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Westgate Shopping Center is a 400,000 square foot neighborhood strip center. An investor is considering purchasing the property on August 1, 2010, hold if for five years and expects to sell it based on a cap rate of 7.5% applied to end-of-the year 5 net operating income. Selling costs would be 3% of the sale price. He hopes to get a 12% rate of return over the life of the investment. The purchase price is $3,000,000.

Assumptions:

Inflation over the next 5 years is expected to be 2% per year

The vacancy rate for similar shopping centers is 5%

Credit loss is projected at 2%

Expenses are as follows:

Real estate taxes are $55,000 the first year increasing 2.5% / year

Insurance is $.40 per / foot increasing 3% / year

Common area maintenance is $2.25 / square foot increasing 2% / year

Management fee is 4% of effective gross income

Rent roll:

Tenant A

Square feet: 50,000 square feet

Term: July 1, 2005 June 30, 2015

Base rent: $12 / square foot

Expenses: Taxes, Insurance, Common Area Net basis

Expiry:

Base rent: $12 / square foot increasing at 3% / year

Term: 5 years

Expenses: Net basis

Tenant B

Square feet: 20,000 square feet

Term: July 1, 2008 June 30, 2011

Base rent: $15 / square foot

Percentage rent: 5% of retail sales in excess of $225 / square foot

Sales: $250 / square foot

Expenses: Taxes, Insurance, Common Area Net basis

Expiry:

Base rent: $16 / square foot increasing at 3% / year

Term: 3 years

Expenses: Net basis

Tenant C

Square feet: 120,000 square feet

Term: July 1, 1990 June 30, 2014

Base rent: $8.50 / square foot

Expenses: Taxes, Insurance, Common Area Net basis

Expiry: Vacating

Based on this information you must decide:

1.Will the investor receive the expected 12% rate of return over the life of the investment?

2.What types of risks should the investor consider?