Case Problem - DrugSmart (please type out all answers and calculations )

James Scheidt is looking at a free-standing retail center that is subject to a triple net lease to DrugSmart. The propertys lease payment for the first three years is $250,000 per year. In lieu of percentage rent, the rent contractually increase 2% per year starting in year-four. James investment period is five years and he intends to sell the property at market rate pricing at the end of year-five. The market requires a real rate of return of 7% on similar real estate investments.

Question 1. Assuming that there is no vacancy or credit risk associated with expected NOI stream, what is the terminal cap rate (associated with year 6 NOI) for the property? (2 pts)

Question 2. How much should James be expected to sell the property at the end of year five? (2 pts)

At the end of year three, DrugSmart announced on its earning call, that it has been struggling with increased drug prices and that it would material affect its financial health going forward. Its corporate bonds were immediately downgraded to BB and the market risk premium increased by 300 bps from 7% to 10%.

Question 3. What effect, if any, does the increased credit risk have on the sale price of the property James was expecting and why? (2pts)

Question 4. How does this effect the terminate cap rate? Calculate the terminal cap rate. (2pts)

In an effort to keep DrugSmart from filing bankruptcy, landlords including James Scheidt, agreed to lower the contractual rent increases to 1%.

Question 5. Under this scenario, what is the expected sales price of the property at the end of year five? (2 pts)