End of Chapter 14 Questions and Answers
1. Can a property have a break even point above 1.0? What would this imply?
Answer: No, it would imply greater than 100% occupancy.
2. What is the difference between the Net Operating Income and the Before-tax Cash
Flow?
Answer: Before tax cash flow is after debt service while the NOI is prior to debt service.
The NOI is the free and clear return on an unlevered property.
3. Consider the projection of the reversion value in a multi-year proforma.
a) What should be the typical expected relationship between the going-in cap
rate and the going-out (“reversion value”) cap rate projected for the resale of
the property at the end of the expected holding period (i.e., should you usually
expect the going-out to be less than, equal, or greater than the going-in)?
b) Why?
Answer: The going in cap rate should be higher than the going out cap rate as the
property is likely to wear out a little and higher risk of uncertain repair induces a higher
cap rate.
c) How would your answer change if you project capital improvements during
the holding period?
Answer: Capital improvements are not operating expenses and hence NOI remains as it is
yet the upside rent should increase with the new investment. The going-out cap rate
should increase if these capital improvements are successful in producing better rental
growth.
4. Describe the types of items included in the operating expenses?
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Answer: Management expense for the work of contracting for all necessary
services, book keeping and financial reporting, leasing and marketing strategies
and tenant communications. On site managers might also be required.
Leasing Commissions
Property insurance
Property taxes
Cleaning
Security
Landscaping
Utilities not paid by tenants
Exterminators
Advertising
Repairs and maintenance.
Supplies
5. Why should you subtract out management expenses before determining the property
NOI even if you are managing the property yourself?
Answer: Property management is an "opportunity cost", absorbing the time and energy
of whoever is performing this job. The owner manager puts in time and effort even if
they manage the property. Not including these costs would favor the financial figures
and make them look healthier than they are by including a return on labor in the return on
capital.
6. Show a 10-year proforma projection of the operating NOI and net property before-tax
cash flow (BTCF)for a 3-unit apartment house in which: (i) each unit currently (year 1)
rents for $300/mo; (ii) Rents are projected to grow at 3% per year; (iii) the average tenant
will remain 3 years, and then the apartment will be vacant an average of 3 months before
the next tenant moves in; (iv) operating expenses are currently estimated at $1500 per
unit per year (including management expenses), expected to escalate at 3% per year; (v)
you anticipate needing to replace kitchen appliances for $1000 per unit in year 3; and (vi)
you anticipate having to replace the shingle roof for $2500 in year
Answer:
Year
1
2
3
4
5
6
7
8
9
10
Rent
Roll
$10,800
$11,124
$11,458
$11,801
$12,155
$12,520
$12,896
$13,283
$13,681
$14,092
Vacancy
$831
$856
$881
$908
$935
$963
$992
$1,022
$1,052
$1,084
Oper.Exp
$4,500
$4,635
$4,774
$4,917
$5,065
$5,217
$5,373
$5,534
$5,700
$5,871
NOI
$5,469
$5,633
$5,802
$5,976
$6,156
$6,340
$6,531
$6,726
$6,928
$7,136
Cap.Impr
$0
$0
$3,000
$0
$2,500
$0
$0
$0
$0
$0
PBTCF
$5,469
$5,633
$2,802
$5,976
$3,656
$6,340
$6,531
$6,726
$6,928
$7,136
7. A 150,000 SF Office Building has a triple-net lease providing a constant rent of
$20.00/SF per year. (With a "triple-net" lease you can assume the rent equals the net
operating cash flow.) The lease has 5 years before it expires (i.e., assume the next
payment comes in 1 year, and there are 4 more annual payments after that under the
present lease). Rents on similar leases being signed today are $22/SF. You expect rents
on new leases to grow at 2.5% per year for existing buildings. You expect to re-lease the
building in year 6 after the current lease expires, but only after experiencing an expected
vacancy of 6 months, and after spending $10/SF in "tenant improvements" (TI). After 10
years you expect to sell the building at a price equal to 10 times the then-prevailing rent
in new triple-net leases. Based on survey information about typical going-in IRRs
prevailing currently in the market for this type of property, you think the market would
require a 12% expected return for this building. (a) What is the NPV of an investment in
this property if the price is $30,000,000? Should you do the deal? (b) What will be the
IRR at that price? (c) What is the "cap rate" at the $30 Million price?
Answer:
Year
0
1
2
3
4
5
6
7
8
9
10
Market
Net Rent
Building
Expected
Rent
Vacancy
Allowance
Cap
Expdtrs
(TI Cost)
$22.55
$23.11
$23.69
$24.28
$24.89
$25.51
$26.15
$26.80
$27.47
$28.16
$20.00
$20.00
$20.00
$20.00
$20.00
$25.51
$25.51
$25.51
$25.51
$25.51
$0.00
$0.00
$0.00
$0.00
$0.00
($12.76)
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
($10.00)
$0.00
$0.00
$0.00
$0.00
Reversion
$281.62
PV=
NPV=
IRR=
Ask Cap=
Mkt Cap=
CashFlow
Per SF
($200.00)
$20.00
$20.00
$20.00
$20.00
$20.00
$2.76
$25.51
$25.51
$25.51
$307.13
$203.43
Building
CashFlow
($30,000,000)
$3,000,000
$3,000,000
$3,000,000
$3,000,000
$3,000,000
$413,494
$3,826,988
$3,826,988
$3,826,988
$46,069,778
$30,513,895
$513,895
12.27%
10.00%
9.83%