Question

In: Finance

Property Assumptions Purchase Price: &nb

Property Assumptions

Purchase Price: $12,500,000

Year 1 Potential Rental Income (PRI): $1,650,000

PGI annual growth rate: 3%

Annual Vacancy and Credit Loss (VCL): 5%

Over next 6yrs.

Year 1 operating expenses (OER): (Oper. Expense Ratio) 35%

OPEX annual growth rate (after year 1): 2%

Sales Price : Terminal Cap Rate .09

Capitalize 6^th yr. NOI

Sales Costs: Commissions 3% of Sales Price

Anticipated holding period 5 years

Maximum loan-to-value (LTV) ratio: 75%

Interest Rate: 5.25%

Amortization Period: 20 years

Payments per year: 12

Investors’ Hurdle Rate (unleveraged) 12%

Investors’ Hurdle Rate (leveraged) 15%

What is the Operating Expense Ratio for years 1-6?
What is the Unleveraged IRR and NPV?
What is the leveraged IRR and NPV?
Do you recommend purchasing this property? Explain

Expert Solution

The Excel formulas for the solution are provided towards the end of the solution.

	Amount	%
Potential Rental Income (Year 1)	1650000
PGI growth rate		3%
Vacancy and Credit Losses		5%
Operating Expense Ratio (Year 1)		35%
OPEX growth rate		2%

1. For year 1, Operating Expense = OER*(PRI - VCL)

For subsequent years, (Operating Expense)_t = (Operating Expense)_t-1 * (1+OPEX growth rate)

Similarly, (Property Rental Income)_t = (Property Rental Income)_t-1 * (1+PGI growth rate)

	0	1	2	3	4	5	6
Potential Rental Income (PRI)		1650000	1699500	1750485	1803000	1857090	1912802
Vacancy and Credit Losses (VCL)		82500	84975	87524	90150	92854	95640
Operating Expenses		548625	559598	570789	582205	593849	605726
Net Operating Income (NOI)		1018875	1054928	1092171	1130644	1170386	1211436
Operating Expense Ratio		35.00%	34.66%	34.32%	33.99%	33.66%	33.33%

2. (Sales Price)₅ = NOI₆/Terminal Cap Rate

Sales Costs Commissions = 3%*(Sales Price)₅

Terminal Cap Rate	9%
Sales Price	13460398
Sales Costs: Commissions	403812	3%

Terminal Value of the Investment = Net Sales proceeds = Sales Price-Sales Commission

UNLEVERAGED PROPERTY

	0	1	2	3	4	5
Purchase Price	-12500000
NOI		1018875	1054928	1092171	1130644	1170386
Terminal Property Value						13056586
Net Cash flows (unleveraged)	-12500000	1018875	1054928	1092171	1130644	14226971
NPV (unleveraged)	-1180612
IRR (unleveraged)	9.43%

Net Cash flow in the 5th year would be the sum of Net Operating Income (NOI) plus the (Sales Price-Sales Commission) received on selling the property at the end of 5th year.

3. LEVERAGED PROPERTY

Purchase Price = 12,500,000

Loan principal amount = LTV ratio * Purchase Price

Monthly EMI = PMT(Monthly Interest Rate, No. of Periods, PV)

Monthly Interest Rate = 5.25%/12 = 0.438%

No. of Periods = 20*12 = 240

PV = Loan principal amount

LTV ratio		75%
Loan principal amount	1237500
Interest Rate		5.25%
Term period (years)	20
Payments per year	12
Monthly EMI	8338.82

	0	1	2	3	4	5
Purchase Price	-12500000
NOI		1018875	1054928	1092171	1130644	1170386
Annual EMIs		100066	100066	100066	100066	100066
Annual Cash flows (leveraged)		918809	954862	992105	1030578	1070320
Terminal Property Value						13056586
Net Cash flows (levered)	-12500000	918809	954862	992105	1030578	14126905
NPV (leveraged)	-2713892
IRR (leveraged)	8.65%

4. No, it is not recommended to purchase this property, as the NPV of this investment is negative in either case.

jeff jeffy answered 3 years ago

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