D E . 1 2 3 4 5 6 Income Property Case Study 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 currently rented last year 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 was leased last year 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 fee expense is 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 CPlis projected to increase 3% per year. Estimated operating expenses for the next year include the following: Property Taxes Insurance Utilities Janitorial Maintenance Total Operating Expense 100,000 10,000 75,000 25,000 40,000 250,000 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 All expenses are projected to increase 3% per year. The market rental rate at which leases are expected to be renewed is also projected to increase 3% 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% of EGI for the last three years (years 4, 5 and 6). 1. Calculate the NOI for each of the next 6 years 2. Assuming the property is purchased for $5 million, what is the overall cap rate (going-in cap rate)? 3. Assuming you sell the property at the end of 5 years at the going-in cap rate, what would be the IRR on your investment? 4. Now, assume you finance this property with a 20 year amortization loan with a 8% interest rate, annual mortgage payments, and a loan-to-value of 70%. A. What is the first-year debt coverage ratio? B. What is your before-tax internal rate of return on your equity invested? (BTIRR) 38 M N 0 P R S T 1 2 3 0 1 2 3 4 5 6 4 5 6 Rental Income Expense Reimbursements Potential Gross Rents Vacancy Effective Gross Income 7 852,699 Property Taxes Insurance Utilities Janitorial Maintenance Total Operating Expense Cost per sf 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 Management Fee NOI 528,687 Sale Price Cash Flows IRR 28 29 30 31 Debt Service Before-tax cash flows Loan Balance Before-tax cash flows IRR on equity (BTIRR) D E . 1 2 3 4 5 6 Income Property Case Study 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 currently rented last year 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 was leased last year 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 fee expense is 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 CPlis projected to increase 3% per year. Estimated operating expenses for the next year include the following: Property Taxes Insurance Utilities Janitorial Maintenance Total Operating Expense 100,000 10,000 75,000 25,000 40,000 250,000 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 All expenses are projected to increase 3% per year. The market rental rate at which leases are expected to be renewed is also projected to increase 3% 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% of EGI for the last three years (years 4, 5 and 6). 1. Calculate the NOI for each of the next 6 years 2. Assuming the property is purchased for $5 million, what is the overall cap rate (going-in cap rate)? 3. Assuming you sell the property at the end of 5 years at the going-in cap rate, what would be the IRR on your investment? 4. Now, assume you finance this property with a 20 year amortization loan with a 8% interest rate, annual mortgage payments, and a loan-to-value of 70%. A. What is the first-year debt coverage ratio? B. What is your before-tax internal rate of return on your equity invested? (BTIRR) 38 M N 0 P R S T 1 2 3 0 1 2 3 4 5 6 4 5 6 Rental Income Expense Reimbursements Potential Gross Rents Vacancy Effective Gross Income 7 852,699 Property Taxes Insurance Utilities Janitorial Maintenance Total Operating Expense Cost per sf 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 Management Fee NOI 528,687 Sale Price Cash Flows IRR 28 29 30 31 Debt Service Before-tax cash flows Loan Balance Before-tax cash flows IRR on equity (BTIRR)