Ace Investment Company is considering the purchase of the Apartment Arms project. Next year’s NOI and cash flow is expected to be $ 2,000,000, and based on Ace’s economic forecast, market supply and demand and vacancy levels appear to be in balance. As a result, NOI should increase at 4 percent each year for the foreseeable future. Ace believes that it should earn at least a 13 percent return on its investment.

a. Assuming the above facts, what would the estimated value for the property be now?
b. What “ going- in” cap rates should be indicated from recently sold properties that are comparable to Apartment Arms?
c. Assuming that in part ( a) the required return changes to 12 percent, what would the value be now?
d. Assume results in part ( c). What should the investor now be observing regarding the price of “ comparable” sales? What market forces may be accounting for the differences in value between ( a) and ( c)?

An office 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 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 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 next year include 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 the first leases expire, vacancy is estimated to be 10 percent of EGI for the last two years ( years 4 and 5).
a. Project the effective gross income ( EGI) for the next five years.
b. Project the expense reimbursements for the next five years.
c. Project the net operating income ( NOI) for the next five years.
d. How much does the NOI increase ( average compound rate) over the five years?
e. Assuming the property is purchased for $ 5 million, what is the overall capitalization rate (“ going- in” rate)?

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