Real Estate Investment

1)   An investor is considering an investment that has a Market Value of $2.5millions. The                   following information can be obtained:

Rent = $1,300 per unit per month. Rental Growth Rate = 3% per year                                           compounded.

Number of units = 25

Vacancy rate is 8%.

Operating expenses = $150,000. Operating Expense Growth Rate = 3% per year compounded.

Loan-to-value ratio is 80%.

Interest rate on mortgage is 5% per annum.

Maturity of mortgage = 15 years (with monthly payments).

Financing Costs = $25,000 amortized over life of the mortgage.

Depreciable basis = 75 percent of total cost

Depreciable life = 27.5 years (use 25% max for DEPR tax and 15% for CG tax)

Expected appreciation rate = 3% per year, compounded.

Anticipated Holding period = 10 years

The marginal tax rate of investor is 34%.

Expected Selling Expenses = 6%.

Required after-tax Return on Equity = 11%.

1. a)Calculate the NPV and IRR for the project on after-tax basis.                    

1. b)Calculate the following 6 rules of thumb for the first year: Potential Gross Income Multiplier (PGIM); Capitalization Rate(R), Operating Expense Ratio (OER), Equity Dividend Rate (EDR); Debt Coverage Ratio (DCR); and Break-even Cash Flow Ratio (BER), for the project. Give your reactions on the calculated rules of thumb with respect to the investment decision!                                                                                                                                                                         
2. c)Calculate the Brokers’ Rate of Return (rule of thumb) based on the cash flows in problem 1(a), above.                                                                                          

Based on the results on (a), (b), and (c) above, will you recommend this project to the equity investor (your client)? Why?