Problem $11-3$

You are an employee of University Consultants, Limited, and have been given the following assignment. You are to present an investment analysis of a small retail income$-$producing property for sale to a potential investor. The asking price for the property is $$1,250,000$; rents are estimated at $$160,000$ during the first year and are expected to grow at $2\mathrm{.}5$ percent per year thereafter. Vacancies and collection losses are expected to be $10$ percent of rents. Operating expenses will be $35$ percent of effective gross income. A fully amortizing $70$ percent loan can be obtained at $8$ percent interest for $30$ years $($total annual payments will be monthly payments $\backslash$times $12).$ The property is expected to appreciate in value at $3$ percent per year and is expected to be owned for five years and then sold. The investor tells you she would also like to know how tax considerations affect your investment analysis. You determine that the building represents $85$ percent of value and would be depreciated over $39$ years $($use $1/39$ per year, except year $1$ depreciation is also multiplied by $11\mathrm{.}5/12$ to adjust for the mid month convention$).$ The potential investor indicates that she is in the $37$ percent tax bracket and has enough passive income from other activities so that any passive losses from this activity would not be subject to any passive activity loss limitations$.$ Capital gains from price appreciation will be taxed at $20$ percent and depreciation recapture will be taxed at $25$ percent. Because the investor works over $750$ hours per year in real estate related activities, she is able to avoid the NIIT $3\mathrm{.}8$ percent surcharge.

Required:

a$.$ What is the investor$$s expected after$-$tax internal rate of return on equity invested $($ATIRR$)?$

b$.$ What is the effective tax rate and before$-$tax equivalent yield?

d$.$ Recalculate the ATIRR in part $($a$)$ under the assumption that the investor cannot deduct any of the passive losses $($they all become suspended$)$ until the property is sold after five years.