Question

The properties PGI is $350,000, comparable properties have a 10% vacancy, operating expenses at 30% of EGI, and are valued on a GRM basis at a 8 multiple of PGI. Market PGI growth for this type of property is generally two percent per year. Investors for this type of property demand a desired rate of return of 10%.

a. Compute the properties value using the GRM approach.

b. Compute the “going-in” cap rate for the property based on the value calculated in a. above.

c. Compute the discounted cash flow value of the property assuming a two year holding period, a 100% equity purchase, and a “terminal” cap rate equal to the “going-in” cap rate calculated in b. above.

d. Calculate the available mortgage assuming you are interested in financing this purchase over 25 years, at an interest rate of 6% per annum, and a bank required 1.15 debt service coverage ratio.

e. Assuming a sale at the end of year two, the same “terminal” cap rate used in c. above, the available mortgage calculated in d. above, and an outstanding loan balance at the end of year 2 of $2,407,718. Calculate the discounted cash flow value of the property using a 12% target rate of return. Please label the debt and equity portions values of the total.

Answer 1

PGI ( potential groos income ): $350000

EGI(Effective gross income) at 90% occupancy= 90%* PGI

= .9*350000= $ 315000

operating expenses = 30% of EGI

Gross rent income = EGI - Operating expenses = EGI - 30%* EGI

= $315000*.70 = $220500

A. Property value using GRM approach:

Generally valued at 8 times the PGI

Value of property = $350000*8

= $2800000

B. Going in cap rate :

NOI/Value of property

= 220500/2800000

=7.875%

C. Discounted cash flow value of property

V= CF0*(1+g)/(1+r )+CF0*(1+g)^2/(1+r)^2+ Terminal value/(1+r)^2

lets calculate terminal value cash flows of the property after 2 years:

Terminal cash flow: $220500*1.02^2 = 229408.2

Terminal interest rate= 7.875%

Terminal growth rate= 2%

Terminal value = 3989708

V= 220500*(1.02/1.1) + 220500*(1.02/1.1)^2 + 3989708/ 1.1^2

V = $3691336

D. Table for the solution is as follows:

	Growth	2%
	Value	3691336
	Debt	1917392	52%
	Equity	1773944	48%
	Interest	6%
	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15	16	17	18	19	20	21	22	23	24	25
Cash Inflow	220500	224910	229408.2	233996.4	238676.3	243449.8	248318.8	253285.2	258350.9	263517.9	268788.3	274164	279647.3	285240.3	290945.1	296764	302699.2	308753.2	314928.3	321226.9	327651.4	334204.4	340888.5	347706.3	354660.4
Principal Repayment	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66	76695.66
Opening balance	1917392	1840696	1764000	1687305	1610609	1533913	1457218	1380522	1303826	1227131	1150435	1073739	997043.6	920348	843652.3	766956.6	690261	613565.3	536869.7	460174	383478.3	306782.7	230087	153391.3	76695.66
Closing balance	1840696	1764000	1687305	1610609	1533913	1457218	1380522	1303826	1227131	1150435	1073739	997043.6	920348	843652.3	766956.6	690261	613565.3	536869.7	460174	383478.3	306782.7	230087	153391.3	76695.66	9.6E-10
Interest	115043.5	110441.8	105840	101238.3	96636.54	92034.8	87433.06	82831.32	78229.58	73627.84	69026.1	64424.36	59822.62	55220.88	50619.14	46017.4	41415.66	36813.92	32212.18	27610.44	23008.7	18406.96	13805.22	9203.48	4601.74
Outflow	191739.2	187137.4	182535.7	177933.9	173332.2	168730.5	164128.7	159527	154925.2	150323.5	145721.8	141120	136518.3	131916.5	127314.8	122713.1	118111.3	113509.6	108907.8	104306.1	99704.36	95102.62	90500.88	85899.14	81297.4
DSCR	1.15	1.201844	1.256786	1.315074	1.376988	1.442833	1.512952	1.587726	1.667584	1.753005	1.844531	1.942772	2.048424	2.162278	2.285241	2.418357	2.56283	2.720063	2.891695	3.079655	3.286229	3.514145	3.766687	4.047843	4.362506

Maximum debt which can be given is 52% for equal installments of 25 years.