We are considering an acquisition of an existing medical office building (MOB) to our portfolio. There are 4 tenants. Tenants 1 and 2 occupy 15,000 and 8,000 square feet respective, at $19.00 per square foot. Tenant 3 has 10,000 at $20.00 and tenant 4 has 4,000 at $22.00. All the leases are presently expected to continue through the 4 year holding period and have CPI increases estimated at 2% per year. The asking price for the property is $3,000,000 of which 75% of the value would be allocated to the building; and vacancy and collection losses are projected at 10% of rents. First year operating expenses include $120,000 (i.e. taxes, insurance, utilities, maintenance, etc.) and management estimated at 5% of EGI. Our tax rate is 36% and all loses are recognized in the year they are incurred. Capital gains and depreciation recapture are both taxed at 15%. A 70% loan can be obtained at 9.5% for 25 years. Both the property value and operating expenses are expected to grow 4% per year and our projected holding period is 4 years. Selling expenses are projected at 4% of the gross sales price. The reinvestment rate for cash flows is 7% and the discount rate is 12%.

1. What is the before tax IRR and MIRR to the investor under the proposed mortgage arrangement? Comment on the differences for the investor yield estimates you just calculated.

• IRR= 10%nand MIRR= 9%

2. What is the after tax IRR, and the effective tax rate under this scenario?

• IRR= 8% and Effective tax rate= 15.02% in year 4

3. Calculate the terminal cap rate based on the information above.

• 14.88%

4. What is the NPV to the equity of the project?

• 513270.97

5. Assume the 12% discount rate holds. Examine the equity BTIRR under the following sample of LTVs and interest charges.

@ 65%	7%
@ 70%	10%
@75%	12%
@80%	15%

Does this project have positive or negative leverage at the given LTV levels?

• BTIRR= 19% so it has positive leverage

Part II

The market where the MOB is located is unstable with extensive tenant churning and lease buyouts occurring regularly. The truth is our 10% vacancy and collection loss estimate is fairly optimistic due to the perceived stability of current leases. A more realistic estimate (most likely) is 15% and a worst case (pessimistic) estimate for V&C would be 20%. Lets assign the probability of occurrence as follows: 40% for most likely, 35% for optimistic and 25% for worst case.

Compute the following

1. BTIRR and ATIRR for each scenario (you already have the optimistic estimate)
2. The expected IRR given the 3 scenarios
3. The variance and standard deviation of IRRs and the coefficient of variation for both before and after tax
4. Are the expected returns in excess of 12%?
5. Now, assume that the increase in value for year five is expected to be 6%. What is the marginal return for keeping the property one additional year? What is your advice?