In summer 2022, an investor group is evaluating a residential building that contains one-bedroom, two-bedroom and three-bedroom apartments of 10 units each. The units are currently rented at monthly rents of $750, $1,300, and $1,900 respectively. Based on current market data, the vacancy loss is estimated at 8 percent of the potential gross income in each of the first two years. The operating expense ratio is estimated at 28 percent of the effective gross income for both years. The land to value ratio is assessed to be 30 percent.

The investors consider purchasing the property at $10,000,000. They are approved for an interest only mortgage loan with annual payments for a term of 30 years at the loan-to-value ratio of 75 percent and an interest rate of 6 percent. The investor plans to hold the property for 2 years.

Encouraged by the unexpected housing boom induced by the pandemic, the investors believe the local market will continue to grow at a fast pace. They estimate that the potential gross income of the property is to increase at 3 percent in year 2, and the value of the property is to increase at 10 percent each year. The selling expenses are estimated to be 6 percent of the selling price. The investors are currently in the 36 percent income tax bracket, and expected to incur a 20% capital gain tax rate and a 25% rate on depreciation recapture. Since they control a sizable real estate portfolio, the investors are able to utilize any tax credits (negative income taxes) in current fiscal years. Their required rate of return on the property is generally 15 percent. You are hired as an analyst to help making the investment decisions and strategies.

Problem 1.

Build a discounted cash flow model to analyze this investment. (Your work will be evaluated on its correctness. 3 points)

Analyze the results of your model directly. Make your recommendation and strategies. (Your work will be evaluated on its thoroughness and depth. 3 points)

Problem 2. What if you are asked to evaluate the investment for 6 years? What changes would you make in the model? (Please make a clear list of changes or assumptions, and modify your model. Your work will be evaluated on its correctness. 3 points)

Compare this model with Problem1. Make your recommendation and strategies. (Your work will be evaluated on its thoroughness and depth. 1 points)