Question

A property is forecasted to generate annual rental income of $110,000 in year Vacancy rate is expected to be 5%, there is also a 5% management fee. Other operating expenses will total $19,000 for year 1. Rent is expected to grow at 8% in years 2 and 3, and other operating expenses are expected to grow at 5% in years 2 and 3. You believe that you can sell the property at the end of year 3 for $1,220,000. Using a required rate of return of 9%, calculate a fair value of the property today (at t=0).

Answer 1

It is assumed that management fee is charged on the rent net of vacancy rate.

Given,

Year 1 rent forecasted=$110,000

Vacancy rate=5%. Management fee= 5%

Therefore, net rent expected for year 1= $110,000*0.95*0.95= $99,275

Growth rate=8%.   Required rate of return=9%

PV of 3 year net rentals= $270,734.88 as follows:

Other operating expenses for year 1=$19,000

Growth rate of Other operating expenses=5%

PV of 3 year other operating expense= $50,398.02 as follows:

PV of expected sale value= $1,220,000*PVIF(9%,3)= $1220,000* 0.772183 = $942,063.85

Fair value of the property today= PV of net rentals-PV of operating expenses +PV of sale value

=$270,734.88-$50,398.02+$942,063.85= $1,162,400.71