REAL ESTATE FINANCE:

You are thinking about buying a small office building.

Tenants sign one year gross rent leases and may renew at market rates, if they so desire. The building is configured with 20 suites. Five (5) suites have 4,000 rentable square feet and five (5) have 2,500 rentable square feet.

The remaining 10 suites each have 1,000 rentable square feet. These measures include each tenant's allocation of common charges. The building has 7,500 square feet of common area. In addition, a food truck pays $5,000 per year to operate in the parking lot during lunch hours. Market rents are $40 per square foot.

As this is the only similar facility in the market, market rents are expected to increase 4% per year indefinitely. Property taxes are $250,000 per year and increases are capped at 2% per year. Other operating expenses total $280,000 per year and are expected to increase at the rate of inflation, estimated at 3% per year.

In most years, capital expenditures equal 4% of effective gross income, although the roof will need to be replaced just before the expected sale at the end of year 5, at an estimated cost of $175,000.

You estimate that 5% of the space will be vacant, on average, and that collection losses will total 2% of occupied space. Your market review indicates this property will sell at a price yielding a goingin capitalization rate of 8%. You believe the cap rate will increase to 8.5% at the time of a sale. Selling costs are expected to be 5% of the gross sales price.

This building is suitable for professional investors, who view capital expenses as a "below the line" item. Based on these parameters, the unleveraged property returns exceed your required returns and you decide to seek mortgage financing.

Local lenders are willing to lend up to 65% of the value of the building provided that debt service coverage exceeds 1.35x. Because of the relatively short holding period, lenders are willing to provide interestonly financing at 5.5% with total fees of 1.5%.

For the purpose of this exercise you may ignore depreciation and income taxes. Your brother will provide 50% of the equity capital, but as you are going to be the managing member, you agree that you will receive 60% of any profits in excess of those needed to provide you and your brother a 10% IRR as a preferred return.

Questions:

1.

what is the market value of the building, in dollars?

2

what is the maximum amount of debt proceeds (net of fees) that will be available from the lender

3

what is the projectlevel levered return expectation, in percent?

4

what is the passive investor's expected investment multiple?

5

what is the investor's expected IRR?

6

If the exit cap rate were to increase to 10%, would the preferred return threshold of 10% be reached?