Potential gross income					$	105,100
Less: Vacancy at 7.041%						7,400
Effective gross income					$	97,700
Less: Operating expenses
Electricity	$	2,000
Water		400
Sewer fees		30
Heating fuel		7,600
Payroll/contract cleaning		3,600
Cleaning supplies		700
Janitorial payroll		4,300
Janitorial supplies		400
Heating/air-conditioning		2,100
Electrical repairs		400
Plumbing repairs		500
Exterior repairs		400
Roof repairs		400
Parking lot repairs		200
Decorating (tenant)		1,800
Decorating (public)		400
Miscellaneous repairs		1,100
Management fees		4,500
Other administrative fees		1,000
Landscaping maintenance		400
Trash removal		600
Window washing		200
Snow removal		2,200
Miscellaneous services		500
Total operating expenses						35,730
Real estate taxes						15,800
Net operating income					$	46,170

The property to be analyzed is a two-story, multitenant office building containing 10,000 square feet of rentable space. The building is situated on a 25,000-square-foot site that is partially landscaped and contains 35 parking spaces. The property is being offered for $500,000. The investors ordinary and capital gain tax rates are 28 and 15 percent, respectively.

Multitenant office buildings are sometimes leased on a gross rental basis. In this case, the property owner pays all operating expenses. Income from the building is $10.51 per square foot of rentable area, for a total of $105,100 per year before vacancy losses. Office buildings in the area experience a vacancy rate of 7 percent, on average, of potential gross income.

Table 1 contains income and expense information for the property (first year pro forma). Expenses were estimated after studying the buildings operating history and that of comparable buildings in the area.

A loan of $375,000 is available at 8 percent interest with a 30-year amortization schedule and annual payments.

The investor will use the straight-line depreciation method over a 39-year period and 25 percent depreciation recapture bracket. The expected purchase price of $500,000 is allocated 85 percent to building and 15 percent to the land (no personal property). This allocation is supported by the local tax assessors records.

Rental income is expected to grow by 8 percent per year. Operating expenses are expected to grow by 4 percent per year.

The terminal capitalization rate of 10 percent is applied to expected net operating income in year 3 to determine the sales price at the end of year 2. Selling expenses are 7 percent of the sale price. All passive activity losses (PAL) from the investment will be used to shelter income from passive income generators (PIGs), of which the investor has a barn full.

Required:

a. Compute the after-tax cash flows for year 1 and 2. (Do not round intermediate calculations and round your final answer to nearest whole dollar amount.)

b. What will be the after-tax equity reversion (cash flow) from the sale? (Do not round intermediate calculations and round your final answer to nearest whole dollar amount.)

c. Assuming a two-year holding period, should the investor make this investment given a required levered, after-tax rate of return of 14 percent?