Project 2

Building A Simple Financial Model

A Commercial Real Estate Example

The REIT you work for is considering purchasing a new mixed use commercial development, holding it for 10 years, and then selling it. You need to model the cashflow of the property and compute the NPV and IRR of the project.

The Property, Revenues, and Operating Expenses

The property your firm is considering is a mixed use development that has both retail and living units. The development is for sale from the developer for the Toledo market asking price per unit for the residential space plus the Toledo market retail price per sqft for the commercial space . Below is a table of the units in the property, their area, and estimated monthly rental rates per square foot.

Apartment Units	No. of Units	Sq. Ft.	$/Sq.Ft./Month
Studio	4	800	$1.30
One Bed, One Bath	8	950	$1.25
Two Bed, One Bath	6	1,100	$1.20
Two Bed, Two Bath	6	1,450	$1.15
Commercial Units	No. of Units	Sq. Ft.	$/Sq.Ft./Month
Anchor One	1	15,000	$1.02
Anchor Two	1	12,000	$1.02
Restaurant	1	10,000	$1.06

You estimate that overall vacancy will be approximately 3% of revenue per year and bad debt write offs will be 1% of revenue per year. Property management fees are expected to be 4% of total revenue. Insurance, SG&A, replacement expenses, and common area utilities are expected to be $400, $800, $100, and $125 per unit respectively per year. Property taxes are 1.5% of the total value of the property. Top line revenues are expected to grow 2% per year and operating costs are expected to grow at 3% per year.

Financing, Depreciation, and Sale

Your REITs policy is to finance all deals with 6% equity. Therefore you will borrow 94% of the purchase price. The commercial loan is non amortizing (interest only). The total balance of the loan is due upon sale of the property. Your bank will lend to you at a 5% annual rate. The building will be depreciated over a 27.5 year life using a straight line basis. You anticipate that the property will appreciate at 2.5% per year.

Taxes

Your firm has a 25% income tax rate and a 15% capital gains tax rate.

Analysis

You should calculate both the unlevered (assume the property is purchased with cash) and levered (assume the property is purchased with 6% equity and 94% debt) NPV and IRR. You should use an 8% discount rate for the unlevered NPV and 15% discount rate for the levered NPV. Additionally, you should perform a sensitivity analysis on each of the commercial unit rental prices, percent financed, and bad debt expense impacts IRR.