Apply What You've Learned $-$ Real Estate and High$-$Risk Investments

Scenario: You are considering investing in real estate$-$both for the short$-$term cash flows and the potential long$-$term capital gains$-$and are

evaluating both a commercial lease property $($such as a strip shopping center or an office building$)$ and a residential rental property $($such as several

rental houses or a small apartment complex$).$ It is likely that you will invest in only one of these properties at this time.

The general data regarding these investments is as follows:

The first potential investment consists of a seven$-$store shopping center, which has a current market price of $$750,000.$ Of this amount, $$187,500$

represents the cost of the land, and the balance, $$562,500,$ is attributable to buildings on the property. The second possible investment, which costs

$$450,000,$ consists of a small four$-$unit apartment complex. $$135,000$ of the investment's total price is reflects the cost of land, and the remaining

$$315,000$ is associated with structures on the land. For both properties, you believe you can increase the rents $2\%$ per year for each of the next four

years, and expect to sell either property at the end that time. You desire a return of $8\%$ on your investments.

One of the more important considerations associated with your investment is a property's potential for generating a positive cash flow. One indicator

of a property's likelihood of generating a positive cash flow is the property's rental yield. The best formula for computing a property's rental yield

is: Check all that apply.

Rental yield $(\%)=[\frac{\frac{\text{M}\text{o}\text{n}\text{t}\text{h}\text{l}\text{y}\text{r}\text{e}\text{n}\text{t}**12}{2}}{P}$urchase price $]100$

Rental yield $(\%)=[\frac{\text{M}\text{o}\text{n}\text{t}\text{h}\text{l}\text{y}\text{r}\text{e}\text{n}\text{t}**12}{\text{P}\text{u}\text{r}\text{c}\text{h}\text{a}\text{s}\text{e}\text{p}\text{r}\text{i}\text{c}\text{e}\frac{?}{2}}]100$

Rental yield $(\%)=[\frac{\text{A}\text{n}\text{n}\text{u}\text{a}\text{l}\text{r}\text{e}\text{n}\text{t}\frac{?}{2}}{P}$urchase price $]100$ In the equations above, the reason that the values are divided by two is that it is assumed that

spent on expenses other than debt repayment.

The rental yield expected on the commercial property is $3\mathrm{.}0562\%$grad, while the expected yield on the residential property is

Based on their respective rental yields, the apartment complex grad is the better investment.

Another indicator of their relative attractiveness as an investment is each property's price$-$to$-$rent ratio. The shopping center has a price$-$to$-$rent ratio

ot

$,$ while the corresponding ratio for the apartment complex is

$.$ Based on this data, the

is

the better investment. From an investor's perspective, a negative conclusion associated with an overly large ratio is that it suggests that property

prices are very

$.$ Similarly, a discouraging explanation for an overly small

ratio is that rents and market prices are so close in value that

a financially astute investor would rathe

a given property.

The loan$-$to$-$value $($LTV$)$ for the shopping center is

for the apartment complex.

Assume that your expected annual operating costs$-$excluding your annual depreciation expense$-$for the commercial property will be $35\%$ of your

annual rental income. For the residential property, the annual operating costs $($excluding depreciation expense$)$ will be $20\%$ of your annual rental

income. The interest rates of the mortgages for the commercial and residential lease properties are expected to be $6\%$ and $4\%,$ respectively. Total PV of Cash flows

The net discounted return expected from an investment in the shopping center$-$after deducting the cost of the investment$-$is

Now perform a comparable analysis for the residential lease property:

Total PV of Cash flows

The net discounted return expected from an investment in the apartment complex$-$after deducting the cost of the investment$-$is The net discounted return expected from an investment in the apartment complex$-$after deducting the cost of the investment$-$is

Based on the results of your analysis, which of the following statements best reflects your decision regarding the commercial or residential lease

opportunities?

Based on the numbers alone, you should prefer an investment in the shopping center since it has a net present value that is greater than

that expected from the residential lease property $($apartment complex$).$

As the apartment complex has a NPV that is greater than that expected from the shopping center, it is more financially sound to invest in

the residential lease property. Because the shopping center is expected to generate a negative NPV$,$ you should not consider making this

investment.

Given that the apartment complex has a NPV that is greater than that expected to be generated by the shopping center, you should

prefer to