What is the maximum price you should pay for the following vacant lot:

(a) if you maintain the parking forever? (20 points)

(b) if you redevelop the site now? (30 points)

(c) if you choose the best strategy? (You need to determine the best strategy, which may be different from (a) or (b).) (50 points)

(Bonus, 10 points) How does the investor size impact your answer? For example, this project can be one of many projects for a large investor but the only project for a small investor.

Description of a downtown vacant Lot

I.The lot is currently used as parking.

• A 36K s.f. vacant block, which is currently used as surface parking.
• The effective gross income (EGI) and operating expenses (OE) of the parking are $2.5M/y & $0.5M/y, respectively.
• The landowner will receive NOI once a year starting now (the first at t =0, the second at t=1,...)
• The parking NOI is stable without growth.
• The discount rate for the parking NOI is 3%/y.

II.The lot can be redeveloped into office.

• The landowner can build a 20-story, 500,000 s.f., office building.
• The construction cost is $200M without inflation, whenever you build.
• The construction period is zero (if you spend $200M at t=0, you receive the first office CF at t=0).
• The discount rate for the construction cost is 3%/y.

III.The office NOI is uncertain.

• The office NOI is currently $16M/year (If you redevelop now, you will receive $16M at t=0).
• The city will decide before t=1 whether to build a convention center (CC) near the vacant lot you are analyzing. The city's decision is uncorrelated with office market conditions.
• If CC is built in the neighborhood, the expected office NOI will grow 2%/y forever from t=2. Without CC, the expected office NOI will not grow.
• The discount rate for the office NOI is 8%/y.
• The following diagram summarizes the office NOI.

t=0 t=1 t=2 t=3 and after Prob=0.5 $16M $16M*1.02 grows forever With C With CC With CC NO|= $15M Prob=0.5 $16M $16M constant forever w/o CC Without CC Without CC