How to evaluate an ultra long term contract offer?
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How to evaluate an ultra long term contract offer?
Some partners and I have received a lease offer. The terms are below. I have to keep things somewhat vague.
- 40 year lease
- 4 year diligence period. So the 40 years would begin sometime in 2026.
- Rent is ~4x above current (today's) market rate. 1% annual escalator begins in year 5 of the lease.
My concern is inflation. Future inflation is unknowable. I'm just trying to gauge everyone's gut reaction to the above terms. Is it more.... alarm bells over a 40 year deal with fixed payments +1% after 5 years? Or is it more.... don't overthink this, ~4x above current market rate is a no brainer?
- 40 year lease
- 4 year diligence period. So the 40 years would begin sometime in 2026.
- Rent is ~4x above current (today's) market rate. 1% annual escalator begins in year 5 of the lease.
My concern is inflation. Future inflation is unknowable. I'm just trying to gauge everyone's gut reaction to the above terms. Is it more.... alarm bells over a 40 year deal with fixed payments +1% after 5 years? Or is it more.... don't overthink this, ~4x above current market rate is a no brainer?
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
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Re: How to evaluate an ultra long term contract offer?
Why not tie future rental rate to the CPI or some other index?
Most experiences are better imagined.
Re: How to evaluate an ultra long term contract offer?
Seems to me your break even point is an average rent inflation of 6.25% with a payment that started in year 1, with the 6.25% inflation rent exceeding the proposed method in year 27.
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Re: How to evaluate an ultra long term contract offer?
Are you saying as long as inflation averages under 6.25% over 40 years then it's a good offer? And if inflation averages over 6.25% then it's not?
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
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Re: How to evaluate an ultra long term contract offer?
A 4-year due diligence period? Would this mean that you'd basically be locked into a purchase contract for that whole period of time? What do you get in return for such generosity? A large, non-refundable deposit, paid directly to you and not held in escrow?
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Re: How to evaluate an ultra long term contract offer?
We would receive a small fee during the diligence period. The property would continue to be used for what it's currently being used for during the four year diligence period. So the small fee would be extra $ even though it isn't much at all.mdavis6890 wrote: ↑Wed Jan 19, 2022 6:49 pm A 4-year due diligence period? Would this mean that you'd basically be locked into a purchase contract for that whole period of time? What do you get in return for such generosity? A large, non-refundable deposit, paid directly to you and not held in escrow?
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
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Re: How to evaluate an ultra long term contract offer?
Yes but you’re giving them a very valuable option on your property for a long period of time. I’ll pay you a small fee for a 4 year option on just about anything!
They get the luxury of waiting to see what happens to rents and maybe they’ll look for someone they can sublet to at a high profit. And hey, if it doesn’t work out they just say oops and move on.
There’s a variation on this in the residential home market that works pretty much exactly like this and is considered a scam against unsuspecting sellers.
They get the luxury of waiting to see what happens to rents and maybe they’ll look for someone they can sublet to at a high profit. And hey, if it doesn’t work out they just say oops and move on.
There’s a variation on this in the residential home market that works pretty much exactly like this and is considered a scam against unsuspecting sellers.
Re: How to evaluate an ultra long term contract offer?
Hi Wade,
I understand your desire to be vague; can you share (vaguely) what sort of lessor would want to overpay by 4x today’s market rents in hopes that they’ll be vindicated by inflation? I am scratching my head here.
lgs88
I understand your desire to be vague; can you share (vaguely) what sort of lessor would want to overpay by 4x today’s market rents in hopes that they’ll be vindicated by inflation? I am scratching my head here.
lgs88
merely an interested amateur
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Re: How to evaluate an ultra long term contract offer?
Just…. Say… No.
Re: How to evaluate an ultra long term contract offer?
So what’s your thoughts that inflation is going to go crazy high and thus the additional 1% per year won’t be a bad deal later on?
Seems like a crazy bet to me.
Seems like a crazy bet to me.
Re: How to evaluate an ultra long term contract offer?
Surely it's the opposite, no? If you're willing to pay 4x market rates on rent today and locking in that rate for 40 years, that had better mean you are betting hard that inflation is going to cause market rates for rent to skyrocket some years down the line and surpass that now-high fixed rate. So common sense dictates that more inflation = more payoff for you, less inflation = more payoff for the counterparty.Wade Garrett wrote: ↑Wed Jan 19, 2022 3:56 pmAre you saying as long as inflation averages under 6.25% over 40 years then it's a good offer? And if inflation averages over 6.25% then it's not?
Re: How to evaluate an ultra long term contract offer?
I got a slightly different break even point of 6.78%:
You need 6.78% inflation for 40 years to earn 0.03% annual return. Or say you wanted a heftier 10% return; then you'd need constant 10.75% inflation for 40 years.
Re: How to evaluate an ultra long term contract offer?
One thing to watch out for is that companies will often get out of a lease that is unfavorable to them by doing a strategic bankruptcy I have seen this happen and it was part of their business plan.
I didn't play with the numbers but with interest rates as low as they are now I would think that it would be less expensive for them to buy the property and have it paid off long before the rent payment would be a good deal because of inflation.
Re: How to evaluate an ultra long term contract offer?
I assumed a standard rent would start paying this year vs after 4 years….that is why I said “started in year 1”.
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Re: How to evaluate an ultra long term contract offer?
Good question. I'm wondering the same. Here's what I can share.....
Our property along with surrounding properties have been used as part of an industry going back generations. A different industry has now come in. This different industry is pretty new but has operated in other parts of the country in recent years. Companies in this different industry are competing with each other for properties in my area but the offers are all similar.
Maybe the offers being made are standard within this new industry? But the ultra long contract with fixed payments +1% raises some questions.
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
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Re: How to evaluate an ultra long term contract offer?
They (tenant) would pay us (landlord)
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
Re: How to evaluate an ultra long term contract offer?
Oh, then I had it completely backwards, haha. I thought you were the renter. My spreadsheet above is still accurate, except flip all the signs!
Ah, I see what you meant now.
Re: How to evaluate an ultra long term contract offer?
If you are on the receiving deal then it looks decent in my view. I wouldn’t pay 4x but if they will pay you then fine. Additionally I should say that I was assuming this is within the US
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Re: How to evaluate an ultra long term contract offer?
Thanks. Yes it's within the US.
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
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Re: How to evaluate an ultra long term contract offer?
You would willingly lock up your property for 4 years hoping that the (prospective) tenant comes through in the end to pay you 4x market rent?
Re: How to evaluate an ultra long term contract offer?
Sounds like some sort of weird scam to me. Without some more detail about why a 4 year due diligence, I would run from this.
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Re: How to evaluate an ultra long term contract offer?
I think you're misunderstanding. There is no 4 year "lockup" as in no $ received.mdavis6890 wrote: ↑Fri Jan 21, 2022 12:09 pm You would willingly lock up your property for 4 years hoping that the (prospective) tenant comes through in the end to pay you 4x market rent?
The property is currently in use as part of one industry as it has been going back decades. That will continue during the four year diligence period. Plus, during the 4 years, we would receive a small fee from the company in the new industry on top of that.
So it would be more $ during the 4 years. And then the real $ increase would be after the 4 years.
Last edited by Wade Garrett on Fri Jan 21, 2022 1:30 pm, edited 1 time in total.
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
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Re: How to evaluate an ultra long term contract offer?
See above. It isn't a scam. At all. The question is about the ultra long contract with only a 1% annual escalator, the impact of inflation on that, etc.
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
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Re: How to evaluate an ultra long term contract offer?
I wouldnt do it because it turns you from a landlord into an inflation speculator with a 44 year horizon. I'll admit that I have no idea how long term leases normally work.Wade Garrett wrote: ↑Fri Jan 21, 2022 1:29 pmSee above. It isn't a scam. At all. The question is about the ultra long contract with only a 1% annual escalator, the impact of inflation on that, etc.
Re: How to evaluate an ultra long term contract offer?
My biggest concern would be the financial viability of the lessee and who the lessee party actually is (and that may not actually find that out until agreement signing day). If they're a seemingly limited purpose special entity they can fill bankruptcy and be gone anytime, or they can be acquired if they could make money on a sell-out of themselves (even if their only asset is the lease). A problem that can arise with any lease is the lessee doing something that causes a toxic waste situation that leaves the property-owner holding the bag (the lessee can exit pretty much anything with bankruptcy).
I'd tend to walk away from such an offer. It just doesn't smell right. That 4X rent offer is just an enticement to a poor long-term deal if there is only a 1% annual escalator.
I'd tend to walk away from such an offer. It just doesn't smell right. That 4X rent offer is just an enticement to a poor long-term deal if there is only a 1% annual escalator.
The closest helping hand is at the end of your own arm.
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Re: How to evaluate an ultra long term contract offer?
Thanks barnaclebob and 123 for your responses. You make fair points.
123 - a potential toxic waste situation is not a concern in this case
123 - a potential toxic waste situation is not a concern in this case
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
Re: How to evaluate an ultra long term contract offer?
Wouldn't an early termination actually be a good thing for the OP?123 wrote: ↑Fri Jan 21, 2022 2:17 pm My biggest concern would be the financial viability of the lessee and who the lessee party actually is (and that may not actually find that out until agreement signing day). If they're a seemingly limited purpose special entity they can fill bankruptcy and be gone anytime, or they can be acquired if they could make money on a sell-out of themselves (even if their only asset is the lease). A problem that can arise with any lease is the lessee doing something that causes a toxic waste situation that leaves the property-owner holding the bag (the lessee can exit pretty much anything with bankruptcy).
I'd tend to walk away from such an offer. It just doesn't smell right. That 4X rent offer is just an enticement to a poor long-term deal if there is only a 1% annual escalator.
The risk in this deal is that the lease runs the entire 40 years, and there is high inflation such that the 1% escalation does not keep up. In that case the renters get a very low rent relative to market in the later years of the lease. The price they pay for that is a very high rent relative to the market in the early years of the lease.
For the OP, the best case scenario seems like would for the tenant to terminate the lease just as the rent approaches market rates somewhere in the middle of the term.
Once in a while you get shown the light, in the strangest of places if you look at it right.
Re: How to evaluate an ultra long term contract offer?
You are selling the potential buyers two separate things:Wade Garrett wrote: ↑Fri Jan 21, 2022 1:26 pmI think you're misunderstanding. There is no 4 year "lockup" as in no $ received.mdavis6890 wrote: ↑Fri Jan 21, 2022 12:09 pm You would willingly lock up your property for 4 years hoping that the (prospective) tenant comes through in the end to pay you 4x market rent?
The property is currently in use as part of one industry as it has been going back decades. That will continue during the four year diligence period. Plus, during the 4 years, we would receive a small fee from the company in the new industry on top of that.
So it would be more $ during the 4 years. And then the real $ increase would be after the 4 years.
a) An option on inflation on inflation from now until 44 years from now that they don't have to exercise for four years, and
b) A stream of payments with a Net Present Value.
You can calculate (b) yourself for various inflation rates. The tricky bit is (a). If you sign the contract and we have a LOT of inflation between now and 2026 then the NPV in (b) drops a lot and the leasee will execute the option and start leasing from you. If we DON'T have a lot of inflation between now and 2026 then, basically, the leasee will rent the building from you with the specified NPV for some sort of low-ish inflation rate *OR* walk away from their option by not exercising their option to purchase the lease.
If the NPV calculation for (b) doesn't work out then you probably don't want to sign this. If the NPV calculation for (b) DOES work out then you still might not want to sign this. I'd be a bit concerned that they understand how to value the option much better than you do and that the price they are offering for the four year option is too low.
I think you need to understand how to value the option before you know if this makes sense or not.
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Re: How to evaluate an ultra long term contract offer?
Likely I was misunderstanding. Are you able to cancel this agreement and sell or lease the property to someone else instead if you want to, prior to the start of the 40-year lease (during the due-diligence period)? This would be my primary concern. My understanding of "due-diligence" is that usually there is no particular commitment from the buyer/tenant side, but that there is on the selling/lessor side. But maybe that means something different in your case.Wade Garrett wrote: ↑Fri Jan 21, 2022 1:26 pmI think you're misunderstanding. There is no 4 year "lockup" as in no $ received.mdavis6890 wrote: ↑Fri Jan 21, 2022 12:09 pm You would willingly lock up your property for 4 years hoping that the (prospective) tenant comes through in the end to pay you 4x market rent?
The property is currently in use as part of one industry as it has been going back decades. That will continue during the four year diligence period. Plus, during the 4 years, we would receive a small fee from the company in the new industry on top of that.
So it would be more $ during the 4 years. And then the real $ increase would be after the 4 years.
Can the prospective tenant cancel during the due-diligence period?
Re: How to evaluate an ultra long term contract offer?
Just a wild thought but could they be trying to lock up the property for four years at a low cost just so that a competitor could not get the property?Wade Garrett wrote: ↑Wed Jan 19, 2022 9:58 pm Companies in this different industry are competing with each other for properties in my area but the offers are all similar.
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Re: How to evaluate an ultra long term contract offer?
Nomdavis6890 wrote: ↑Fri Jan 21, 2022 5:31 pm Are you able to cancel this agreement and sell or lease the property to someone else instead if you want to, prior to the start of the 40-year lease (during the due-diligence period)?
Can the prospective tenant cancel during the due-diligence period?
Yes
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
Re: How to evaluate an ultra long term contract offer?
This. The 4x offer is too good to be true and the simplest explanation is that your lessee doesn’t intend to follow through with it.Watty wrote: ↑Fri Jan 21, 2022 5:58 pmJust a wild thought but could they be trying to lock up the property for four years at a low cost just so that a competitor could not get the property?Wade Garrett wrote: ↑Wed Jan 19, 2022 9:58 pm Companies in this different industry are competing with each other for properties in my area but the offers are all similar.
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Re: How to evaluate an ultra long term contract offer?
Don't think so. Multiple companies in this new industry are making offers on other properties in my area. Chatter is all the offers are similar.
There are good reasons for the ultra long term lease offers. Unfortunately, I have to remain vague. Because things are vague, I understand how it may look scammy or underhanded etc. to others. If I were able to divulge more info, things would make much more sense.
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
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Re: How to evaluate an ultra long term contract offer?
The first point is surprising to me. You should be able to sell your property, subject to existing contracts (including this one) even during the DD period.Wade Garrett wrote: ↑Fri Jan 21, 2022 6:37 pmNomdavis6890 wrote: ↑Fri Jan 21, 2022 5:31 pm Are you able to cancel this agreement and sell or lease the property to someone else instead if you want to, prior to the start of the 40-year lease (during the due-diligence period)?
Can the prospective tenant cancel during the due-diligence period?
Yes
Sounds like a ground lease proposal. I see these a lot. I’ve seen many different economic structures - $1 rent in exchange for other consideration, 3% annual increases, flat amounts, CPI increases, FMV adjustments every X years. You name it.
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Re: How to evaluate an ultra long term contract offer?
I need to re-check the exact offer terms so you may be right. It has been a couple of weeks since I read them. That said, the odds of the partners wanting to sell the property are zero (or very near zero).playtothebeat wrote: ↑Fri Jan 21, 2022 6:46 pm The first point is surprising to me. You should be able to sell your property, subject to existing contracts (including this one) even during the DD period.
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
Re: How to evaluate an ultra long term contract offer?
Is the lease your negotiating a triple net lease. That would ease some of your inflationary concerns.
Do you have a mortgage on the building that might be subject to substantial increases in interest rates
in the future.
You should really talk to an expert in this field before you make a 40 year committment.
In NYC 10 years leases are common and I've heard of 15 year leases. I've never heard of a 40 year lease
(though there was a 50 year lease for the underlying property of a commerical building (the Chrysler
Building to be exact).
Do you have a mortgage on the building that might be subject to substantial increases in interest rates
in the future.
You should really talk to an expert in this field before you make a 40 year committment.
In NYC 10 years leases are common and I've heard of 15 year leases. I've never heard of a 40 year lease
(though there was a 50 year lease for the underlying property of a commerical building (the Chrysler
Building to be exact).
Re: How to evaluate an ultra long term contract offer?
NYC Land Lease buildings are typically 50-100 year leases. They are also increasingly becoming a nightmare for the homeowners who have to pay onerous monthlies. You wind up with things like a $6 million apartment hoping to sell for $500K just to get out from under.Rob5TCP wrote: ↑Fri Jan 21, 2022 8:19 pm Is the lease your negotiating a triple net lease. That would ease some of your inflationary concerns.
Do you have a mortgage on the building that might be subject to substantial increases in interest rates
in the future.
You should really talk to an expert in this field before you make a 40 year committment.
In NYC 10 years leases are common and I've heard of 15 year leases. I've never heard of a 40 year lease
(though there was a 50 year lease for the underlying property of a commerical building (the Chrysler
Building to be exact).
70% Global Stocks / 30% Bonds
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Re: How to evaluate an ultra long term contract offer?
This is exactly what I'm talking about - you are giving the other party a 4 year option in exchange for a "small fee." - That doesn't sound worth it to me, but as you pointed out there may be information you can't disclose which somehow could justify this.Wade Garrett wrote: ↑Fri Jan 21, 2022 6:37 pmNomdavis6890 wrote: ↑Fri Jan 21, 2022 5:31 pm Are you able to cancel this agreement and sell or lease the property to someone else instead if you want to, prior to the start of the 40-year lease (during the due-diligence period)?
Can the prospective tenant cancel during the due-diligence period?
Yes
Imagine for example that I propose that you promise to sell me a share of Tesla stock in 4 years for $4000 if I want (that is, I want you to write me a call option), in exchange for $100 I pay you now (the option premium). That doesn't seem worth it for you. 4 years is a long time, and who knows what might happen. And in your case it's worse than that because it also limits your other options during that whole period of time.
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Re: How to evaluate an ultra long term contract offer?
Can you offset the lease by sucking more than the value of the land out as a long term loan secured by the lease? Let’s say Property is worth 100 with value of $8 rent. Renter offers $32 a year starting in 4 years. Can I get a loan of, say $200 against the new higher rents, still make money on the lease, and have zero dollars at risk?
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Re: How to evaluate an ultra long term contract offer?
Can't say too much but none of this applies to our situation
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Re: How to evaluate an ultra long term contract offer?
Ok but I don't understand why this is such a problem. As I've said, the property has been used in the same way going back generations. It will be used in this same way during the 4 years. If the other party walks away, it will be still be used in this way. There are no other options. If the other party walks away after 4 years, we're out nothing. If I could share more details, you would understand.mdavis6890 wrote: ↑Fri Jan 21, 2022 9:20 pm This is exactly what I'm talking about - you are giving the other party a 4 year option in exchange for a "small fee."
And in your case it's worse than that because it also limits your other options during that whole period of time.
I've used the word "property." Some are assuming commercial or industrial buildings. I meant it in the broadest sense possible.
I appreciate everyone's input. This offer from the other party may or may not be a good deal for us but this isn't a scam situation. The question is about inflation and its effect over 44 years. Is 4x current market enough of a cushion? Probably impossible to answer but I'm all ears as to everyone's thoughts. I welcome any further replies but I want to re-direct things back to the inflation aspect and away from the idea that this company is trying to pull a fast one.
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Re: How to evaluate an ultra long term contract offer?
Thanks for the reply. Sounds overly complicated but it's something to consider.softwaregeek wrote: ↑Sat Jan 22, 2022 12:39 am Can you offset the lease by sucking more than the value of the land out as a long term loan secured by the lease? Let’s say Property is worth 100 with value of $8 rent. Renter offers $32 a year starting in 4 years. Can I get a loan of, say $200 against the new higher rents, still make money on the lease, and have zero dollars at risk?
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
Re: How to evaluate an ultra long term contract offer?
With only the details provided, I would pass, because I would want to preserve the opportunity to sell the asset within the next 44 years. I know you said some of the partners will never want to sell, but 44 years is a long time, and a lot can change - divorces, deaths, bankruptcies, etc not to mention regulatory or climatic changes.
If you do want to rent the property I think you owe it to yourselves to have a broker test the broader market.
If you do want to rent the property I think you owe it to yourselves to have a broker test the broader market.
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Re: How to evaluate an ultra long term contract offer?
exactlymarcopolo wrote: ↑Fri Jan 21, 2022 3:01 pm The risk in this deal is that the lease runs the entire 40 years, and there is high inflation such that the 1% escalation does not keep up. In that case the renters get a very low rent relative to market in the later years of the lease. The price they pay for that is a very high rent relative to the market in the early years of the lease.
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
Re: How to evaluate an ultra long term contract offer?
Surely the concern is the new industry will drive up lease rates to something greater than 4x in the next 4 years and you will be stuck with 4x for 40 years. If the industry does not take off they walk away with minimal risk.
Re: How to evaluate an ultra long term contract offer?
Also impossible to answer, but what is the expected price appreciation of the property over the next 44 years? Shouldn't you consider that too?Wade Garrett wrote: ↑Sat Jan 22, 2022 9:59 am The question is about inflation and its effect over 44 years. Is 4x current market enough of a cushion?
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Re: How to evaluate an ultra long term contract offer?
Historically price appreciation for our type of property in our region has been low compared with the same type of properties in other regions and other types of properties in any region. But who knows what the future holds.
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
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Re: How to evaluate an ultra long term contract offer?
I guess this possible. So far all offers from various companies on properties in my area are very similar. Problem is there are a lot of properties in my region. No guarantees but I'd say the odds that the 4x would increase very much in 4 years are very low.
"I'm not an inventor. I'm an improver. I see things that are wrong, and I improve them." - Larry David, Curb Your Enthusiasm
Re: How to evaluate an ultra long term contract offer?
This makes it a closer call, but to me, optionality is everything, so I would bet on price appreciation but also pass on the lease offer to preserve full liquidity.Wade Garrett wrote: ↑Sat Jan 22, 2022 10:18 amHistorically price appreciation for our type of property in our region has been low compared with the same type of properties in other regions and other types of properties in any region. But who knows what the future holds.