You are an analyst with Perception Partners and have been asked to make pricing recommendations regarding the acquisition of Rose Garden Apartments. This project was built five years ago and contains 250 units in a suburban market area. The broker that brought the project to your attention indicates that the asking price will be $27,000,000. She has also provided the attached information based on a market survey showing data from three sales of comparable apartment properties that have occurred in a one-mile radius of Rose Garden during the past six months (see table below).
Perception believes that market returns (IRR) should be in a range of 8 percent (compounded annually) for this type of investment. Perception (1) plans to own the property for five years and then sell it and (2) believes that rents will grow at 3 percent per year. At the present time,

Perception believes that the sale price that it hopes to achieve at the end of year 5 should be based on a €œgoing-out€ cap rate that will be .005 greater than the €œgoing-in€ cap rate. The property is to be acquired on an €œall cash€ basis.

a. Prepare an analysis of Rose Garden with the three comparable properties. Based on this analysis, do you think that the €œgoing-in€ cap rate today for Rose Garden should be higher or lower than the cap rates shown for the comparables?

b. If Rose Garden is acquired for $27,000,000, what would be the €œgoing-in€ cap rate at that price? How does this compare to cap rates for the comparables?

c. If Rose Garden is acquired for $27,000,000, would the 8 percent required return be achieved over the five-year period of ownership?

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Rose Garden Comparable 1 Comparable 2 Comparable 3 Age 5 10 Acres 14 10 8.75 12.5 250 17.9 # Units 200 175 250 20.0 Units per acre 20.0 20.0 $21,000,000 S Rent / # Units / SF: Price $20,000,000 S Rent / # Units / SF: 820 / 60 / 770 835 / 40 / 800 1,030 / 80 / 950 1,250 / 20 / 1,170 950 / x/ 888 177,600 $16,625,000 $ Rent / # Units / SF: Bedroom / Bathroom: S Rent / # Units / SF: 1/1 830 / 75 / 780 791 / 53 / 740 775 / 75 / 750 795 / 50 / 775 970 / 110 / 900 1,170 / 15 / 1,100 888.5 /x/ 842 850 / 50 / 810 1/1.5 810 / 35 / 780 1,000 / 70 / 920 1,200 / 18 / 1,130 925 /x/ 864 2/2 1,040 / 100 / 960 1,270 / 25 / 1,180 962 / x/ 898 224,500 3/2 Weighted average Rentable area (SF) Vacancy Operating expense 150,130 210,500 5% 5% 5% 5% 40% 40% 40% 45% Gross rent $2,886,000 $2,280,000 8.77 $1,928,076 8.62 $2,665,500 7.88 GIM $1,099,000 Net income $1,645,000 $1,300,000 $1,393,000 Cap rate Wt. Avg month rent/unit 0.0650 0.0661 0.0663 $962 $950 $918 $889 $12.663 $84,000 Rent per sq.ft Price per unit Price per sq.ft Quality $12.855 $12.838 $12.843 $95,000 $100,000 $112.61 $110.74 $99.76 Excellent Very good Average Average Slightly less desirable 1.50 No Location Excellent Desirable Desirable 2.00 Yes Parking spaces per unit Security gate Washer/dryer A/C 1.75 Yes 1.60 Yes Not in 1/1 Yes Yes Yes Yes Yes Yes Yes Built-ins Yes Yes Yes Yes Yes No Covered parking Free cable TV Yes No No Yes No Yes No Yes Fireplaces Exercise room No No No No No Yes Swimming pool/BBQ Yes Yes Yes Yes