You are thinking about the purchase of 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 duringlunchhours. 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 thespacewillbevacant,onaverage,andthatcollectionlosseswilltotal2%ofoccupiedspace. Yourmarketreviewindicatesthispropertywillsellatapriceyieldingagoingincapitalizationrateof8%.Youbelievethecapratewillincreaseto8.5%atthetimeofasale.Sellingcostsareexpectedtobe5%ofthegrosssalesprice.

Thisbuildingissuitableforprofessionalinvestors,whoviewcapitalexpensesasa"belowtheline"item.Basedontheseparameters,theunleveragedpropertyreturnsexceedyourrequiredreturnsandyoudecidetoseekmortgagefinancing.

Locallendersarewillingtolendupto65%ofthevalueofthebuildingprovidedthatdebtservicecoverageexceeds1.35x.Becauseoftherelativelyshortholdingperiod,lendersarewillingtoprovideinterestonlyfinancingat5.5%withtotalfeesof1.5%.

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 excessofthoseneededtoprovideyouandyourbrothera10%IRRasapreferredreturn.

Questions:

1.

whatisthemarketvalueofthebuilding,indollars?

2

whatisthemaximumamountofdebtproceeds(netoffees)thatwillbeavailablefromthelender

3

whatistheprojectlevelleveredreturnexpectation,inpercent?

4

whatisthepassiveinvestor'sexpectedinvestmentmultiple?

5

whatistheinvestor'sexpectedIRR?

6

Iftheexitcaprateweretoincreaseto10%,wouldthepreferredreturnthresholdof10%bereached?