In: Finance
Five years later, you are offered your dream job in Costa Rica. You need to sell this house in order to purchase a new one where you are moving. Rents have increased since you purchased the home and you estimate that the home will rent for $20,400 per year (net). You have found a high quality tenant willing to sign a five year lease under the following conditions. Rent will be $$20,400 each year for the first three years, and increase to $24,000 for the remaining two years. The average investor’s holding period on residential rental properties is five years. You have estimated sale proceeds will be $339,427 at the end of the investor’s holding period. The appropriate discount rate is 4.25%.
9. What is the minimum price you should list the property for (i.e. the maximum an investor would be willing to pay)? *Remember, the value of an investment property comes from its cash flows. That is, you need to consider both the estimated proceeds at the end of the holding period AND the stream of cash flows the investor will receive from rent while they own the property.
10. What will the investor’s “going-in” IRR be if they pay exactly list price?
11. Assume you have been making payments of $1,000 per month at a rate of 4% per year on a 30 year, fixed rate mortgage. You will close on the home after making your last payment in year 5. How much will your loan payoff amount be (in other words, what is the outstanding balance on your loan after 5 years)?
12. Assuming you sell the home for $371,809.50, pay a 6% real estate broker commission and $4,500 in Seller closing costs, what will be your net proceeds from the sale? Round to the nearest whole dollar. *don’t forget to include your loan payoff amount from question 11!
(9) The idea is to calculate the NPV of future cash flows from the rental property. In this context, the future cash flows are $20,400 at the end of the first three years as rent, $24,000 at the end of the next two years as rent, and $339,427 as sale proceeds at the end of five years. Using the discount rate r = 4.25%, we've,
On putting in the values,
On solving,
On solving, we'obtain: -
Hence, (d) is the correct choice.
(10) In case the investor pays $371,809.50 to purchase, as mentioned in the aforementioned sub-part, the future cash flows are $20,400 at the end of the first three years as rent, $24,000 at the end of the next two years as rent, and $339,427 as sale proceeds at the end of five years for the investor. In case IRR is r, we've,
On putting in the values,
On simplifying,
As clear from the sub-part above, the value of r is 4.25%. Excel can be used in solving the above-equation. Put the six cash flows in cells A1 to F1, and use the formulae IRR(A1: F1) to obtain r = 4.25%. Hence, (c) is the correct choice.
(11) The outstanding balance on the loan should be the present value of the remaining payments after 5 years. Once year 5 is over, monthly payments are $1,000 per month for the next 25 years (300 months) at an annual rate of 4% per year. Hence, if r is the annual rate,
On putting in the values,
The above can be obtained in Excel using the formulae PV(0.04/12, 300, 1000). In this case, 0.04/12 represents the monthly rate, 300 is the number of months, and 1,000 is the monthly payment. Here (d) is the correct response.
(12)
Thus, (a) is the correct choice.