Question

One of your investment clients is thinking of purchasing the freehold interest in an office refurbishment opportunity. The asking price is 1,200,000 and the property is ready for refurbishment upon expiry of the current lease in five years' time. The current net rent is 100,000 p.a. Your client plans to hold the property until lease expiry, refurbish and then sell.

Assume the following information:

-The current cost of refurbishment is 750,000 and will take one year

-The current market rent of the property in its existing state is 100,000 p.a. and in its refurbished state is 150,000 p.a.

-Forecast rental growth for property in a refurbished condition is 4% per annum

-The yield after refurbishment is estimated to be 7%

-Your client's target rate of return is 15%

-Building costs are inflating at an average of 2.5% p.a.

a.Prepare investment appraisal and advise your client as to whether this is a good investment opportunity at the asking price stated.

b. Briefly outline the methods you would use to advise your client of the risks associated with this investment opportunity.