Small Office Building Example

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					Small Office Building Investment
Two-story building
Asking Price = $1.25 million
Acquisition costs =
      1% of purchase price
Effective Age = 8 years
Gross Leaseable Area = 20,000 square feet
Net Leaseable Area = 18,200 square feet
Brick/concrete/steel construction
Parking Space = 7,000 square feet
                                            1
Current Leases

First Floor - Bank
9,500 sq. ft. for $10,500 per month with level payments for 3 more years
with option to renew for 10 years for $12,000/month

Second Floor - Insurance Company
6,200 sq. ft for $12.85/sq. ft. per year. Lease expires end of two years.
New terms will be at market rate

Second Floor - Law Office
2,500 sq. ft for $2,750/month; annual increase of 50% of CPI increase
for next 5 years.
At end of 5 years, space is expected to be rented at the market rate
       Current Tenants have “B” Credit Ratings
                                                                            2
Operating Expenses Projections

Management fees: 6% of effective gross income

Property taxes:    $20,000 in Year 1 and 2; 15% increase in Year 3

Utility expenses: $1.50/sq. ft. of gross building area; 5.5% increase per year

Insurance:         $.18/sq. ft. of net rentable area; 4% increase per year

Janitorial expense: $.75/sq. ft. of gross area; 6% increase per year

Maintenance:       $.25/sq. ft. of gross area for year one; 4% increase per
                    year

                                                                             3
Vacancy and Credit Allowances

•Building is currently 100% leased, but possibility tenant
will leave before lease expiration

•Vacancy and credit allowance under current lease is
   •2% per year for first two years
   •4% per year thereafter




                                                             4
Lease Comparable 1

•Signed two months ago
   • 5,000 square feet of net leaseable area
   • $14.50 per square foot
   • 10 year term
   •Not indexed
   • Option to renew for additional 5 years at $15.00/sq. ft.
   • Tenant is an accounting firm with “C” credit rating
                            Building Profile
 2-story structure with 18,500 sq. ft. of net leaseable area; similar to
  subject in structure. This is a newer building located in the same
                     general location as subject.
                                                                           5
Lease Comparable 2
•Signed one month ago

   •12,500 square feet net leaseable area
   •$14.25 per square foot
   •8 year term
   •Indexed to CPI
   •No additional options to the lease
   •Tenant is a dentist with an “A” credit rating
                        Building Profile
  2-story structure with 25,000 sq. ft. of net leaseable area;
  similar to subject in structure, but is in a better location
                                                                 6
Lease Comparable 3
•Signed four months ago

   • 2,500 square feet of net leaseable area
   •$13.75 per square foot
   •3 year term
   •Renewable for additional 5 years at market rent
   •Indexed to CPI and contained expense-stop provision
   on property taxes
   •Tenant is a law firm with a “B” credit rating
                            Building Profile
3-story structure with 36,500 sq. ft. of net leaseable area; same type of
               construction, age, and location as subject
                                                                            7
 Lease Comparable 4
•Signed two months ago

   •10,000 square feet of net leaseable area
   •$13.50 per square foot
   •3 year term
   •Indexed to CPI with expense-stops on insurance and
   property taxes above the current levels
   •Tenant is an insurance company with an “A” credit
   rating
                       Building Profile
20,000 sq. ft. of net leaseable area; older than subject and is
                  in the same general location
                                                              8
Lease Comparable 5
•Signed six months ago
   • 6,500 square feet of net leaseable area
   • $14.25 per square foot
   • 5 year term
   • Not indexed and had no other options
   • Tenant was a tanning salon with a “B” credit rating
                       Building Profile
 30,000 sq. ft. of net leaseable area; same age as the subject
              and is in the same general location
                                                                 9
Market Trends


    •   Rents expected to increase at CPI of 4% per
        year
    •   Market vacancy rate of 5% seems typical
    •   Selling prices of office properties have
        increased 5% over the past year
    •   New construction of office buildings in the
        last year


                                                      10
Reversion Assumptions

   Forecasted selling price at end of holding period uses a
    “going-out” cap rate of 13%.

   Selling expenses are expected to be 3% of the selling
    price.

   Holding period is 5 years.




                                                               11
Sales of Comparable Office Properties

                                                       Comparables
Characteristic                        1               2               3             4
Sale Price                        $1,275,000      $1,250,000      $1,550,000 $1,135,000
Months since sale                     2               4               6             2
Effective Gross Income at Sale      $270,000        $247,000         $312,000     $216,000
Vacancy                                   5%              5%               7%           3%
Operating Expenses at sale          $110,500         $94,500         $125,000      $82,500
Property rights                    Leased fee      Leased fee      Leased fee Leased fee
Construction                     Brick/Steel     Brick/Steel     Brick/Steel   Brick/Steel
Effective age                              12                6               8            2
Number of Tenants                            7               4               6            3
Tenant credit rating                         C               B               B            A
On-site parking (Square Feet)           6,000           5,500            7,500        6,000
Leaseablearea (Square Feet)            20,000          19,000           24,000      17,000
Gross area (Square Feet)               22,000          21,000           26,000      18,000



                                                                                              12
Comparable Land Sales

 Site has 90,000 square feet, and is in an average
 location and average topographical features.
                 Comparable Land Sales
                                    Comparables
                           1             2                 3
Sale Price             $315,500       $225,000         $270,000
Sale Date            6 months ago   4 months ago     2 months ago
Size (Square Feet)      125,000        85,000           110,000
Price per Sq. Ft.        $2.52         $2.65             $2.45
Location               Excellent      Average          Average
Topography             Average          Poor           Average



                                                               13
Land Market Trends




  • Land Prices have increased 6% over the past year
  • Land in excellent locations sell for 5% more
  • Topographical differences result in a 10% value
  differential




                                                       14
Construction Costs


Base Construction Cost:        $65 per square foot gross area
Location Adjustment Factor:      0.95
Effective Age:                   8 years
Remaining Economic Life:        27 years
Other depreciated site cost:   $35,000
Entrepreneurial profit:        $75,000



                                                            15
Mortgage Assumptions

 Mortgage Amount:   75% Loan-to value
 Interest Rate:      9%
 Maturity:          20 years (monthly amortization)
 Prepayment Penalty: 4.5% of outstanding balance
 Financing Costs:   2.5% of the amount borrowed




                                                      16
Depreciation and Tax Rates

Depreciation
• Straight Line Method
• 39 years of useful life
• Depreciable basis allocation: 80% to building, 20% to land

Investor’s Tax Rates
• Ordinary income tax rate:     35%
• Capital gains tax rate:       20%
• Depreciation recapture tax rate: 25%
                                                          17
Investor’s Required Rates of Return

    Equity Dividend Rate:    16.5%
    Equity Before-Tax Rate: 20%
    Equity After-Tax Rate:   12%




                                     18
Question 1

Using information on comparable sales, calculate the
  following ratios:
 Rent per leaseable square foot
 Rent per gross square foot
 Gross income multiplier
 Operating expense ratio
 Overall cap rate
 Sale price per leaseable square foot
 Sale price per gross square foot




                                                       19
Answer to Question 1

Ratios                     1        2        3        4
Rent (leaseable)         $13.50   $13.00   $13.00   $12.71
Rent (gross)             $12.27   $11.76   $12.00   $12.00
GIM                       4.72     5.06     4.97     5.25
OER                      40.93%   38.26%   40.06%   38.19%
Overall Cap Rate         12.50%   12.20%   12.06%   11.76%
Sale Price per Sq. Ft.   $63.75   $65.79   $64.58   $66.76
(leaseable)
Sale Price per Sq. Ft.   $57.95   $59.52   $59.62   $63.05
(gross)

                                                             20
Question 2

Analyze the rental comparables.

What is the market rental rate?




                                  21
Answer to Question 2
Summary of Lease Comparables
Characteristic          1           2           3            4            5
Date             2 months ago 1 month ago 4 months ago 2 months ago 6 months ago
Rent                 $14.50      $14.25      $13.75       $13.50       $14.25
Square Feet          5,000       12,500       2,500       10,000        6,500
Term                10 years     8 years     3 years      3 years      5 years
Lease Options Not indexed;    Indexed to   Indexed to      Indexed to Not indexed;
                option to      CPI; no     CPI; option         CPI;    no other
              renew at $15       other     to renew at      Expense-    options
                                options    market rent;      stop on
                                            Expense-      insurance &
                                             stop on        property
                                            property          taxes
                                              taxes
Age                Newer        Similar      Similar         Older       Similar
Location           Similar      Better       Similar        Similar      Similar
Size (Sq. Ft.)     18,500       25,000        36,000        20,000       30,000
Tenant Rating         C           A             B             A            B
                                                                                   22
Answer to Question 2
Summary of Lease Comparables (con’t)

Rent for Comparable 4 is at the
lower end of the market at $13.50


Rent for Comparable 1 is the
upper limit at $14.50


Market rent is around $14.00


                                    23
Question 3

a. Forecast the net operating income under the existing leases
for years 1 through 6.

b. Forecast the net sale price at the end of year 5.

c. At the discount rate of 14% for the net income stream, how
much would the investor be willing to bid?




                                                            24
Answer to Question 3a
  3a. Forecast NOI under the existing leases

              1        2          3          4          5          6
Bank       126,000   126,000   126,000    144,000    144,000    144,000
Ins. Co.   79,670    79,670    93,883     97,638     101,544    105,605
Lawyer      33,00    33,660    34,333      5,030     35,720     42,583
PGI        238,670   239,330   254,216    276,658    281,264    292,188
Vacancy    (4,773)   (4,787)   (10,169)   (11,066)   (11,251)   (11,688)
EGI        233,897   234,548   244,047    265,592    270,013    280,500




                                                                       25
Answer to Question 3a (con’t)
Expenses:
Management    14,034     14,073     14,643    15,936     16,201   16,830

Prop. Tax     20,000     20,000     23,000    23,000    23,000    23,000
Insurance      3,276      3,407      3,543     3,685     3,832     3,985
Utilities     30,000     31,650     33,391    35,227    37,165    39,209
Janitor       15,000     15,900     16,854    17,865    18,937    20,073
Maintenance    5,000      5,200      5,408     5,624     5,849     6,083
Total
              (87,310)   (90,230)   (96,839) (101,337) (104,984) (109,180)
Expenses
NOI           146,587    144,314    147,209   164,254   165,029   171,320



                                                                             26
Answer to 3b

b. Forecast the net sale price at the end of Year 5:


                               175,320
                        SP =
                                 .13
                          = $ 1,317,846


3% selling expense = $39,535

Net sale price = 1,317,846 - 39,535 = $1,278,311
                                                       27
Answer to 3c
       c. How much to bid?

Year         NOI       NSP         PVF@14%          PV
 1         $146,587                .8772          $128,586
 2          144,314                .7695           111,050
 3          147,209                .6750            99,366
 4          164,254                .5921            97,255
 5          165,026   $1,278,311   .5194           749,671

                        Value = $1,185,928  $1.2 Million
                        ( PV)

                                                            28
Question 4

a. Forecast the net operating income at the market
rent for years 1 through 6.

b. Forecast the net sale price at the end of year 5.

c. At the discount rate of 14%, how much would the
investor be willing to bid?




                                                       29
Answer to 4a
Forecast NOI at Market Rental Rates
Market rent of $14.00 (from Question 2) is used in these calculations
Rents are expected to increase 4% per year.

           1        2        3               4        5              6
 PGI    $254,800 $264,992 $275,592        $286,615 $298,080       $310,003

- VAC   (12,740)   (13,250)    (13,780)   (14,331)    (14,904)    (15,500)

 EGI    242,060     251,742    261,812     272,284    283,176      294,503

- OE    (87,310)   (90,230)    (96,839)   (101,337) (104,984)     (109,180)

 NOI    $154,750 $161,512 $164,973        $170,947    $178,192    $185,323

                                                                             30
Answer to 4b
b. Forecast the net sale price at the end of Year 5:



                             185,523
                        SP =
                               .13
                           = $ 1,425,561


  3% selling expense = $47,766

  Net sale price = 1,425,561 - 47,766 = $1,382,794


                                                       31
Answer to 4c

     c. How much to bid?
Year        NOI       NSP         PVF@14%          PV
 1        $154,750                .8772          $135,747
 2         161,512                .7695           124,283
 3         164,973                .6750           111,357
 4         170,947                .5921           101,214
 5         178,192   $1,382,794   .5194           810,776

                        Value = $1,283,377  $1.28 Million
                        ( PV)
                                                        32
Question 5

For the mortgage financing, at $1.25 million asking
price, calculate the following:
a.   Monthly payment
b.   Annual payment
c.   Amortization schedule for years 1 through 5
d.   Financing costs
e.   Prepayment penalty in Year 5




                                                      33
Answers to 5a and 5b
a. Monthly Payment
        = $1,250,000 (.75) (.0089973)
        = $8,434.97
Note: Assume price paid is the asking price. The .0089973 is the
monthly mortgage constant at 9% for 240 months. The annual
mortgage constant is .0089973(12) = .108

b. Annual payment
        = $8,435 (12) = $101,220

                                                                   34
Answer to 5c
 Amortization Schedule
          Amount        Debt
  Year                            Interest    Principal
         Outstanding   Service
   0      $ 937,500
   1       919,943     $101,220    $83,663     $17,557
   2       900,740     101,220     82,017       19,203
   3       879,735     101,220     80,215       21,005
   4       856,759     101,220     78,244       22,976
   5       831,629     101,220     76,090       25,130

Note: The proportion of the mortgage outstanding at the end of
year 5 is 831,629/937,500 = .88707.

                                                            35
Answers to 5d and 5e


d. Financing costs
     = .025 ($937,500)
     = $23,438

e. Prepayment penalty
      = $831,629 (.045)
      = $37,423

                          36
Question 6

 Forecast the BTCF for years 1 through 5 and
 the BTER in Year 5 at the $1.25 million asking
 price under:

 a. The lease rents

 b. The market rents



                                                  37
Answer to 6a
6a. Before-Tax cash flows at lease rent:

           Year 1       Year 2   Year 3       Year 4      Year 5
  NOI      146,587    144,314    147,209      164,254    165,029
 - DS     (101,220)   (101,220) (101,220) (101,220)     (138,643)*
  BTCF      45,367      43,094   45,989       63,034      26,386
   *includes prepayment penalty of $37,423.
  BTER at lease rent:
  NSP       $ 1,278,311
  -UM        -831,629
  BTER      $ 446,682

                                                                     38
Answer to 6b
6b. Before-tax cash flows at the market rent:

          Year 1      Year 2    Year 3       Year 4      Year 5
 NOI      154,750     161,512   164,973      170,192    178,192
- DS     (101,220)   (101,220) (101,220) (101,220)     (138,643)*
 BTCF      53,530     60,292     63,753      68,972      39,549
  *includes prepayment penalty of $37,423.

BTER at market rent:
NSP     $ 1,382,784
-UM       -831,629
BTER     $ 551,155
                                                                    39
Question 7

Compute the NPV and IRR on equity at the
$1.25 million asking price using:

a. The lease rental BTCF’s and BTER

b. The market rental BTCF’s and BTER




                                           40
Answer to 7a

At $1.25 million the investor’s cash outflow is:
Downpayment:            $312,500
+ Financing Costs:        23,438
+ Acquisitions Costs:    12,500
   Total Equity:        $348,438




                                                   41
Answer to 7a (con’t)
NPV and IRR calculated based on before tax cash flows using the lease rental rates:

      Year        Equity        BTCF          BTER       PVF@20%           PV
        0         -348,438                                   1.0        -348,438
        1                       $45,367                     .8333        37,804
        2                       43,094                      .6944        29,926
        3                       45,989                      .5787        26,614
        4                       63,034                      .4823        30,398
        5                       26,386       $446,682       .4019       190,126
                                    IRR= 17.0%               NPV= - $33,570



                                                                                   42
Answer to 7b

NPV and IRR using market rental rates:
 Year    Equity     BTCF        BTER      PVF@20%           PV
  0     -$348,438                             1.0         -348,438
  1                 $53,530                  .8333        44,607
  2                 60,292                   .6944         41,867
  3                 63,753                   .5787        36,894
  4                 68,972                   .4823        33,265
  5                 39,549     $551,155      .4019        237,404
                              IRR = 23.82%          NPV = $45,599



                                                                     43
Question 8

a. Calculate the depreciation deduction for tax purposes, at
   the asking price of $1.25 million
b. Calculate the adjusted basis and the cumulative
   depreciation deductions for Years 1 through 5
c. Calculate the taxable income and taxes from operation for
   years 1 through 5 under the existing leases
d. Calculate the taxes due on sale in Year 5
e. Forecast the ATCF from operation for Years 1 through 5
f. Forecast the ATER from sale in Year 5




                                                         44
Answer to 8a

Depreciable basis
     = .8(1,250,000 + 12,500)
     = 1,010,000

 Depreciation deduction
      = 1,010,000/39
      = $ 25,897
                                45
Answer to 8b

                                                    Cumulative
                                   Depreciation
   Year       Adjusted Basis                        Depreciation
                                    Deduction
                                                     Deduction
    0          $ 1,262,500
    1             1,236,603          $ 25,897          $ 25,897
    2             1,210,706            25,897            51,794
    3             1,184,809            25,897            77,691
    4             1,158,912            25,897          103,588
    5             1,133,015            25,897           129,485

Adjusted Basis = Original Basis - Cumulative Depreciation + any capital
expenditures

                                                                          46
   Answer to 8c
  Taxes from Operation
                               1            2             3             4               5
     NOI                  $ 146,587      144,314       147,209        164,254         165,029

     - Interest            (83,663)      (82,017)     (80,215)        (78,244) (113,513)*

     - Depreciation        (25,897)      (25,897)     (25,897)        (25,897)       (25,897)

     - AFC**                 (1,172)       (1,172)      (1,172)        (1,172)       (18,750)

     TI                      35,855        35,228       39,925          58,941           6,869

     x   Tax rate               x .35         x .35        x .35            x .35           x .35


     Taxes                 $ 12,549        12,330       13,974          20,629           2,404

* Includes prepayment penalty of $37,423
** Amortized financing costs is $23,438/20 = 1,172 per year. Balance ($18,750) is taken in Year 5.
                                                                                                47
Answer to 8d
 Taxes due on sale:
Sale Price          $ 1,317,846   Capital Gain            $ 15,811

-Selling Expenses       -39,535   x Tax Rate                 x 0.2
                                  Capital Gain Tax          3,162
  Net Sale Price     1,278,311
-Adjusted Basis      -1,133,015
                                  Cum. Dep. Ded.          $ 129,485
  Total Gain           145,296
                                  x Tax Rate                 x 0.25
Cum. Dep. Ded.        -129,485    Tax on Dep. Recapture     32,371
  Capital Gain          15,811
     Tax Due on Sale = $3,162 + 32,371
                              = $35,533
                                                                      48
Answer to 8e

    ATCF for Years 1-5 under existing leases


             1          2          3          4         5
  BTCF     45,357     43,094     45,989     63,034    26,386
- Taxes   (12,549)   (12,330)   (13,974)   (20,629)   (2,404)
 ATCF     32,818     30,764     32,015     42,405     23,982




                                                            49
Answer to 8f

ATER in Year 5
Sale Price           $ 1,317,846
-Selling Expenses       -39,535
Net Selling Price     1,278,311
-Unpaid Mortgage       -831,629
BTER                   446,682
-Taxes Due on Sale      -35,533
ATER                   411,149

                                   50
Question 9

 What is the NPV and IRR to the investor
 using the forecast of after-tax cash flows?




                                               51
Answer to 9

Year   Equity       ATCF      ATER       PVF@12%      PV
 0     - $348,438                          1.0     - $348,438
 1                  $32,818               .8929       29,303
 2                   30,764               .7972       24,525
 3                   32,015               .7118       22,788
 4                   42,405               .6355       26,948
 5                   23,982   $411,149    .5674      246,892

                     IRR = 12.15%           NPV = 2,018

                                                           52
Question 10

 Using the gross income multiplier approach,
 estimate the following:

 a. Leased-fee value
 b. Market value




                                               53
Answers to 10a and 10b

 10a. Using the comparable sales data, Comparables 2 & 3
 yield a gross income multiplier of between 4.97 to 5.06.
 Leased-fee value = $233,897 * 5.0
                 = $1,169,485  $1.17 million


 10b. The market value is:
 Market Value = $242,060 * 5.0
               = $1,210,000    $1.21 million

                                                            54
Question 11


   Using a market extracted cap rate,
   estimate the following:

   a. Lease-fee value
   b. Market value




                                        55
Answers to 11a and 11b

 11a. Using the comparable sales data, overall cap rate is
       12.05% to 12.2% for comparables 2 and 3. Using
       a cap rate of 12.1%
 Leased fee value = 146,587/.121
                  = $1,211,463  $1.21 million
 11b. The market value is:
 Market Value = 154,750/.121
               = $1,278,926     $1.28 million

                                                             56
Question 12


Using the band of investment approach to derive
the cap rate, estimate the:

a. Lease-fee value
b. Market value




                                                  57
Answers to 12a and 12b

12a. At the investor’s require dividend rate of 16.5% and the
      mortgage terms (75% loan-to-value, 9% interest rate,
      20 years with monthly compounding)
R = 0.108(0.75) + 0.165(0.25) = 0.122
Leased-fee value = 146,587/0.122 = $1,201,532  $1.2
million

12b. The estimated market value is:
Market Value = 154,750/.122
              = $1,268,443     $1.27 million
                                                                58
Question 13


   Based on the comparable land sales,
   estimate the value of the site for the
investment, using price per square foot as
         the unit of comparison.




                                             59
Answer to 13
Adjustment Grid for Comparable land sales

 Characteristic              1           2          3
 Sale Price               $315,000   $225,000   $220,000
 Size (Sq. Ft.)           125,000     100,000    110,000
 Price per Sq. Ft.         $2.524     $2.25      $2.455
 Sale Date Adjustment      + 3%       + 2%        1%
 Adj. Price per Sq. Ft.     $2.60     $2.30      $2.48
 Location                  - 5%        0%         0%
 Topography                 0%        + 10%       0%
 Total Adjustment          - 5%       + 10%        0%
 Adj. Price per Sq. Ft.    $2.47      $2.52       $2.48

     Estimated land value: ($2.50)*(90,000) = $225,000

                                                           60
Question 14

 Using the cost information, estimate the
 value using the cost approach.
Base Construction Cost:        $65 per square foot gross area
Location Adjustment Factor:      0.95
Effective Age:                   8 years
Remaining Economic Life:        27 years
Other depreciated site cost:   $35,000
Entrepreneurial profit:        $75,000
                                                            61
Answer to 14
Gross Building Area              20,000 Sq. Ft.
Base building cost per sq. ft.          $65.00
Location multiplier                         .95
Adj. Cost per sq. ft.                   $61.75
Reproduction cost of building       $1,235,000
Less physical depreciation           - 284,500
Depreciated cost of building           950,950
Plus other site improvements         + 35,000
Plus entrepreneurial profit          + 75,000
Plus land value                      + 225,000
Indicated value from cost           $1,285,950
  approach
                                                  62
Question 15


Comparable sales 2 and 3 appear to be the
most similar to the subject property. Using
the price per square foot of leaseable area
  as the unit of comparison, what is the
              indicated value?




                                              63
Answer to 15
                                        2                    3
Selling Price                       $1,250,000           $1,550,000

Net leaseable area                    19,000              24,000

Price per square foot                 65.79                64.58

Time since sale                     4 months             6 months

Adjustment                            1.62%                2.5%

Adjusted price per square foot        $66.89              $66.19

The indicated value per sq. ft. is about $66.50. Since the
subject has 18,200 sq. ft. of net leaseable area, the total
estimated value is:
                  Value = 18,200 * $66.50 = $1,210,300
                                                                      64
Question 16

Estimate the leased-fee value using
mortgage-equity analysis assuming a 75% loan-to-
value ratio at an interest rate of 9% with monthly
amortization over 20 years.

The equity required rate of return is 20%.




                                                     65
Answer to 16

                  146,587 .75(V)(.108)       144,314 .75(V)(.108)
   V  .75(V)                            
                              1                            2
                        (1.20)                       (1.20)
                 147,209 .75(V)(.108)        164,254 .75(V)(.108)
                                         
                              3                           4
                       (1.20)                        (1.20)
                 165,029 .75(V)(.108)        1,278,311 .75(V)(.887071)
                                         
                              5                                5
                      (1.20)                      (1.20)
   V  .75(V)  2.9906(.75)(V)(.108)
              146,587(.83333)  144,314(.69444)  147,209(.5
                                                            787)
              164,254(.48225)  165,029(.40188)
              1,278,311(.40188) .75(V)(.887071)(.401 88)
   V  .75(V)  .2422(V)  966,818 .26737(V)
   V  .24043(V)  966,818
   .75957(V)  966,818
   V  $1,272,850
                                                                           66
Question 17


 Why does the estimate of the value using
 mortgage-equity analysis in question 16 conflict
 with the result given in the NPV analysis in
 question 7a?




                                                67
Answer to 17

     The discounted cash flow analysis in
 question 7a accounts for all the cash outflows,
 including the acquisition costs, the financing
 costs and the mortgage prepayment penalty.
 The value estimated using mortgage-equity
 analysis in question 16 does not include these
 cash outflows.



                                                   68
 Answer to 17 (con’t)
Adjusting the value estimate in question 16 to include
these results in the following:
  Acquisition costs (AC) = 1% of value
  Financing costs (FC) = 2.5% of the mortgage amount
  Prepayment Penalty (PP) = 4.5% of the unpaid mortgage balance
In equation form:
  AC = .01(V)
  FC = .75(V)(.025)
  PP = .75(V)(.887071)(.045)



                                                              69
Answer Question 17 (con’t)

The AC and FC are paid immediately and
thus require no discounting. The
prepayment penalty occurs in year 5 and is
discounted at the 20% annual rate. In
present value terms the prepayment
penalty is:
     PVPP = .75(V)(.887071)(.045)(.40188)
     PVPP = .01203

                                             70
Answer Question 17 (con’t)
Adjusting the solution in question 16 to
reflect these costs,
V = .24043(V) + 966,818 - .01(V) - .75(V)(.025) -
    .75(V)(.887071)(.045)(.40188)
V = .24043(V) + 966,818 - .01(V) - .01875(V) - .01203(V)
V = .19965(V) + 966,818
.80035(V) = 966,818
       V = $1,207,994


                                                           71
Answer Question 17 (con’t)

Proof:
Value = $1,207,991 ( $1,208,000)
Mortgage = $1,208,000(.75) = $906,000
Debt Service = $906,000(1.08) = $97,848
Unpaid Balance at end of year 5 = $906,000(.887071) = $803,686
Prepayment Penalty at end of year 5 = $803,686(.045) = $36,166
Equity Outflow:
       Downpayment = $1,208,000(.25) = $302,000
       Acquisition Costs = 1,208,000(.01) = $12,080
       Financing Costs = .025(906,000) =      $22,650
                                        Total     $336,730
BTER at end of year 5 = $1,278,311 - $803,686 = $474,625
                                                                 72
Answer Question 17 (con’t)
 Year    Equity       NOI        DS       BTCF      BTER

  0     -$336,730
  1                 $146,587   $97,848   $48,739
  2                 144,314    97,848    46,466
  3                 147,209    97,848    49,361
  4                 164,254    97,848    66,406
  5                 165,029    134,014   31,015    $474,625
                                          NPV =      0
                                          IRR =     20%


                                                              73
Question 18
 Summarize and analyze the various estimates
of value.
What are the advantages/disadvantages of each
method for value estimation?
 Why is the leased-fee value less than the market
value?
 What are the risks associated with this
investment?
 How much would you be willing to bid for the
investment?
Justify   your answer.
                                                     74
Answer Question 18

   Techniques                Leased-Fee Value   Market Value
1. GIM                          $1,170,000       $1,210,000
2. Market Extracted Cap Rate    $1,210,000       $1,280,000
3. Band of Investment           $1,200,000       $1,270,000
4. Cost Approach                   -----         $1,290,000
5. Comparison Approach          $1,210,000          -----
6. Mortgage Equity Approach     $1,272,850          -----
7. Mortgage-Equity Approach     $1,208,000          -----
   (Adjusted)




                                                          75
Answer Question 18 (con’t)
The discounted cash flow analysis at the asking
price of $1,250,000 indicates that the NPV of
equity is -$33,570 using the forecast of flows at
the before-tax cash flows at the current lease
rates.

 The NPV is +$2,018 using the after-tax cash
flow forecasts.



                                                    76

				
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