Question

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An Owner just purchased an office building for $5 million dollars with 80% LTV an a...

An Owner just purchased an office building for $5 million dollars with 80% LTV an a loan of 6.5%, 30 year term. The owner intends to hold the building for five years.

The building has three floors of rentable space with a single tenant on each floor. The first floor has 20,000 square feet of rentable space and is currently renting for $15 per square foot. Three years remain on the lease. The lease has an expense stop at $4 per square foot. The second floor has 15,000 square feet of rentable space and is leasing for $15.50 per square foot and has four years remaining on the lease. This lease has an expense has an expense stop at $4.50 per square foot. The third floor has 15,000 square feet of leasable space and a lease just signed for the next five years at a rental rate of $17 per square foot, which is the current market rate. The expense stop is at $5 per square foot, which is what expenses per square foot are estimated to be during the next year (excluding management). Management expenses are expected to be at 5 percent of effective gross income and are not included in the expense stop. Each lease also has a CPI adjustment that provides for the base rent to increase at half the increase in the CPI. The CPI is projected to increase 3 percent per year. Estimated operating expenses for the first year of ownership includes the following:

Property taxes

$ 100,000

Insurance

     10,000

Utilities

     75,000

Janitorial

     25,000

Maintenance

     40,000

Total

$ 250,000

All expenses are projected to increase 3 percent per year. The market rental rate at which leases are expected to be renewed is also projected to increase 3 percent per year. When a lease is renewed, it will have an expense stop equal to operating expenses per square foot during the first year of the lease. To account for any time that may be necessary to find new tenants after current leases expire and new leases are made, vacancy is estimated to be 10 percent of EGI for the last two years (years 4 and 5).

  1. Project the net operating income (NOI) for the next five years.
  2. How much does the NOI increase (average compound rate) over the five years?
  3. What is the BTCF each year?
  4. What is the overall capitalization rate (“going-in” rate)?
  5. Assuming the going out cap rate is .25 less than the going in cap rate. What is the sale price at the end of year five?
  6. What is the reversion value after sale?
  7. What is the levered IRR?
  8. What is the unlevered IRR?

Solutions

Expert Solution

a. Net Operating Income (NOI) is the income or profit which is generated from investing in a project or any other investment avenues. It is calculated as the revenue earned from the property after adjusting the operating expenses associated with the property.

A property's projected net operating income (NOI) is dependent on several factors like expected occupancy rate in future, the expected rent in the market in future etc.

All values in $

Input data
Current Market Rent 17 per s.f.
Gross Square feet of building 50000 s.f
Net rentable square feet of building 50000 s.f
Projected Increase in Market Rent 3% per year
Management Costs 5% of Effective Gross Income
Estimated increase in CPI 3% per year
Vacancy rate starting 4th year 10% per year
Summary Lease Income Information
Particulars Year
1 2 3 4 5 6
Base Income
Tenant 1 =20000*15 =20000*15 =20000*15 =17*(1.03)^3*20000 =17*(1.03)^3*20000 =17*(1.03)^3*20000
Tenant 2 =15000*15.5 =15000*15.5 =15000*15.5 =15000*15.5 =17*(1.03)^4*15000 =17*(1.03)^4*15000
Tenant 3 =15000*17 =15000*17 =15000*17 =15000*17 =15000*17 =17*(1.03)^5*15000
Total Base Income (A) =SUM(C15:C17) =SUM(D15:D17) =SUM(E15:E17) =SUM(F15:F17) =SUM(G15:G17) =SUM(H15:H17)
CPI
Tenant 1 =C15*(1.015)-C15 =D15*(1.015)^2-D15 =E15*(1.015)^3-E15 0 =G15*(1.015)^1-G15 =H15*(1.015)^2-H15
Tenant 2 =C16*(1.015)-C16 =D16*(1.015)^2-D16 =E16*(1.015)^3-E16 =F16*(1.015)^4-F16 0 =H16*(1.015)^1-H16
Tenant 3 0 =D17*(1.015)^1-D17 =E17*(1.015)^2-E17 =F17*(1.015)^3-F17 =G17*(1.015)^4-G17 0
Total CPI (B) =SUM(C20:C22) =SUM(D20:D22) =SUM(E20:E22) =SUM(F20:F22) =SUM(G20:G22) =SUM(H20:H22)
Total Income (A+B) =C18+C23 =D18+D23 =E18+E23 =F18+F23 =G18+G23 =H18+H23
Summary Lease Income Information
Particulars Year
1 2 3 4 5 6
Base Income
Tenant 1         3,00,000.00 3,00,000.00 3,00,000.00 3,71,527.18 3,71,527.18 3,71,527.18
Tenant 2         2,32,500.00 2,32,500.00 2,32,500.00 2,32,500.00 2,87,004.75 2,87,004.75
Tenant 3         2,55,000.00 2,55,000.00 2,55,000.00 2,55,000.00 2,55,000.00 2,95,614.89
Total Base Income (A)         7,87,500.00 7,87,500.00 7,87,500.00 8,59,027.18 9,13,531.93 9,54,146.82
CPI
Tenant 1               4,500.00        9,067.50      13,703.51 0        5,572.91      11,229.41
Tenant 2               3,487.50        7,027.31      10,620.22      14,267.03 0        4,305.07
Tenant 3 0        3,825.00        7,707.37      11,647.99      15,647.71                     -  
Total CPI (B)               7,987.50      19,919.81      32,031.11      25,915.01      21,220.61      15,534.48
Total Income (A+B)         7,95,487.50 8,07,419.81 8,19,531.11 8,84,942.19 9,34,752.54 9,69,681.30
Summary Operating Expenses
Particulars Year
1 2 3 4 5
Property tax 100000 =C29*(1+0.03) =D29*(1+0.03) =E29*(1+0.03) =F29*(1+0.03) =G29*(1+0.03)
Insurance 10000 =C30*(1+0.03) =D30*(1+0.03) =E30*(1+0.03) =F30*(1+0.03) =G30*(1+0.03)
Utilities 75000 =C31*(1+0.03) =D31*(1+0.03) =E31*(1+0.03) =F31*(1+0.03) =G31*(1+0.03)
Janitorial 25000 =C32*(1+0.03) =D32*(1+0.03) =E32*(1+0.03) =F32*(1+0.03) =G32*(1+0.03)
Maintenance 40000 =C33*(1+0.03) =D33*(1+0.03) =E33*(1+0.03) =F33*(1+0.03) =G33*(1+0.03)
Total =SUM(C29:C33) =SUM(D29:D33) =SUM(E29:E33) =SUM(F29:F33) =SUM(G29:G33) =SUM(H29:H33)
Operating expenses per square foot =C34/$C$4 =D34/$C$4 =E34/$C$4 =F34/$C$4 =G34/$C$4 =H34/$C$4
Summary Operating Expenses
Particulars Year
1 2 3 4 5
Property tax         1,00,000.00 1,03,000.00 1,06,090.00 1,09,272.70 1,12,550.88 1,15,927.41
Insurance            10,000.00      10,300.00      10,609.00      10,927.27      11,255.09      11,592.74
Utilities            75,000.00      77,250.00      79,567.50      81,954.53      84,413.16      86,945.56
Janitorial            25,000.00      25,750.00      26,522.50      27,318.18      28,137.72      28,981.85
Maintenance            40,000.00      41,200.00      42,436.00      43,709.08      45,020.35      46,370.96
Total         2,50,000.00 2,57,500.00 2,65,225.00 2,73,181.75 2,81,377.20 2,89,818.52
Operating expenses per square foot                       5.00                 5.15                 5.30                 5.46                 5.63                 5.80
Summary Reimbursement
Particulars Year
1 2 3 4 5
Tenant 1 =(C35-4)*20000 =(D35-4)*20000 =(E35-4)*20000 0 =(G35-F35)*20000 =(H35-F35)*20000
Tenant 2 =(C35-4.5)*15000 =(D35-4.5)*15000 =(E35-4.5)*15000 =(F35-4.5)*15000 0 =(H35-G35)*15000
Tenant 3 =(C35-5)*15000 =(D35-5)*15000 =(E35-5)*15000 =(F35-5)*15000 =(G35-5)*15000 0
Total Reimbursement =SUM(C40:C42) =SUM(D40:D42) =SUM(E40:E42) =SUM(F40:F42) =SUM(G40:G42) =SUM(H40:H42)
Summary Reimbursement
Particulars Year
1 2 3 4 5
Tenant 1            20,000.00      23,000.00      26,090.00 0        3,278.18        6,654.71
Tenant 2               7,500.00        9,750.00      12,067.50      14,454.53 0        2,532.39
Tenant 3                            -          2,250.00        4,567.50        6,954.53        9,413.16 0
Total Reimbursement            27,500.00      35,000.00      42,725.00      21,409.05      12,691.34        9,187.10
Total Effective Gross Income
Potential gross income =C24+C43 =D24+D43 =E24+E43 =F24+F43 =G24+G43 =H24+H43
Vacancy 0 0 0 =F46*$C$9 =G46*$C$9 =H46*$C$9
Effective gross income =C46-C47 =D46-D47 =E46-E47 =F46-F47 =G46-G47 =H46-H47
Total Effective Gross Income Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Potential gross income         8,22,987.50 8,42,419.81 8,62,256.11 9,06,351.24 9,47,443.88 9,78,868.40
Vacancy 0 0 0      90,635.12      94,744.39      97,886.84
Effective gross income         8,22,987.50 8,42,419.81 8,62,256.11 8,15,716.12 8,52,699.49 8,80,981.56
Net Operating Income (NOI) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Effective gross income =C48 =D48 =E48 =F48 =G48 =H48
[-] Operating expenses =C34 =D34 =E34 =F34 =G34 =H34
[-] Management expenses =C51*$C$7 =D51*$C$7 =E51*$C$7 =F51*$C$7 =G51*$C$7 =H51*$C$7
Net Operating Income =C51-C52-C53 =D51-D52-D53 =E51-E52-E53 =F51-F52-F53 =G51-G52-G53 =H51-H52-H53
Net Operating Income (NOI) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Effective gross income         8,22,987.50 8,42,419.81 8,62,256.11 8,15,716.12 8,52,699.49 8,80,981.56
[-] Operating expenses         2,50,000.00 2,57,500.00 2,65,225.00 2,73,181.75 2,81,377.20 2,89,818.52
[-] Management expenses            41,149.38      42,120.99      43,112.81      40,785.81      42,634.97      44,049.08
Net Operating Income         5,31,838.13 5,42,798.82 5,53,918.30 5,01,748.56 5,28,687.32 5,47,113.96

b & d.

Average compound increase in NOI =RATE(5,,C54,-H54,0)
Asking Price =5*10^6
Going-in Capitalilsation rate =C54/C59 (1st year NOI / Asking price)
Average compound increase in NOI 0.57%
Asking Price $50,00,000.00
Going-in Capitalilsation rate 10.64%

e.

Going-out cap rate =C60-0.25%
Sale price =G54/C62 (5th year NOI / Going-out cap rate)
Going-out cap rate 10.39%
Sale price $50,90,010.64 (5th year NOI / Going-out cap rate)

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