You have been hired to perform an investment analysis for a high net worth individual to determine if they should purchase a commercial real estate property. The investment includes office, retail and townhome land.

The following are the income characteristics:

Office 50,000 square feet is leased to a national tenant, Funeral Directors Association for $40 per square foot for the next 20 years. The rent will not increase. There are expense stops of $8.50 per square foot and there is no risk of vacancy or credit loss. 20,000 square feet is leased to an accounting firm, Dewey Cheatham and Howe for $36 per square foot for the next three years with no rent increases and there is no risk of vacancy or credit loss. At the end of three yeas they will vacate the space and it will take six months to lease the space at which time the market rent is projected to be $40 per square foot with annual increases of 2 percent. The new lease term on this space will be 15 years and the vacancy and credit loss on this space is projected at 1 percent. Office expenses for all tenants are $7.25 per square foot and increasing 3 percent per year.

Retail 15,000 square feet is leased to Trader Joes for $45 per square foot with no rent increases on a triple net basis for the next 20 years and there is not risk of default. They pay percentage rent of 2.5 percent over the natural breakpoint. Their current annual store sales are $20 million and expect those sales to grow by 8 percent per year. 30,000 square feet is leased to HH Gregg for $35 per square foot on a triple net basis for the next 15 years with no rent increases. However percentage rent is 4 percent over the natural breakpoint. Current store sales are $24 million and are expected to grow by 10 percent per year. Caribou Coffee leases 1,200 square feet for $50 per square foot with annual rent increases of 4 percent per year on a triple net basis for 15 years. There is nooverage rent and there is no risk of credit loss.

Townhome Land There is acreage to support 120 townhomes. These lots are under contact to three different builders: Eagle of Virginia, Ryan Homes and HHHunt. Each builder will take down (purchase) 10 lots per year at an initial price of $75,000 each and lot prices will increase by $10,000 per year until all lots are sold. The development cost of each lot is $30,000 and will increase by $5,000 per year. Holding costs are $1,000 based on the remaining lots and the cost of sale for each lot is 6 percent.

Financing Third Fifth Bank is providing a mortgage of 70 percent loan to value at 6.75 percent amortized over 25 years with a 10 year call on the office and retail area only. No financing is available on the land. Taxes Your investor has an ordinary income tax rate of 28 percent. The long term capital gain taxes are 20 percent and recapture is 25 percent.

Investment Criteria /Assumptions The property is being offered for $45 million. The terminal cap rate is 7.50 percent and the discount rate is 9.5 percent. The holding period is 10 years. Assume that the mixed use land value is 10 percent of the total value. Also assume that the cost of sale at the end of the holding period is 1 percent.

Questions:

What are the annual cash flows for periods 1 to 11; what is the terminal value; what is the before and after tax NPV and IRR (use end of period); what is the division of value between cash flows and resale? Do your recommend purchasing the property? Explain why or why not. Show all calculations PGI, EGI, Expenses, NOI, Taxes, etc. If unclear about something, clearly state your assumptions.