Arnold Benedict is thinking of buying an apartment complex that is offered for sale by the firm of Getabinder and Flee. The price, $2.25 million, equals the property's market value. The following statement of income and expense is presented for Benedict's consideration:

The Sated Satyr Apartments Prior Year's Operating Results

Presented by Getabinder and Flee, Brokers

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30 Units, All Two-Bedroom Apartments, $975 per Month $351,000

Washer and Dryer Rentals $10,000

Gross Annual Income $361,000

Less Operating Expenses:

Manager's Salary $10,000

Maintenance Staff (one person, part time) $7,800

Seedy Landscapers $1,300

Property Taxes $13,000 $32,600

Net Operating Income $328,400

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By checking the electric meters during an inspection tour of the property, Benedict determines the occupancy rate to be about 80 percent. He learns, by talking to tenants, that most have been offered inducements such as a month's free rent or special decorating allowances. A check with competing apartment houses reveals that similar apartment units rent for about $895 per month and that vacancies average about 7 percent. Moreover, these other apartments have pools and recreation areas that make their units worth about $35 per month more than those of the Sated Satyr, which has neither.

The tax assessor states that the apartments were reassessed 12 months ago, and that current taxes are $76,374.

Benedict learns that the resident manager at Sated Satyr, in addition to a $10,000 salary, gets a free apartment for her services. He also discovers other expenses: insurance will cost $6.50 per $1,000 of coverage, based on estimated replacement cost of about $1.8 million; workers' compensation ($140 per annum) must be paid to the state; utilities, incurred to light hallways and other common areas, cost about $95 per month for similar properties; supplies and miscellaneous expenses typically run about .25 percent of effective gross rent. Professional property management fees in the market area typically are about 5 percent of effective gross income.

Based on this information that Benedict obtained and assuming typically competent, professional management, Benedict arrived at the following reconstructed operating statement as shown below:

The Sated Satyr Apartments

Reconstructed Operating Statement

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Potential Gross Rent (30 Units, at $860 per month) $309,600

Less: Allowance for Vacancies (7 percent) $21,672

Plus: Other Income (Laundry and vending Machines) $7,500

Effective Gross Income $259,428

Less: Operating Expenses:

Management Fee (5% of effective gross income) $14,771

Resident Manager (Salary Plus Free Rent) $20,320

Utilities $1,140

Property Insurance $11,700

Workers' Compensation Insurance $140

Supplies and Miscellaneous (.0025 X $299,250) $748

Landscaping and Grounds Maintenance $3,300

Maintenance and Repairs $7,800

Property Tax $76,374 $136,293

Net Operating Income (Annual) $159,135

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Given the reconstructed operating statement, you need to do the following:

A. Based on the reconstructed net operating income and the current market value, determine the capitalization rate.

B. Develop a five-year forecast of net operating income for the Sated Satyr Apartments2, incorporating the following assumptions:

1) Potential gross rent and miscellaneous other income will grow at 2.25

percent per annum over the forecast period.

2) Vacancies in the market area will remain constant over the forecast

period.

3) Operating expenses other than management fees and property taxes

will grow at 2.25 percent per annum over the forecast period.3

4) Management fees as a percent of effective gross income will remain

constant over the forecast period.

5) Property taxes are expected to increase to $80,048 in the third year

of the forecast.

C. Develop a 5-year amortization schedule for Sated Satyr Apartments assuming that Benedict can obtain a $1,500,000 loan with terms of interest at 8.5 percent per annum and level annual payments to amortize the loan over 20 years.4 There are no points or loan amortization fees anticipated.

D. With information from (b) and (c) above, calculate the BTCFs for each of the 5 year holding period.

E. Using the capitalization rate arrived at in (a), assuming that it will remain constant over the holding period, estimate the property's market value at the end of the 5 year holding period. Assuming that transaction costs (brokerage, legal and accounting fees, and so forth) equal 8 percent of the sales price, determine the BTER from the sale of the property.

F. Using the information from (d) and (e) and the following assumptions, we next need to arrive at the ATCFs (from operation) and the ATER (from reversion). We can assume:

1) Eighty percent of the purchase price is attributed to the buildings

2) The taxpayer is in the 40 percent marginal income tax bracket and will incur no liability for the alternative minimum tax during the projected holding period.

3) It is assumed that the property is put into service on January 1st and sold on December 31st

4) Assume the client is "active" in the property management.

5) It is assumed that the client has an adjusted gross income of $95,000 and has no other passive income not offset by other passive losses

(for each year of the anticipated holding period).