You are considering purchasing a small office building for about $2,000,000. You have two options:

Building 1: First-Tier Property. Total acquisition price: 2.050.745 . Property consists of ten office suites, five on the first floor and five on the second. Contract rents: two suites at $2,000 per month, three at $3,000 per month, and five at $1,600 per month. For this building you expect yearly operating expenses for 40% of the EGI and Capital Expenditure of 5% of the EGI.

Building 2: Third-Tier Property. Total acquisition price: 1.850.600 . Property consists of six office suites, three on the first floor and three on the second. Contract rents: the suites at the first floor for $2,800 per month, and the suites at the second floor for $4.000 per month. For this building you expect yearly operating expenses for 35% of the EGI and Capital Expenditure of 5% of the EGI.

In both cases you estimate an annual rent increase of 1% a year and a vacancy and collection loss of 10% of the PGI. With your Financial Institution you negotiated the following loan terms: LTV = 70%, annual interest rate fix for 1 year = 2,5% and a yearly repayment = 2%, up-front fee = 1%

Question 2: Why are the capitalization rates different? Why is the second opportunity more interesting regarding the capitalization rate?