Case: Apartment Complex The apartment rental market has always been a good investment in Anchorage. A 50 apartment complex has recently been offered for sale. A friend, Sally, not extremely financially savy has asked you to help her answer some questions about the financial viablity of the this investment project. The particular cost estimates/information for this 5 year old structure are listed in the table below. Cost Land Cost Building Cost Annual Upkeep Property Taxes and Insurance Useful Life, N MARR Amount $1,000,000 $2,500,000 $150,000 5% of the Total Investment Costs 25 year MV(25) 15% 1,000,000 plus 10% of Initial Building Cost Exhibit 1: Basic Cost Information There are additional expenses that the friend expects to incur. At EOY 15 the apartment complex will need a roof replacement at a cost of $200,000. In addition, your friend thinks the common areas as well as drive areas should have periodic maintenance beginning at EOY 8 and every eight years thereafter for a cost of $50,000 each time. These costs are to be paid as part for the initial capital investment rather than borrowing the funds at their due date. Sally thinks that this apartment complex will be a good project for about 25 years. She expects a return (MARR) of 15% APY. As far as a market value at EOY 25, Sally thinks the land cost of 1,000,000 plus about 10% of the building cost will be recovered. This is a very conservative but realistic assumption. The biggest question Sally has for you is about recovering the initial capital invested which she wishes to bundle as the initial building and land costs well as the future roof and common area expenses. The income stream for the apartment complex is only monthly rent money. How much should she charge for monthly rent in order to at least recover the bundled capital invested? (Breakeven) Your friend is a realist and wants to plan a base case based on an 85% occupancy rate. In order for Sally to acquire sufficient funding, she will need to persuade lending institutions the project is not only economically viable given a yet to be calculated monthly rent at an average 1 occupancy of 85%. She feels that in order to assure the lenders her best approach would be through a sensitivity graph. A sensitivity graph will visually show the lenders where the risks are with respect to initial costs (land and building), annual expenses and occupancy rates. To make matters more complicated Sally is not convinced that neither the annual revenues from rent nor the annual expenses will remain stable. That is the same for 25 years. Hence Sally as well as the lenders would like an economic analysis done using the following annual expense and revenue projections. Sally thinks that annual expenses will increase at about the rate of 1.75% per year from her EOY1 annual expenses. (Beginning at EOY 2) In order to compensate for the loss of income she plans to increase annual revenue by raising rent starting at EOY 5 by 1.25% and doing this every 5 years thereafter. If these increases come to fruition, is the project (Apartment Complex) economically justified? Once again Sally wishes to assume an 85% occupancy rate. 2. Use the scenario of annual expenses increasing at a rate of 1.75% per year every year after EOY 1 and annual revenues increasing 1.25% at EOY 5 and then 1.25% from that value every 5 years. a. On the Basis of annual worth, is the project economically justified? b. Use percent change increments + 10% for each criterion from the base case. (AW based upon percent changes to EOY 1 cash flows for AE and FC. As well as percent changes to the base 85% occupancy) C. Develop a sensitivity graph showing the effect of changes in: first cost, occupancy rate and annual expenses on the annual worth of the project. d. Which criterion is the most sensitive/riskiest to change? e. What are the breakeven points under the part 2 conditions? Case: Apartment Complex The apartment rental market has always been a good investment in Anchorage. A 50 apartment complex has recently been offered for sale. A friend, Sally, not extremely financially savy has asked you to help her answer some questions about the financial viablity of the this investment project. The particular cost estimates/information for this 5 year old structure are listed in the table below. Cost Land Cost Building Cost Annual Upkeep Property Taxes and Insurance Useful Life, N MARR Amount $1,000,000 $2,500,000 $150,000 5% of the Total Investment Costs 25 year MV(25) 15% 1,000,000 plus 10% of Initial Building Cost Exhibit 1: Basic Cost Information There are additional expenses that the friend expects to incur. At EOY 15 the apartment complex will need a roof replacement at a cost of $200,000. In addition, your friend thinks the common areas as well as drive areas should have periodic maintenance beginning at EOY 8 and every eight years thereafter for a cost of $50,000 each time. These costs are to be paid as part for the initial capital investment rather than borrowing the funds at their due date. Sally thinks that this apartment complex will be a good project for about 25 years. She expects a return (MARR) of 15% APY. As far as a market value at EOY 25, Sally thinks the land cost of 1,000,000 plus about 10% of the building cost will be recovered. This is a very conservative but realistic assumption. The biggest question Sally has for you is about recovering the initial capital invested which she wishes to bundle as the initial building and land costs well as the future roof and common area expenses. The income stream for the apartment complex is only monthly rent money. How much should she charge for monthly rent in order to at least recover the bundled capital invested? (Breakeven) Your friend is a realist and wants to plan a base case based on an 85% occupancy rate. In order for Sally to acquire sufficient funding, she will need to persuade lending institutions the project is not only economically viable given a yet to be calculated monthly rent at an average 1 occupancy of 85%. She feels that in order to assure the lenders her best approach would be through a sensitivity graph. A sensitivity graph will visually show the lenders where the risks are with respect to initial costs (land and building), annual expenses and occupancy rates. To make matters more complicated Sally is not convinced that neither the annual revenues from rent nor the annual expenses will remain stable. That is the same for 25 years. Hence Sally as well as the lenders would like an economic analysis done using the following annual expense and revenue projections. Sally thinks that annual expenses will increase at about the rate of 1.75% per year from her EOY1 annual expenses. (Beginning at EOY 2) In order to compensate for the loss of income she plans to increase annual revenue by raising rent starting at EOY 5 by 1.25% and doing this every 5 years thereafter. If these increases come to fruition, is the project (Apartment Complex) economically justified? Once again Sally wishes to assume an 85% occupancy rate. 2. Use the scenario of annual expenses increasing at a rate of 1.75% per year every year after EOY 1 and annual revenues increasing 1.25% at EOY 5 and then 1.25% from that value every 5 years. a. On the Basis of annual worth, is the project economically justified? b. Use percent change increments + 10% for each criterion from the base case. (AW based upon percent changes to EOY 1 cash flows for AE and FC. As well as percent changes to the base 85% occupancy) C. Develop a sensitivity graph showing the effect of changes in: first cost, occupancy rate and annual expenses on the annual worth of the project. d. Which criterion is the most sensitive/riskiest to change? e. What are the breakeven points under the part 2 conditions