An investor owns a 20,000 square foot office building. The following information is obtained:

There are three existing leases. A bank rents the 9,500 square feet on the first floor for $10,500 per month with level payments for three more years. The bank then has an option to renew for ten years at $12,000 per month. An insurance company rents 6,200 square feet on the second floor for $12.85 per square foot. The lease will expire at the end of two years. You expect to rent the property for the market rental at that time. The current market rent is $14.00 per square foot of rentable space per year. Market rents are expected to increase at the same rate as the CPI which is expected to increase 4% per year. A lawyer leases the 2,500 remaining square feet on the second floor for the next five years with annual increases equal to 50% of the CPI increase. The current monthly payment is $2,750 per month.

Office buildings in the area typically have vacancy rates of 5%. The building is currently 100% leased, but there is still the possibility of a tenant leaving before the lease expires. Thus you project a vacancy and credit allowance of 2% in the first two years, and 4% in years 3-5.

Your projections for operating expenses include management fees equal to 6% of collected income, and property taxes of $20,000 in year one and two with a 15% increase in year three. Utility expenses are based on $1.50 per square foot of gross building area increasing by 5.5% per year. Insurance is based on $.18 per square foot of net rentable area increasing by 4% per year. Janitorial expenses are projected at $.75 per square foot of gross area increasing by 6% per year. Maintenance allowances of $.25 per square foot of gross area are projected in year one and should increase by 4% annually.

(a) Forecast the net operating income for the leased fee estate for the next 5 years. (Show all your workings)

(b) What is the operating expense ratio in year 1 and year 5? (Show all your workings)