Assume you are an analyst working for a private equity investment firm, thus you are writing to your boss (a Chief Investment Officer type) with recommendations on doing this deal.

The Property You have the opportunity to buy a 100 unit apartment building in suburban New Jersey. It is currently 92% leased but the market occupancy is presently 95%, but has averaged only 89% over the past 10 years. The building has an average unit rent of $1,400 per month per unit, but other units in the market only get $1,350. The building has run operating expenses of 40% of EGI, but your property management department thinks that it may be a little low and under expenditure may lead to expensive repairs in the future. The owner has successfully raised rents 3.5% per year the last five years and has resulted in low rates of tenant turnover; but market rents have only risen about 2.5% over the same period, and future inflation is only forecast at 2%.

The Financing The firm has sufficient equity to invest any reasonable amount of down payment to make this acquisition, however, it must earn at least a 10% annualized total return on equity for the CEO to approve. If the deal is risky in the CEOs view, they may require even higher rates, but you cant know what that is ahead of time. While figuring out the CEO is tricky, they have generally said yes to deals that preference income return over appreciation return in the past. The firms preferred lender has prepared the following quotes for apartment building loans:

LTV 70% Minimum DSCR 1.5 Term 10 Years Amortization 30 Years Rate 4.5%

Valuation Information There have not been a lot of market sales for which you can use in basing a price, as such, the seller has not indicated a listing price and has instead said all reasonable offers will be considered. A national brokerage has released a report that apartment buildings in suburban NJ markets should trade for cap rates of 6% to 8% in todays market.

Questions to Address

Develop a pro forma based on the above information on the property and financing options.

Your goal is to recommend to your boss, a price to offer on the property to the seller. There is no listing price, but if your offer is too low, you will not buy it, and probably lose your job. If it is too high, the CEO will probably reject the deal (clue, use guidance on return on equity requirements and DSCR guidelines to work into feasible prices)

In the written part of the memo, explain what assumptions you made and how you approached the analysis to come up with the recommended offer. Is this a good deal? How risky is it?