Part III Mini Case. (40 Points). A well-heeled friend is considering throwing her hat into the real estate investment ring. She has identified a 1990s-vintage apartment building in Goshen, New York, which she wants to purchase and renovate. She expects to buy the building for $10 million and spend another $6.5 million upgrading the units and adding amenities that are now standard on rental properties such as a pool, fitness center, and dog-washing station. She can complete these alterations within one year of purchasing the building (i.e., the building will begin producing revenue in year 1). Once complete, she expects to be able to increase the rent on the building's 95 units from $900 to $1,200 per month (the building will cost around $200 per unit per month for each occupied unit to maintain). Finally, to cover larger future maintenance issues, she plans to place $100 per unit per year (regardless of vacancy) into a capital expenditure (CAPEX) reserve account. She plans to fund the purchase and renovations with a combination of debt and her own equity. She has arranged a $12,000,000, 15-year amortizing mortgage, offered at an annual interest rate of 6% with payments due annually. She will fund the remainder of the project costs with her own equity. But since this is her first project, she is somewhat uncertain about how the rental housing market in Goshen will develop over the next few years. Optimistically, she expects to operate the building with 5% stabilized vacancy and with an annual rent increase of 7% per year (in other words, she expects potential gross income to be 7% higher in year 2 than it was in year 1). If she can hit these targets, she expects that when she sells the building, potential investors will value it based on an 8% capitalization rate. However, she also wants to consider a more pessimistic scenario in which the stable vacancy rate is 10% and rent only increases 3% annually. In this scenario, she expects investors to base their valuations on a 9.5% cap rate. She plans to hold the property for seven years and sell it at the beginning of year 8. (I.e., she'll receive 7 years of income and, hopefully, positive lump sum payment when she pays back the remaining loan in year 8.) She knows that you recently graduated from ISU and took a class on real estate development. Given your expertise, she's asked that you help her model the return from this development and provide advice on whether her plan is sound. Her next best investment option is a mutual fund that yields a return of 4.5% per year. To assess this project, you've decided to create two pro forma models showing the optimistic and pessimistic scenarios for your friend's project. You should include an assessment of her return, including the expected IRR and NPV under each scenario. In addition to the pro formas, you should include a short summary of your analysis, including a recommendation. Remember, your friend is new to this. Although she's heard the terms IRR and NPV, she's not exactly sure what they measure. If it is helpful, you can use the attached pro forma template to assess your friend's return. Upload it (or one of your own creation along with your completed exam. You should write your short memo in the exam. 95 Building Information Size (units) Rent per unit per month OpEx unit per month (Variable) Capital Reverva/unit/year Optimistle Pro Forma $1,200 $200.0 Year o Year 1 Year ears Pro te rear Year 5 Year 6 Year 7 Years SI00.0 Optimistice Assumptions Stable Vacancy Rent Increase Per Year Terminal Cap Pessimistis Assumptions Stable Vacancy Rent Increasa Per Year Terremmel Cap Pro Forma Potentail Gross Income Vacancy Effective Gross Income Optx Net Operatine Income Debt Service Capital Reserve Before Tax Cash Flow Sales Price Outstanding Principal 1st Mrte Uses Net Sales Reves Purchase Price Capital Improvements Total Uuesal Funds Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Ye Sources Amount Interest Rate Payment Ontion A Investor Return Equity BICF Sales Proceeds Net Return IRR NPV Required Equity Pessimistis Pro Torma Year 3 Year 4 Year o Year 1 Year 2 Year 5 Year 6 Pro Forma Potentail Gross Income Year 7 Vacancy Effective Gross Income Opex Net Operating Income Debt Service Capital Reserve Before Tax Cash Flow Sales Price Outstanding Principal Ist Mrte Net Sales Revenues Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Pessimistic Investor Return Investor Return Equity BTCF Sales Proceeds Net Return IRR NPV Part III Mini Case. (40 Points). A well-heeled friend is considering throwing her hat into the real estate investment ring. She has identified a 1990s-vintage apartment building in Goshen, New York, which she wants to purchase and renovate. She expects to buy the building for $10 million and spend another $6.5 million upgrading the units and adding amenities that are now standard on rental properties such as a pool, fitness center, and dog-washing station. She can complete these alterations within one year of purchasing the building (i.e., the building will begin producing revenue in year 1). Once complete, she expects to be able to increase the rent on the building's 95 units from $900 to $1,200 per month (the building will cost around $200 per unit per month for each occupied unit to maintain). Finally, to cover larger future maintenance issues, she plans to place $100 per unit per year (regardless of vacancy) into a capital expenditure (CAPEX) reserve account. She plans to fund the purchase and renovations with a combination of debt and her own equity. She has arranged a $12,000,000, 15-year amortizing mortgage, offered at an annual interest rate of 6% with payments due annually. She will fund the remainder of the project costs with her own equity. But since this is her first project, she is somewhat uncertain about how the rental housing market in Goshen will develop over the next few years. Optimistically, she expects to operate the building with 5% stabilized vacancy and with an annual rent increase of 7% per year (in other words, she expects potential gross income to be 7% higher in year 2 than it was in year 1). If she can hit these targets, she expects that when she sells the building, potential investors will value it based on an 8% capitalization rate. However, she also wants to consider a more pessimistic scenario in which the stable vacancy rate is 10% and rent only increases 3% annually. In this scenario, she expects investors to base their valuations on a 9.5% cap rate. She plans to hold the property for seven years and sell it at the beginning of year 8. (I.e., she'll receive 7 years of income and, hopefully, positive lump sum payment when she pays back the remaining loan in year 8.) She knows that you recently graduated from ISU and took a class on real estate development. Given your expertise, she's asked that you help her model the return from this development and provide advice on whether her plan is sound. Her next best investment option is a mutual fund that yields a return of 4.5% per year. To assess this project, you've decided to create two pro forma models showing the optimistic and pessimistic scenarios for your friend's project. You should include an assessment of her return, including the expected IRR and NPV under each scenario. In addition to the pro formas, you should include a short summary of your analysis, including a recommendation. Remember, your friend is new to this. Although she's heard the terms IRR and NPV, she's not exactly sure what they measure. If it is helpful, you can use the attached pro forma template to assess your friend's return. Upload it (or one of your own creation along with your completed exam. You should write your short memo in the exam. 95 Building Information Size (units) Rent per unit per month OpEx unit per month (Variable) Capital Reverva/unit/year Optimistle Pro Forma $1,200 $200.0 Year o Year 1 Year ears Pro te rear Year 5 Year 6 Year 7 Years SI00.0 Optimistice Assumptions Stable Vacancy Rent Increase Per Year Terminal Cap Pessimistis Assumptions Stable Vacancy Rent Increasa Per Year Terremmel Cap Pro Forma Potentail Gross Income Vacancy Effective Gross Income Optx Net Operatine Income Debt Service Capital Reserve Before Tax Cash Flow Sales Price Outstanding Principal 1st Mrte Uses Net Sales Reves Purchase Price Capital Improvements Total Uuesal Funds Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Ye Sources Amount Interest Rate Payment Ontion A Investor Return Equity BICF Sales Proceeds Net Return IRR NPV Required Equity Pessimistis Pro Torma Year 3 Year 4 Year o Year 1 Year 2 Year 5 Year 6 Pro Forma Potentail Gross Income Year 7 Vacancy Effective Gross Income Opex Net Operating Income Debt Service Capital Reserve Before Tax Cash Flow Sales Price Outstanding Principal Ist Mrte Net Sales Revenues Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Pessimistic Investor Return Investor Return Equity BTCF Sales Proceeds Net Return IRR NPV