Julie Cramer has an opportunity to buy a house on Jan.1 2023, for a price of $300,000. She will need 3 months to fix it up for a total of $30,000, which she will pay when the work is completed at the end of the first quarter.
She hopes to rent the house on April 1st, 2023, for $7,500 per quarter payable quarterly in advance. She also plans to increase rent by 5% each year on April 1st.She requires a security deposit from her tenants equal to one quarter's rent, payable when the tenants move.
Julie expects to keep these same tenants until she sells the house at the end of 3 years (Dec. 31st, 2025). Since she is quite strict in her choice of tenants (non-smokers, no pets allowed), she feels that they will take good care of the house and therefore, expects to return the entire security deposit when they leave.As for any type of investment, property investment has its share of risks. There is always a chance that tenants lose their jobs and cannot make the payments, or that they leave unexpectedly, and the house remains unrented for several months. Given these risks As a result, she considers that, to be worth it, the rate of return that she requires on any of her property investments must be at least 12% per year.
Questions:
a) Assume that she can resell the house for $350,000 at the end of the 3 years, should she make the investment today?
b) Calculate the Net Present Value (NPV) of the project?
c) What should be the minimum resale value of the house for Julie to accept this investment project?