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FRL 3832 Real Estate Finance
Questions:
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.
- What property value are you projecting at the end of year 5?
- What purchase price should you pay to earn your desired IRR?
- 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.
- What is the periodic return for the entire 5-year holding period if all cash flows are reinvested at the discount rate?
- What is the periodic return for the entire 5-year holding period if the cash flows are notreinvested—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.
- 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?
- Using your required return as the discount rate, what is the NPV on yourcash flows?
FRL 3832 Real Estate Finance
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