You are considering the purchase of a small multifamily building. In year 1, you expect to earn an NOI of $675,000. You project that it will grow by 2.5% every year. You plan to spend $500,000 in renovations in the first year, and then you will set aside $50,000 every year thereafter for future renovations. The property will be sold at the end of year 5, and you will pay 7% of the price in selling expenses. You believe that the property will have a terminal cap rate of 7%. You will pay all cash for the property. You want to earn a 12% IRR annually.

1. What property value are you projecting at the end of year 5?

2. What purchase price should you pay to earn your desired IRR?

3. If everything works out according to your projections, how much will the property value appreciate over these five years?

You negotiate a purchase price of $7.5 million with the seller.

4. What is the periodic return for the entire 5-year holding period if all cash flows are reinvested at the discount rate?

5. What is the periodic return for the entire 5-year holding period if the cash flows are not reinvested—and instead are simply added to the final balance?

You decide to create a closed-end limited partnership fund to buy the office property. The fund will have a five-year life. You want a minimum holding period return of 50% for your LPs. As the fund manager, you will receive a “promote” equal to 25% of cash flows remaining after sale of the assets and after LPs receive their 50% preferred return. You raise an equity investment of $7.5 million.

6. According to your pro forma, how much cash will you receive at the end of the fund’s life? How much cash will your GPs receive?

7. Using your required return as the discount rate, what is the NPV on your cash flows?

Answer rating: 100% (QA)

Year 0 1 2 3 4 5 1NOI 675000 691875 709172 726901 745074 2Renovations 500000 50000 50000 50000 50000 3Free cash flow 12 175000 641875 659172 676901 69... View the full answer