Question

Suppose you own a vacant but developable land parcel on the outskirts of the metropolitan area. This land produces no income but owes 2% of its value per year in property taxes. Meanwhile, typical income properties are yielding 9% (that is, they have a current cash yield, or “cap rate,” of 9%). If inflation is expected to be around 3% per year, and you expect your land will appreciate at 10% per year, what should you do with this land parcel? (Be specific and please explain why you should do what you say.

Answer 1

Option A	Let the value of land be $100
	Lets calculate value of land and alternative investment in next 5 years
		0	1	2	3	4	5
	Land	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
	Value	100	110	121	133.10	146.41	161.05
	Taxes @ 2%	2	2.2	2.42	2.66	2.93	3.22
	Value of land after taxes	98	107.8	118.58	130.44	143.48	157.83
		($98.00)	($104.66)	($111.77)	($119.37)	($127.48)	($136.15)
	PV @ 3%	98.00	104.66	111.77	119.37	127.48	136.15
	NPV in 5 years	697.43
	NPV in 3 Years	433.80
Option B	Now treating value of typical income properties as $ 100
	Income Properties	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
	Value(increassing @ 3% per year)*	100	103.00	106.09	109.27	110.27	111.27
	Income @ 9%	9	9.27	9.55	9.83	9.92	10.01
	Less: inflation	0	0.28	0.29	0.30	0.30	0.30
	Net Income	9	8.99	9.26	9.54	9.63	9.71
	Value of property	109.00	111.99	115.35	118.81	119.90	120.98
		($109.00)	($108.73)	($108.73)	($108.73)	($106.53)	($104.36)
	PV@ 3%	109.00	108.73	108.73	108.73	106.53	104.36
	NPV in 5 years	646.07
	NPV in 3 Years	435.19
	Note:
	Value of income yielding property grew @ rate of inflation every year
	if the investor is willing to invest for a time horizon of more than 3 years then he should hold the land parcel as the NPV for both the options is almost identical in 3 years horizon and even greater for the land parcel in the time horizon of 5 years. But if the investor is looking at time horizon of less than three years he should liquidate the land parcel and invest the money in Income yeilding properties. But as we can see from above calculations the benefit is higher from the Land Parcel in long run.