FINC 354 Real Estate Finance and Investments
Homework Assignment II
Please show your work. Unexplained answers may loose points.
If you think important an assumption(s) is (are) left out, you are free to make your own. Make sure that you state your assumption(s) clearly.
1. (10 points) A 1,000 sf office space is leased at $15.00 psf during the first year with $2.00 step-up provisions each of the following years. The lease is gross with an expense stop set at $6.65 psf, and yearly expenses psf are as follows: $6.00, $6.65, $7.05, $7.50, and $8.00 a year over the next five years. The lease provides for two months of free rent at the end of the lease term. If the lease term is five years and the discount rate is 12.00%, what is the effective rent psf?
2. (10 points) A 1,500 sf office space is leased at $12.00 psf per year. The space is vacant one month out of the year. Office expenses are $6.50 psf and an expense stop is set at $6.00 psf. What is the annual net operating income?
3. (10 points) Which lease has the lowest effective rent if discount rate is 16.00%?
YearLease psf / 1 / 2 / 3 / 4 / 5
A / 10.00 / 11.00 / 12.00 / 13.00 / 14.00
B / 0.00 / 13.00 / 14.00 / 15.00 / 16.00
C / 0.00 / 0.00 / 20.00 / 20.00 / 22.00
D / 15.00 / 14.00 / 13.00 / 12.00 / 11.00
4. (10 points) A property is sold for $5,100,000 with selling costs of 3.00% of the sales price. The mortgage balance at the time of sale is $3,600,000. The property was purchased 5 years ago for $4,820,000. Annual depreciation allowances of $153,016 have been taken. If the all relevant tax rate is 28.00%, what is the after-tax cash flow from sale of the property?
5. (10 points) A property produces a first-year net operating income of $24,000. Because of the long economic life of the building, the income is considered as a perpetuity that will grow by 2.50% per year. Using a discount rate of 9.50%, estimate the property value.
6. (10 points) A property is leased for $24,000 per year although market rents are currently $27,500 per year and are expected to increase by 2.00% per year. (Note: $27,500 is market NOI for the first year.) The property is expected to be sold at the end of year 10 based on a 10.00% terminal cap rate applied to the eleventh year NOI. The current lease on the property will expire at the end of year 10 so the property can be leased in the eleventh year at market rates. What is the value of the leased fee estate based on an 11.50% discount rate?
7. (20 points) A real estate investor is considering the purchase of an office building. The investor has the following information:
· The purchase price is $2,000,000.
· The project is a two-story office building containing a total of 30,000 leasable square feet.
· The rents are expected to be $12.85 per square foot per year and are expected to increase 5.00% per year.
· The vacancy rate is expected to be 4.00% of gross rents per year.
· Operating expenses are estimated at 42.00% of the effective gross income.
· A 75.00% LTV ratio loan can be obtained with a 20-year term, monthly payments, and 10.00% interest rate.
· The value of the investment is expected to increase 4.00% per year. The holding period is 5 years.
· Of the total cost, 80.00% is depreciable over 39 years.
· The investor can be considered an active participant in the project and is in a 36.00% percent marginal tax bracket. The capital gains tax rate is 20.00% and the depreciation recovery tax rate is 25.00%.
a. What are BTIRR and ATIRR?
b. If an alternative financing at 85.00% LTV ratio and 11.00% interest rate is available, what are BTIRR and ATIRR?
c. What is the incremental cost of borrowing in part (b)?
d. Which loan is a better alternative 75.00% or 85.00% LTV loan?
e. Justify the financing decision from a lender’s perspective. What are the risks? Should there be any re-pricing of loans?
8. (20 points) A real estate investor is considering the purchase of an office building using an equity participation loan. The following information is known:
· Project Cost:
· Total: $875,000
· Building: 85.00% of total, depreciated over 39 years
· Project financing:
· Loan amount: 80.00% LTV
· Interest rate: 9.00%
· Amortization: 20 years with annual payments
· Participation terms:
· Share of NOI: 40.00% of NOI above $85,000
· Share of price appreciation: 30.00%
· NOI in Year 1: $83,000
· Growth rates:
· NOI: 3.00%
· Resale price: 4.00%
· Investor's marginal tax rate: 28.00%
· Capital gains tax rate: 20.00%
· Depreciation recovery tax rate: 25.00%
· Holding period: 5 years
a. What are the owner’s BTIRR and ATIRR?
b. What is the lender’s expected return?
9. N/A