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Apply What You've Learned - Real Estate and High - Risk Investments Scenario: You are considering investing in real estate - both for the short
Apply What You've Learned Real Estate and HighRisk Investments
Scenario: You are considering investing in real estateboth for the shortterm cash flows and the potential longterm capital gainsand 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 sevenstore shopping center, which has a current market price of $ Of this amount, $
represents the cost of the land, and the balance, $ is attributable to buildings on the property. The second possible investment, which costs
$ consists of a small fourunit apartment complex. $ of the investment's total price is reflects the cost of land, and the remaining
$ is associated with structures on the land. For both properties, you believe you can increase the rents 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 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 urchase price
Rental yield
Rental yield urchase price 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 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 pricetorent ratio. The shopping center has a pricetorent 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 loantovalue LTV for the shopping center is
for the apartment complex.
Assume that your expected annual operating costsexcluding your annual depreciation expensefor the commercial property will be of your
annual rental income. For the residential property, the annual operating costs excluding depreciation expense will be of your annual rental
income. The interest rates of the mortgages for the commercial and residential lease properties are expected to be and respectively. Total PV of Cash flows
The net discounted return expected from an investment in the shopping centerafter deducting the cost of the investmentis
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 complexafter deducting the cost of the investmentis The net discounted return expected from an investment in the apartment complexafter deducting the cost of the investmentis
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
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