You have the opportunity to invest in an office building in downtown, in which you

would purchase assuming a $5-$year holding period with a $9\mathrm{.}0\%$ required rate of return $($discount rate$).$ The building offers a total rentable area of $6,380$ square feet, and $20$ parking spaces. Use Excel to answer this. You are provided the following information on the property from the current owner:

$1.$ The owner is asking $$1,800,000$ for the building.

$2.$ The owner has annual contracts from tenants on the building for $5,423$ square feet of the total space at $$32\mathrm{.}00$ psf$,$ full$-$service gross. Additionally, $20$ parking spaces are leased by annual contract for $$120\mathrm{.}00$ per month, per space. You expect this same office vacancy to occur into perpetuity and expect parking vacancy to be the same as the office vacancy. These lease terms are found to be in line with the downtown office market.

$3.$ Current annual operating expenses for the building follow:

a$.$ Management Fees: $6\%$ of EGI

b$.$ Annual Real Estate Taxes: $$28,710$

c$.$ Hazard Insurance: $$9,570$

d$.$ Maintenance$/$Repairs: $$9,570$

e$.$ Other. $$15,950$

f$.$ Capital Replacement Allowance: $$6,380$

A study of the office building market in downtown Charleston indicates the following trended increases in incomes and expenses, which can safely be assumed in analysis forecasts:

a$.$ Office rents: $2\%$ per annum

b$.$ Parking rents: $2\%$ per annum

c$.$ Real Estate Taxes: $2\mathrm{.}5\%$ per annum

d$.$ Other Operating Expenses: $2\mathrm{.}5\%$ per annum

You have also determined that you expect the capitalization rate at the end of year $5$ to be $25$bps higher than the going$-$in cap rate.

Assume the selling expenses associated with selling the property at the end of year $5$ are $3\%$ of the selling price. With respect to depreciation, the office improvements will be depreciated on a straight$-$line basis over $39$ years. Also assume the office improvements are $75\%$ of the value of the office building.

Assume the owner$$s tax rate is $35\%$ for ordinary income and $20\%$ for capital gains. Assume the tax rate on the recapture of depreciation is $25\%.$

Use the attached template for your answers.

Property Analysis

$1.$ Based on the above information, prepare a pro forma income statement for the $5-$year

holding period $($six years analysis required$).$

$2.$ Calculate the before$-$tax, property cash flows on the property. Calculate the going$-$in or

purchase cap rate.

$3.$ Calculate the exit price and exit cash flow.

Before$-$tax Analysis

$1.$ Calculate the before$-$tax cash flows for the $5$ years.

$2.$ Calculate the exit cash flow.

After$-$tax Analysis

$1.$ Calculate taxable income for the $5$ years

$2.$ Calculate the after$-$tax cash flows for the $5$ years

$3.$ Calculate the after$-$tax cash flow from selling the property

Lease analysis

The buyer is thinking about the structure of the leases in the building. The tenants currently pay

$$32$ psf$,$ full$-$service gross with $2\%$ annual rent escalation $($Option $1).$ Another alternative is for

the tenants to accept pay $$30\mathrm{.}00$ with a $2\%$ annual rent escalation and a $$11\mathrm{.}00$ expense base

stop $($Option $2).$ What is better for the owner of the building? Recall that the owner$$s required

rate of return is $9\mathrm{.}0\%.$

Additionally, given the current softness in the office market, the buyer thinks that he may need

to give a TI package of $$30$ psf to a new tenant. What would be the annual effective rent

assuming the other terms of the lease are that of Option $1?$