'.(*620H(<'C*P'E3*$0'*'.#'*!$'(2(3'*2#'(3*02*
#<<(33*'0*%(:'*9#2I('3*%0$E'*!96#<'*)#85(+*:5'*5$%(2*#$4*(<0$09!<*<8!9#'(+*#$*!$)(3'02**>!88*<.003(*'.(*(75!'4K%(:'*
#880<#'!0$*:#3(%*0$*'.(*%(-2((*0=*2!3I*'.#'*'.(4*#2(*903'*<09=02'#:8(*>!'.*?R!3.(2*UVVW@C*

2010, Vol. 1, No. 1, 15-25

 !"#$%

A#F*,()6(>"0G,45,-(Q,5(2#%9(I*0E(1"03(?!,"#5$0&%6(>"0G,45(@#7#**,(

Rentable A2(#*A33596'!0$*?3=@* YUM+OUW

Average Asking Rate 3.85% $  26.36 $ 27.37 $ 28.43 $ 29.52 $ 30.66 $ 31.84  

Potential Rent Revenue  $  16,380,033 $ 17,010,664 $ 17,665,575 $ 18,345,699 $ 19,052,009 $ 19,785,511 

Vacancy Loss 9.20%   1,506,963  1,564,981  1,625,233  1,687,804  1,752,785  1,820,267

Effective Rent Revenue  $  14,873,070 $ 15,445,683 $ 16,040,342 $ 16,657,895 $ 17,299,224 $ 17,965,244

Operating Expense psf 3.85% $  11.89 $ 12.35 $ 12.82 $ 13.32 $ 13.83 $ 14.36

Expense stop psf 3.85%   10.91  11.33  11.77  12.22  12.69  13.18

Expense Reimbursement psf  $  0.98 $ 1.02 $ 1.06 $ 1.10 $ 1.14 $ 1.18

Expense Reimbursement  $  608,999 $ 622,276 $ 635,807 $ 649,595 $ 663,644 $ 677,956 

R2((*S($'*Q0$<(33!0$3* o**VCUY* * * MYM+Z]M* * MYM+Z]M* * MYM+Z]M* * MYM+Z]M* * MYM+Z]M* * MYM+Z]M* *

Q2(%!'* 033* MCVV[* * * MY^+WVV* * M]V+MV]* * M]Y+YZY* * MW^+OZ]* * MNV+ZUV* * MN]+WZZ

Effective Gross Revenue  $  15,156,698 $ 15,736,281 $ 16,337,922 $ 16,962,462 $ 17,610,776 $ 18,283,773

Total Operating Expenses  $  7,388,779 $ 7,673,247 $ 7,968,667 $ 8,275,461 $ 8,594,066 $ 8,924,937 

Q#6!'#8*S(3(2)(3* o**VCMM* * * 68,357  68,357  68,357  68,357  68,357  68,357  

Total Expenses  $  7,457,136 $ 7,741,604 $ 8,037,024 $ 8,343,818 $ 8,662,423 $ 8,993,294

c('*B6(2#'!$-*P$<09(*?cBP@*02*c('*Q#3.*R80>* * o* * 7,699,562 $ 7,994,677 $ 8,300,898 $ 8,618,644 $ 8,948,353 $ 9,290,479

hF;6(<'(%*!$"#'!0$*2#'(*!3*^CWZ[

**Other variable % and $ from Table II

P,#"( RSST( RSSU( RSVS( RSVV( RSVR( RSVW

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20

Advances in Business Research

G.(*$('*62(3($'*)#85(* ?c/b@*#$%* '.(* P$'(2$#8*S#'(*0=*S('52$* ?PSS@*#2(* '>0*#<<(6'(%*9(#352(3*0=*#$#84\!$-*
'.(*#''2#<'!)($(33*0=*2(#8*(3'#'(*!$)(3'9($'3C*G.(*PSS*:5!8%3*0$*'.(*c/b*=2#9(>02I*#''(96'!$-*'0*D$%*#*%!3<05$'*
2#'(*>.!<.*(75#'(3*'.(*c/b*'0*\(20C*P'*!3*3!9!8#2*'0*#*:2(#I()($*60!$'C*p.!8(*!'*<0$3!%(23*:0'.*'.(*9#-$!'5%(*#$%*
'!9!$-*0=*(#<.*<#3.*"0>+*!'*#3359(3*#*<#3.*"0>*2(!$)(3'9($'*2#'(*#'*'.(*PSS+*>.!<.*<#$*-!)(*#$*5$2(#8!3'!<*)!(>*0=*#*
620H(<'E3*60'($'!#8*)#85(C*A*620H(<'*>!'.*603!'!)(*#$%*$(-#'!)(*<#3.*"0>3*%(8!)(23*958'!68(*PSS3C*A*<0$"!<'*:('>(($*
'.(*%(<!3!0$*258(3*0=*(#<.*'(<.$!75(*<#$*0<<52*9#I!$-*<096#2!30$3*:('>(($*#8'(2$#'!)(*620H(<'3+*(36(<!#884*95'5#884*
(;<853!)(*0$(3+*%!=D<58'C*A$* !$)(3'02*<#$*6#2'!'!0$* '.(*PSS*?T25(--(9#$*#$%*R!3.(2+*UVVW@*>!'.* '.(*0:H(<'!)(*0=*
D$%!$-*05'*>.#'*602'!0$*0=*'.(*2('52$*!3*=209*'.(*#$$5#8*06(2#'!$-*<#3.*"0>3*#$%*>.#'*602'!0$*<09(3*=209*'.(*2(3#8(C**

There generally is more certainty associated with the funds that occur earlier than later in the investment holding 
 !"#$%&'(!)*!+',-!'."!/,!"',-!' "$ $",#$)'$0'"!1/2!'*/1-'3$4+',-!'."!/,!"',-!'"#15'/)'#)6!1,$"'781,'0/*!&'($4!6!"+'!6!)'

 /",#,#$)#).',-!'9::+'#,1'4!/5)!11!1'/"!')$,'/%%"!11!%&';-!'81!'$0',-!'7$%#<!%'#),!")/2'"/,!'$0'"!,8")'=>9::?'.#6!1'

,-!'#)6!1,$"'/' $,!),#/22@'1,"$).!"',!*-)#A8!',$'/)/2@B!',-!'*/1-'3$41'$0'/' "$C!*,&'9,'"!182,1'#)'/'7$"!'*$)1!"6/,#6!'

"!,8")',-/)',-!'9::D')!./,#6!'*/1-'3$41'/"!'*/)*!22!%'$8,'E@' $1#,#6!'$)!1+'/)%'*$7 $8)%1',-!'*/1-'3$41'0$"4/"%'/,'

/'7$"!'"!/2#1,#*'"!#)6!1,7!),'"/,!'E/1!%'$)',-!' "$C!*,F1'*$1,'$0'*/ #,/2&'9,',-!)'%#1*$8),1',-#1'08,8"!'*/1-'3$4'E/*5',$'

,-!'#)#,#/2'$8,2/@'%/,!'/,'/'"/,!',-/,'7$"!'0/#"2@'"! "!1!),1',-!'#)6!1,7!),'"#15'$0',-!' "$C!*,&';-!'E/1#*'7$%!2',$'<)%'

the MIRR is presented below.

Zero = FVNOI
t 
G'=H'I'>9::?t'I':J

t 
G'=H'I'>9::?t -  IO

0

;-!'>9::'#1',-!'"/,!'4-#*-'!A8/,!1',-!'KLJ',$'M!"$
Future value of the sum of each NOI @ capr
N'KO9

t 
=HI'*/ "?t = FVNOI at the end of the lease term

:J'P',-!'"!6!"1#$)'=1/2!?'6/28!'/,',-!'!)%'$0',-!'2!/1!',!"7
KO9'P',-!')!,'$ !"/,#).'#)*$7!'$"')!,'*/1-'3$4'0$"'!/*-'@!/"'#)',-!'#)6!1,7!),'-$"#B$)
Q/ "'P',-!'*/ #,/2#B/,#$)'"/,!'81!%',$'%!,!"7#)!',-!'08,8"!'6/28!'$0')!,'*/1-'3$41'
FVNOI = the future value of the sum of each periodic NOI by the end of the lease term
:J'P',-!':!6!"1#$)'6/28!'0$"',-!'$0<*!'E8#2%#).'/,',-!'!)%'$0',-!'2!/1!',!"7
>9::'P',-!'7$%#<!%'#),!")/2'"/,!'$0'"!,8")'0$"'!/*-'$0<*!'E8#2%#).
IO = the Initial investment outlay
T = the time period as of the end of the lease term. 

;-#1' / !"' 8,1'0$",-',-/,',-!'"!2/,#6!' "$ $",#$)1'$0',-!'>9::+'"! "!1!),!%'E@',-!',4$'*/1-'3$4'1$8"*!1+'*/)'

provide another layer of analysis that reveals that the risk differences between the income properties are strong 
!)$8.-',$'*-/22!).!+'1 !*#<*/22@'#)',-!'*/1!'$0',-!'78,8/22@'!R*281#6!':#6!"1#%!'/)%'S/T/22!' "$C!*,1+',-!',"/%#,#$)/2'

%!*#1#$)'"82!1'$0',-!'KLJ+'9::+'/)%'#,F1' /",#,#$)#).&';-!' "$*!11'$0',-!'1,"/,#0@#).'$0',-!'7$%#<!%'#),!")/2'"/,!'$0'

return is presented below.

   !"# $%&'%()*(+, -) %"# .-/(0#/ 1+%#&+'2 3'%# -) 3#%4&+ 

T,! 'HU'Q/2*82/,!',-!'>9::'/1'%!1*"#E!%'/E$6!&
T,! 'VU'W1!',-!'>9::',$'%#1*$8),'E/*5',-!'KO9'*/1-'3$41'/)%',-!':J'*/1-'3$4
T,! 'XU'Y$"782/,!',-!'4!#.-,'$"'1,"/,/'$0',-!'>9::
[a] PVNOI

t
'I'LJ:J

t 
P';LJQY

t

[b] PVNOI
t 
G';LJQY

t 
= relative proportion of MIRR from the discounted total future NOI 

[c] PVREV
t 
G';LJQY

t 
= relative proportion of MIRR from the discounted future RV, where 

PVNOI
t
 = present value of future net operating income from the end of lease term

PVRV
t 
= present value of future reversion value from the end of lease term

;LJQY
t 
P';$,/2' "!1!),'6/28!'$0'E$,-'$ !"/,#).'/)%'"!6!"1#$)'*/1-'3$41'/,',#7!' !"#$%'B!"$

K$,!U'Z8"$ !/)'L8,'O ,#$)'['08,8"!'"!6!"1#$)'$"'1/2!'$0',-!'$0<*!'E8#2%#).'*/)'$)2@'$**8"'/,',-!'!)%'$0',-!'-$2%#).'

,!"7&'\7!"#*/)'L8,'O ,#$)'['08,8"!'"!6!"1#$)'$"'1/2!'$0',-!'$0<*!'E8#2%#).'*/)'$**8"'/,'/)@',#7!'%8"#).',-!'-$2%#).'

term.
;-!'1,"/,#<*/,#$)'$0' ,-!'7$%#<!%'#),!")/2' "/,!'$0'"!,8")' #1'1,"!).,-!)!%+' #)' ,-#1' / !"+'E@' ,-!'0/*,' ,-/,'/22' ,-!'

/),#*# /,!%'08,8"!'*/1-'3$41'/"!' /",#/22@'%!,!"7#)!%'E@'!R#1,#).'2!/1!1+'7#,#./,#).'1$7!'$0',-!'8)*!",/#),@',@ #*/22@'

/11$*#/,!%'4#,-'!1,#7/,#).',-!1!'08,8"!'*/1-'3$41&

     5.6131789 8:89;$1$

2010, Vol. 1, No. 1, 15-25

S#3/)%



21

Advances in Business Research

This study posits that an investor can approach the income property valuation process either adhering to the 
Z8"$ !/)'L8,'O ,#$)'1,"/,!.@'4-!"!'!/*-' "$ !",@'4#22'E!'1$2%'/,',-!'!)%'$0',-!'<0,-'@!/"'=V]HV?'$"'0$22$4#).'/)'

\7!"#*/)' L8,'O ,#$)' 1,"/,!.@' ,-/,' $00!"1' ,-!' 3!R#E#2#,@' $0' *-$$1#).' ,$' 1!22' ,-!'  "$ !",@' %8"#).' /)@' @!/"' $0' ,-!'

#)6!1,7!),'-$2%#).' !"#$%&'9)'$"%!"',$'%!,!"7#)!',-!'"!6!"1#$)'6/28!'=:J?'0$"'E$,-' "$C!*,':#6!"1#%!'/)%'S/T/22!+'

,-!#"')!,'$ !"/,#).'#)*$7!'=KO9?'0$"',-!'1#R,-'@!/"'=V]HX?+'=;/E2!1'9J'/)%'J?'#1'%#6#%!%'E@'!/*-' "$ !",@F1'!1,#7/,!%'

.$#).[#)'*/ #,/2#B/,#$)'"/,!'=Q/ ':/,!?'=;/E2!'99?&';-!'.#6!)'*/ '"/,!'"! "!1!),1',-!'"!,8")'"!A8#"!%'0$"',-!' /",#*82/"'

property investment based on its risk when compared to returns earned from competing investments. When direct 
*/ #,/2#B/,#$)'#1'81!%+',-!' "$ !",#!1'E!#).'"!6#!4!%')!!%',$'E!'*$7 /"/E2!&';-!',4$'$0<*!'E8#2%#).1'/  !/"',$'E!'

similar in terms of their construction, size, age, location, and functionality. When making estimates of the future 
 "$ !",@' 6/28!+' ,-!' -/)%2#).' $0' */ #,/2' $8,2/@1' #1' #7 $",/),+' ,$$&'(!"!+' !/*-'  "$ !",@' "!3!*,1' /)' /*,8/2' ^Q/ #,/2'

:!1!"6!F' "$6#1#$)'=;/E2!' 99?' #)'%!,!"7#)#).' ,-!')!,'$ !"/,#).' #)*$7!'=KO9?&'Y8",-!"+'*$)1#1,!)*@' #1'7/#),/#)!%'

through the use of Table III’s relevant data from the metro area analysis conducted by REIS, Inc on important items 
/1',-!'/6!"/.!'2!/1!',!"7'/)%'#)3/,#$)'"!),'!1*/2/,$"&';-!'!R !*,!%'08,8"!'*/1-'3$41'0"$7',-!'"!1/2!'$0'!/*-' "$ !",@'

under both the European Put Option and American Put Option are presented in Table VI below.

!'<2# =1> 7'?" @2-A )&-B 3#?'2# C3#D#&?(-+ ='24#E )-& 6&-F#G% 3(D#&?(/# '+/ 

6&-F#G% 9'$'22# H+/#& %"# 54&-I#'+ '+/ 8B#&(G'+ 64% JI%(-+ $%&'%#,(#? 

K$,!U'Z8"$ !/)'L8,'O ,#$)'_':!6!"1#$)'6/28!'$)2@'/,',-!'!)%'$0',-!'-$2%#).',!"7&'\7!"#*/)'L8,'O ,#$)'_':!6!"1#$)'

value calculated at the end of each year in holding period.

;-!'KLJ1'$0'!/*-' "$C!*,'8)%!"',-!'Z8"$ !/)'/)%'\7!"#*/)'L8,'O ,#$)'1,"/,!.#!1'#1' "!1!),!%')!R,'#)';/E2!'J99U

!'<2# =11> :#% 6&#?#+% ='24# C:6=E )-& 6&-F#G% 3(D#&?(/# '+/ 6&-F#G% 9'$'22# 

H+/#& %"# 54&-I#'+ '+/ 8B#&(G'+ 64% JI%(-+ $%&'%#,(#?

K$,!U'Z8"$ !/)'L8,'O ,#$)'_'KLJ'E/1!%'$)'"!6!"1#$)'$)2@'/,',-!'!)%'$0',-!'-$2%#).',!"7&'\7!"#*/)'L8,'O ,#$)'_'KLJ'#1'

calculated as if reversion can occur at the end of any year in the holding period. 

;-!')!R,'1,! '#)',-!'`QY' "$*!11'#1',-!'%!,!"7#)/,#$)'$0'E$,-',-!'#),!")/2'"/,!'$0'"!,8")'/)%',-!'7$%#<!%'#),!")/2'

rate of return. The results for Projects Riverside and LaSalle, under the European and American Put Option strategies, 
are presented below in Table VIII.

 

 

 

2010, Vol. 1, No. 1, 15-25

S#3/)%

 

European Put Option Project Riverside Project LaSalle 

NOI period 6 (2013) $8,581,325 $9,290,479 

Cap Rate 5.20% 7.50% 

Cash Flow from Reversion $165,025,487 $123,873,052 

American Put Option   

Lease term Reversion Value  Reversion Value 

Year 1 $134,737,369 $92,756,207 

Year 2 141,743,712 99,712,923 

Year 3 149,114,386 107,191,392 

Year 4 156,868,334 115,230,746 

Year 5 165,025,487 123,873,052 

European Put Option Project Riverside Project LaSalle 

Initial Outlay  $143,999,995 $108,749,900 

Cap Rate 5.20% 7.50% 

Net Present Value  $16,878,443 $10,983,976 

American Put Option   

Lease term NPV  NPV 

Year 1 ($9,207,428) ($15,302,673) 

Year 2 (2,570,319) (8,384,618) 
Year 3 3,989,284 (1,702,722) 
Year 4 10,471,996 4,750,923 

Year 5 16,878,443 10,983,976 



22

Advances in Business Research

!'<2# =111> 1+%#&+'2 3'%# -) 3#%4&+ C133E '+/ .-/(0#/ 1+%#&+'2 3'%# -) 3#%4&+ C.133E @-&

6&-F#G%? 3(D#&?(/# '+/ 9'$'22# H+/#& %"# 54&-I#'+ '+/ 8B#&(G'+ 64% JI%(-+ $%&'%#,(#?

K$,!U'')/'#1'a)$,'/  2#*/E2!b'/1',-!'KLJ'c']&';-#1'0/*,'.8/"/),!!1',-!'>9::',$'E!'c',-!'Q/ ':/,!+'*/ "'P'.$#).[#)'

cap rate, European Put Option – IRR and MIRR based on reversion only at the end of the holding term, American 
Put Option – IRR and MIRR are calculated as if reversion can occur at the end of any year in the holding period.

!'<2# 1K> 7-+%&'?%(+, -) %"# $%&'%()*(+, -) %"# .-/(0#/ 1+%#&+'2 3'%# -) 3#%4&+ A(%" %"# 6'&%(%(-+(+, -) %"# 

1+%#&+'2 3'%# -) 3#%4&+ )-& 6&-F#G%? 3(D#&?(/# '+/ 9'$'22# H+/#& %"# 54&-I#'+ '+/ 8B#&(G'+ 64% JI%(-+?
 

   

K$,!U')/'#1'a)$,'/  2#*/E2!b'/1',-!'KLJ'c']&' ';-#1'0/*,'.8/"/),!!1',-!'>9::'/)%'9::',$'E!'c',-!'Q/ ':/,!+'

European Put Option – based on reversion only at the end of the holding term, American Put Option – based on 
reversion occurring at the end of any year in the holding period, Partitioning the IRR under-estimates the risk 
/11$*#/,!%'4#,-',-!'"!6!"1#$)'*/1-'3$41'8)%!"'E$,-',-!'Z8"$ !/)'/)%'\7!"#*/)'L8,'O ,#$)1&  

 

 

 

 

2010, Vol. 1, No. 1, 15-25

S#3/)%

European Put Option Project Riverside Project LaSalle 

Relative Proportions of the MIRR   

From operational (NOI) cash flows 20.39% 27.94% 

From reversion (RV) cash flow 79.61% 72.06% 

Relative Proportions of the IRR   

From operational (NOI) cash flows 21.21% 28.86% 

From reversion (RV) cash flow 78.79% 71.14% 

American Put Option Stratifying of the MIRR 

Lease Term   

Year 1 na na 

Year 2 na na 

Year 3: From Operational cash flows 13.37% na 

From Reversion cash flows 86.63% na 

Year 4: From Operational cash flows 17.09% 23.98% 

From Reversion cash flows 82.91% 76.02% 

Year 5: From Operational cash flows 20.39% 27.94% 

From Reversion cash flows 79.61% 72.06% 

                                                             Partitioning of the IRR 

Lease Term   

Year 1 na na 

Year 2 na na 

Year 3: From Operational cash flows 13.57% na 

From Reversion cash flows 86.43% na 

Year 4: From Operational cash flows 17.50% 24.31% 

From Reversion cash flows 82.50% 75.69% 

Year 5: From Operational cash flows 20.21% 28.86% 

From Reversion cash flows 78.79% 71.14% 

European Put Option Project Riverside Project LaSalle 

Capitalization Rate 5.20% 7.50% 

Internal Rate of Return (IRR) 7.78% 9.87% 

Modified Internal Rate of Return (MIRR) 7.56% 9.59% 

Excess of MIRR over Cap Rate 2.36% 2.09% 

Excess of IRR over Cap Rate 2.58% 2.37% 

American Put Option     

Lease Term IRR MIRR IRR MIRR 

Year 1 na na na na 

Year 2 na na na na 

Year 3 6.21% 6.16% na na 

Excess of internal return over capr 1.01% 0.96% na na 

Year 4 7.20% 7.06% 8.78% 8.66% 

Excess of internal return over capr 2.00% 1.86% 1.28% 1.16% 

Year 5 7.78% 7.56% 9.87% 9.59% 

Excess of internal return over capr 2.58% 2.36% 2.37% 2.09% 



23

Advances in Business Research

 ! "#$%$&'(&)*+%,%- "&,)$."/$

The decision regarding investing in Project Riverside and Project LaSalle is being made under a mutually exclusive 
 !"#$%&#!%'$ %()% *!+',!'%-#'./0'12)&#3*245')!')66#7%#8'2(9#' $'%*')66#7%'%-#'72*:#6%'3 %-'%-#'6*&7)2)% "#';2#)%#2'
7*$ % "#'<=>+'?)@9#'>,,5'(!8#2'%-#'A(2*7#)!'=(%'$#6% *!5'2#7*2%$'%-)%'=2*:#6%$'B "#2$ 8#')!8'C)D)99#'2#E#6%'7*$ % "#'
!#%'6)$-'E*3$'*1'FGH5IJI5JJK')!8'FGL5MIK5MJH'2#$7#6% "#9N+'=2*:#6%'B "#2$ 8#'3*(98'@#'1)"*2#8'*"#2'=2*:#6%'C)D)99#+'
O!8#2'%-#'P&#2 6)!'=(%'Q7% *!5'3 %- !'%-#'R"#'N#)2'-*98 !;'7#2 *85'=2*:#6%'B "#2$ 8#'*11#2$')'" )@9#'7*$ % "#'<=>'
 !'#)6-'*1'N#)2$'%-2##5'1*(25')!8'R"#' !'%-#')&*(!%$'*1'FK5MIM5SIT5'FGL5TJG5MMH5')!8'FGH5IJI5TTK'2#$7#6% "#9N+'.(2 !;'
%-#'R2$%'%3*'N#)2$5'1*2'@*%-'72*7#2% #$5'%-#2#' $')!'#$% &)%#8'!#;)% "#'!#%'72#$#!%'")9(#5'&)4 !;'%-#'6-* 6#'%*'$#99'
within that period not a prudent one. For Project LaSalle, under the American Put Option, the investor would realize 
)!'*77*2%(! %N' !'N#)2$'1*(2')!8'R"#')$'N#)2'%-2##'3)$'&#%'3 %-'!#;)% "#'!#%'6)$-'E*3$+',%$'7*$ % "#'<=>' !'N#)2'1*(2'
3)$'FT5JUL5MSK')!8' !'N#)2'R"#'3)$'FGL5MIK5MJH+',!"#$%*2$'-)"#'&*2#'E#V @ 9 %N'3 %-'=2*:#6%'B "#2$ 8#+''''

To corroborate the actions dictated by the NPV rule, the internal returns on both investments need to be compared. 
The expectation is that the respective internal rates of return will be greater than the project’s going-in capitalization 
2)%#')!8'@#'6*!$ $%#!%'3 %-'%-#'<=>'2(9 !;+'O!8#2'%-#'A(2*7#)!'=(%'Q7% *!5'%-#'B "#2$ 8#'72*7#2%N'2#E#6%$')!',BB'
*1'J+JIW'X?)@9#'>,,,Y'3- 9#'=2*7#2%N'C)D)99#';#!#2)%#8')!',BB'*1'M+IJW+'Z#2#5'=2*:#6%'C)D)99#' $'1)"*2#8')$' %$',BB'
#V6##8$'!*%'*!9N' %$'*3!'6*$%'*1'6)7 %)9'*1'J+UW'@(%' $';2#)%#2'%-)!'%-)%'*1'%-#'B "#2$ 8#'72*7#2%N+''P'6*!E 6%'@#%3##!'
the NPV and IRR exists. When considering the American Put Option, there is still no resolution, as Table VIII 
2#7*2%$'%-)%'%-#',BB$'*1'=2*:#6%'C)D)99#'#V6##8'%-)%'*1'=2*:#6%'B "#2$ 8#' !'N#)2$'1*(2')!8'R"#+''B#6*;! [ !;'%-)%'%-#'
3#)4!#$$#$')$$*6 )%#8'3 %-'%-#' !%#2!)9'2)%#'*1'2#%(2!'6)!'@#')"* 8#8'3 %-'%-#'($#'*1'%-#'&*8 R#8' !%#2!)9'2)%#'*1'
2#%(2!5'?)@9#'>,,,')9$*'2#7*2%$'%-#'\,BB'R!8 !;$')$'3#99+'O!8#2'%-#'A(2*7#)!'Q7% *!5'=2*:#6%'B "#2$ 8#'-)8')'\,BB'
*1'J+UHW'3- 6-'#V6##8#8' %$'6)7'2)%#'*1'U+SW'@N')'&)2; !'*1'S+KHW'X%-#',BB'#V6##8#8'%-#'6)7'2)%#'@N'S+UIWY+'?-#'
MIRR associated with Project LaSalle was 9.59% and exceeded its cap rate of 7.5% by a margin of 2.09% (the IRR 
3)$';2#)%#2'%-)!'%-#'6)7'2)%#'@N'S+KJWY+''

Project LaSalle is favored by its MIRR but not by its NPV. Within the American Put Option strategy, there is 
!*'6*!E 6%' !'N#)2'%-2##')$'=2*:#6%'C)D)99#]$'\,BB' $'9#$$'%-)%' %$'6)7'2)%#'3- 9#'=2*:#6%'B "#2$ 8#'-)$')'\,BB'%-)%'
#V6##8$' %$';* !;^ !'6)7'2)%#'&)4 !;' %')'72#1#22#8'72*:#6%+'_*%-'72*7#2% #$'2#E#6%'\,BB'")9(#$'3- 6-'#V6##8'%-# 2'
6)7'2)%#$' !'N#)2$'1*(2')!8'R"#+',!'N#)2'T5'=2*:#6%'C)D)99#]$'\,BB'*1'I+HHW'#V6##8#8' %$'6)7'2)%#'@N'G+GHW'3- 9#' %$'
IRR of 8.78% had a spread of 1.28%. Project Riverside’s MIRR of 7.06% exceeded its cap rate by 1.86% while its IRR 
*1'J+SLW'-)8')'$72#)8'*1'S+LW+'.(2 !;'N#)2'R"#5'=2*:#6%'C)D)99#]$'\,BB'*1'M+UMW'3)$'9)2;#2'%-)!' %$'6)7'2)%#'@N')'
margin of 2.09% while its IRR of 9.87% had a spread of 2.37%. For Project Riverside, its MIRR of 7.56% exceeded 
its cap rate by a spread of 2.36% while its IRR of 7.78% was associated with a spread of 2.58%. The MIRR delivers a 
more conservative return measurement as evidenced by the relatively larger cap rate spreads associated with the IRR 
calculations. The IRR consistently overstates the return associated with each project.  

` %- !'%- $'#!" 2*!&#!%'*1'6*!E 6% !;' !"#$%&#!%'8#6 $ *!'2(9#$5'%-#'72*7#2%N' !"#$%*2'!##8$'%*'@#')@9#'%*'1(2%-#2'
&#)$(2#')'72*:#6%]$'#V7#6%#8'1(%(2#'6)$-'E*3'2 $4+'Q!#'&#%-*8'%*'-#97')882#$$'%-#'9)%%#2' $'%-#'7)2% % *! !;'*1'%-#'
internal rate of return. Its objective is to gain some sense of the relative proportion of the components of the return 
)!8' %*'" #3'%-#' % & !;')!8a*2'&);! %(8#'*1')'72*:#6%]$'6)$-'E*3$+'?- $'7)7#2'#V%#!8$' %-#' 9 %#2)%(2#' %-2*(;-' %-#'
 !%2*8(6% *!'*1' %-#' $%2)% 1N !;'*1' %-#'&*8 R#8'  !%#2!)9' 2)%#' *1' 2#%(2!+'P3)2#'*1' %-#' $%2#!;%-$' *1' %-#'\,BB'*"#2'
%-#',BB')!8'" #3 !;' %' !'6*!:(!6% *!'3 %-'*%-#2'2 $4'1)6%*2$'X$(6-')$'*1R6#'@( 98 !;'6*!$%2(6% *!'#V6##8$'&)24#%'
)@$*27% *!'*2'%-#2#' $')!'#V7#6%#8' !62#)$#' !'")6)!6N'2)%#$Y5' %'*11#2$')!' !$ ;-%1(9'&#)$(2#'*1'%-#'2 $4')$$*6 )%#8'
3 %-'#V7#6%#8'*7#2)% *!)9')!8'2#"#2$ *!'6)$-'E*3$+''

` %- !'?)@9#',b5'%-#'A(2*7#)!'=(%'Q7% *!'2#7*2%$' !%#2#$% !;'2#$(9%$+',%'-)$'@##!'#$%)@9 $-#8'%-)%'@*%-'%-#'\,BB'
)!8',BB'1)"*2'=2*:#6%'C)D)99#'*"#2'=2*:#6%'B "#2$ 8#+'c#%5'%2)8 % *!)9'./0')!)9N$ $'3*(98'-)"#'%-#' !"#$%*2'8#1#2'%*'
%-#'!#%'72#$#!%'")9(#'2(9#'%*'&)4#')'R!)9'8#6 $ *!')!8'6-**$#'=2*:#6%'B "#2$ 8#+'_#1*2#'&)4 !;'%-)%'8#6 $ *!5'-*3#"#25'
the stratifying of the MIRR and the partitioning of the IRR reveal that approximately 80% and 79% of Riverside’s 
2#$7#6% "#'6)$-'E*3$')2#')$$*6 )%#8'3 %-'%-#'2#"#2$ *!'")9(#'*1'%-#'72*:#6%+'Q!'%-#'*%-#2'-)!85'1*2'=2*:#6%'C)D)99#5'
%-#'2#9)% "#'72*7*2% *!$'*1'%-#'\,BB')!8',BB'6*& !;'12*&' %$'2#"#2$ *!'6)$-'E*3')2#')772*V &)%#9N'JSW')!8'JGW+'
P'2#9)% "#';2#)%#2'2 $4' $')$$*6 )%#8'3 %-'%-#'1(%(2#'6)$-'E*3$'@#N*!8'%-#'-*98 !;'7#2 *8'1*2'=2*:#6%'B "#2$ 8#+'

` %- !'%-#'P&#2 6)!'=(%'Q7% *!5'=2*:#6%'B "#2$ 8#'-)8'%-#'*!9N'" )@9#'7*$ % "#'6)$-'E*3'*7% *!' !'N#)2'%-2##+'
The respective stratifying of the MIRR and partitioning of the IRR show relative proportions from the resale of 
the property to be approximately 87% and 86% respectively. Project Riverside’s relative proportions of the MIRR 
)$$*6 )%#8'3 %-'%-#'#V7#6%#8'2#$)9#'6)$-'E*3'*"#2'N#)2$'1*(2')!8'R"#')2#')772*V &)%#9N'IKW')!8'ILW+'?-#',BB'
partitioned according to its reversion value during the same time period was approximately 83% and 79%. Project 
C)D)99#';#!#2)%#8'2#9)% "#'72*7*2% *!$'*1' %$'\,BB'12*&'%-#'1(%(2#'$)9#$'72 6#'*"#2'N#)2$'1*(2')!8'R"#'%-)%'3#2#'
approximately 76% and 72%. Regarding the proportions of the IRR over the same time frame, Project LaSalle 
showed approximate weights of 76% and 71%.   

2010, Vol. 1, No. 1, 15-25

C E)!8



24

Advances in Business Research

?-#' !"#$%*2^@(N#2'&($%'@#')3)2#'*1'%-#'2#9)% "#';2#)%#2'2 $4')$$*6 )%#8'3 %-'%-#'4#N'2#"#2$ *!'6)$-'E*3+'?-#'
2#$(9%$'*1'%-#'$%2)% 1N !;'*1'%-#'\,BB'*"#2'N#)2$'1*(2')!8'R"#'2#"#)9')'6*!$ $%#!%'7)%%#2!'3-#2#'%-#'#V7#6%#8'2#"#2$ *!'
6)$-'E*3'2 $4'*1'=2*:#6%'B "#2$ 8#' $';2#)%#2'%-)!'%-)%'*1'=2*:#6%'C)D)99#]$+'O!8#2'@*%-'%-#'A(2*7#)!')!8'P&#2 6)!'
=(%'Q7% *!'$%2)%#; #$5'%)4 !;' !%*')66*(!%'%- $')$$#$$&#!%'*1'6)$-'E*3'2 $4'12*&'%-#'$%2)% 1N !;'*1'%-#'\,BB'!##8$'
%*'@#'7#21*2&#8' !'2#6*;! % *!'*1'*%-#2'$7#6 R6'2 $4'1)6%*2$+'02*&'?)@9#',,5'2#7*2% !;'2#9#")!%'8)%)'12*&'%-#'&#%2*'
)2#)5'BA,D5',!6+'2#7*2%#8'%-)%'%-#')!!()9 [#8'U^N#)2'")6)!6N'2)%#'3)$'GJ+HW+'=2*:#6%'C)D)99#' $'3#99'@#9*3'%- $'R;(2#'
with a rate of 9.2% while Project Riverside stands at 14.4%. The annualized 5-year rent growth rate is only 2.1%. The 
2#; *!'$-*3$')!')772*V &)%#'SdG'2)% *'*1'%-#'6*!$%2(6% *!'*1'*1R6#'@( 98 !;$'2#9)% "#'%*'%-# 2')@$*27% *!+'?- $'6*(98'
lead to a future downward pressure on rent revenue as well as an increase in vacancy rates.  

The area shows a stability rate of approximately 68%. Stabilization is achieved when the average vacancy rates of 
%-#'72*7#2% #$'@( 9%' !')!N'; "#!'N#)2'X-#2#5' %' $'SLLIY')2#'#e()9'%*'*2'9#$$'%-)!'%-#'&#%2*]$')"#2);#'*"#2)99'")6)!6N'
2)%#'1*2'%-#'9)$%'R"#'N#)2$+'?-#' !E)% *!'1)6%*2'1*2'%-#'7#2 *8'3)$'K+IUW'3- 6-' &7)6%$'&*$%'*1'%-#'6)$-'E*3'#$% &)%#$'
 !'?)@9#$',>')!8'>+'?-#'$%2)% 1N !;'*1'%-#'\,BB'%*;#%-#2'3 %-'%-#$#'2 $4'1)6%*2$5')!8')!' !"#$%*2]$'(! e(#')"#2$ *!'
to risk, the NPV default rule may not be followed by the investor. The acceptance decision could be directed back 
towards Project LaSalle and not the Riverside property. 

 

-'!-".$%'!

A"#!'%-*(;-'%-#'%2)8 % *!)9'. $6*(!%#8'/)$-'09*3'X./0Y'&#%-*8'%)4#$' !%*')66*(!%'%-#'% &#'")9(#'*1'&*!#N5'
$N$%#&)% 6'6)$-'E*3$5')!8'%-#'(9% &)%#'2#$)9#'*1'%-#'72*7#2%N5' %'-)$')'3#)4!#$$' !'%-)%' %'%#!8$'%*'@#'7)$$ "#')!8'8*#$'
not capture the ability of the investor to adapt or revise their decisions in response to market developments.  With 
%- $'@)6482*75'%- $'7)7#2'9**4$')%'%-#'./0')!)9N$ $'3 %- !'%-#'12)&#3*24'*1')!'P&#2 6)!')!8'A(2*7#)!'=(%'Q7% *!'
$%2)%#;N+',%'7(%$'1*2%-'%-#'!*% *!'%-)%'%-#$#'2#)9'*7% *!$'; "#'%-#'72*7#2%N' !"#$%*2'%-#'E#V @ 9 %N'%*'&)4#'6-* 6#$')%'
&(9% 79#'7* !%$'8(2 !;'%-#' !"#$%&#!%'-*98 !;'7#2 *8+'?2)8 % *!)9'./0')!)9N$ $'$#%%9#$'72*:#6%')66#7%)!6#'6*!E 6%$'
@N'6*&7)2 !;'%-#'<=>'3 %-'%-#' !%#2!)9'2)%#'*1'2#%(2!'X,BBY+'?-#'6)$#' $'&)8#'%-)%'%-#'&*8 R#8' !%#2!)9'2)%#'*1'
2#%(2!'X\,BBY' $')'@#%%#2'%#6-! e(#'%-)!'%-#'9)%%#2+'?-#'\,BB'8#9 "#2$')'2#%(2!'%-)%' $'&*2#'6*!$#2")% "#5'6)!'-)!89#'
)'$#e(#!6#'*1'7*$ % "#')!8'!#;)% "#'6)$-'E*3$5')!8'$7#6 R#$'%-#'72*:#6%]$'6)7'2)%#')$'%-#'2# !"#$%&#!%'2)%#+''

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faces more risk the greater the proportion of the MIRR that is comprised of the future resale value. Under conditions 
of uncertainty the need to have accurate measures of risk is essential. In this study, the IRR consistently overstates 
the return, as compared with the MIRR, in each of the years in the holding period. The partitioning of the IRR 
(!8#2$%)%#$'%-#'&*$%'"*9)% 9#'*1'%-#'<=>'6)$-'E*3'6*&7*!#!%$'1)6 !;'%-#' !"#$%*25')$'6*&7)2#8'3 %-'%-#'$%2)% 1N !;'
of the MIRR, in every year of the holding period, under both the European and American Put Option strategies. The 
stratifying of the MIRR provides a practical improvement over the IRR partitioning and offers another layer of risk 
)!)9N$ $'%-)%'1)6 9 %)%#$'72*:#6%'6*&7)2 $*!$'#"#!'3-#2#'*%-#2'%#6-! e(#$'9#)8'%*'6*!E 6% !;'2#$(9%$+'

,)(),)!-)$

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Managerial Finance and Journal of Academy of Business and Economics. 

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author provide further insight and clarity in the presentation.

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