You have been hired by Pine Hill Gardens, LLC, (PHG) to advise them on whether or not they should renovate their property or sell it. The property is located in Mechanicsville, PA. It is currently owned by a group of investors from Sherman Oaks, CA. They have owned the property for 10 years. During this time, they have invested little to no money into improving the property. They purchased the property for $11,700,000.00, which at the time yielded a 6.50% free and clear return. The property is managed by a local management company. Due to the lack of investment in capital improvements and absentee ownership, the property is in a state of disrepair. The ordinary income tax rate is 28%. Annual Depreciation is $382,910.

Pine Hill Gardens is a garden style apartment complex consisting of 18 two story buildings with a total of 180 dwelling units. The current gross potential rent income is $1,728,000.00 annually. The current monthly net rent income after vacancies is $129,600.00. Operating Expenses are $790,000.

They could also invest $1,500,000.00 into the property. If they make the investment, PHG believes they will be able to increase rents by $100 per month per unit and reduce operating expenses by $500 annually per unit. They estimate their vacancy would be 3% of the gross potential rent income after renovation.

PHG could, in lieu of renovating the property, sell the property today for a price which would equate to a 8.0% capitalization rate to the buyer.

1. When PHG purchased the property, how much cash did it generate for their investment?

2. If PHG were to sell the property today at the 8% cap rate, how much would they have to invest in a new property (assume they have no mortgage on the property)?

3. What is PHGs Net Operating Income today (prior to renovation)?

4. What is PHGs vacancy factor today?

5. If PHG renovates the property, in terms of a dollar amount, what would their vacancy be?

6. What would the gross potential rent be after renovation?

7. What would be PHGs free and clear return be after renovation?

8. What would PHGs Net Operating Income be after renovations?

9. How much would operating expenses be after renovation (annually)?

10. If PHG were to renovate the property, what would be the after tax cash flow?

11. Assume if PHG sells the property today (before renovation) and are able to purchase a property yielding 7.0%, how much cash would the new property generate (before depreciation and taxes)?

12. What would you recommend PHG do; sell the property today or renovate and hold? Why?