I am considering the purchase of a commercial property that totals 30,000 square feet. The owner has not given a price for the building and instead is asking me to put in an offer. The property is currently 80% occupied with an average rental rate of $20/sqft/yr. The leases on average increase in rent by $1.00/sqft/yr. Leases for this property are full pass-through and the operating expenses for this property including taxes and insurance total $6.00/sqft. I have a tenant in mind for the remaining 6,000 unleased square feet but they will not start paying rent for 6 months and I need to invest $20,000 in improvements and lease commissions to bring the tenant in. The rent for this new tenant is $24.00/sqft/yr and is fixed for the duration of it lease term. I will finance the purchase solely with equity (no debt a cash deal). Once the new tenant is in, the property will be 100% full!! To account for unexpected vacancies and collection issues that may arise, however, I will assume a vacancy/collection reserve of 10% of my gross potential rent throughout my ownership. I will also assume I must invest $60,000 per year fixed for capital items to maintain the property - I cannot recover this capital cost from the tenants. (If you think I have missed providing you with enough information for completing this problem, indicate what is missing and make an assumption that addressed the missing information. I do not think I have missed anything but let me know if I did!!)

1. The capitalization rate for similar properties is around 10%. If I base my offer using the cap rate of 10% on the second year NOI (a more stabilized figure), what will my offer be? (10 points)

$6,852,000

2. Lets assume that my offer in Part A) is accepted. I plan on holding the property for 5 years and will sell the property based on my Year 5 NOI at a capitalization rate of 9%. Assume that the property will be sold at the end of the fifth year. Sales expenses will total 10% of the sale price. Disregarding taxes (look at this from a pre-tax basis and disregard depreciation), what rate of return (use IRR) will this investment yield for me? (10 Points)
3. Heres where things get interesting for your bonus!! If your investment depreciates over a 40-year schedule (treat the capital investment of $60,000 per year as unrecoverable expense that reduces taxable income this is a simplifying assumption! Otherwise things will get complex very fast from the standpoint of preparing a depreciation schedule!!), and your approximate income tax rate is 20%, what is your after-tax rate of return for this investment?