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Assume that you have recently inherited $500,000 that you would like to invest in an income producing commercial real estate investment. Assume that local commercial real estate lenders are typically loaning up to 75% debt of an income producing property’s valuation. That means your equity investment would represent 25% of the valuation. What would be the maximum amount that you could pay for your investment property?
How much would that mean you could borrow in this scenario?
Assume that you find a small 10-unit apartment complex containing only 1-bedroom efficiency units that are leasing at $2,000/month in rent for a total annual potential gross income (PGI) of $24,000/year per unit or $240,000 overall. Assume that over a typical year, there is a 10% vacancy and collection loss (VCL) for this complex. Assume that it generates $3,000/year in other income (OI) from vending machines, laundry machines, etc. Calculate the annual effective gross income (EGI) for this property. Assume that annual total operating expenses (TOE) for this property are 35% of effective gross income (EGI). Calculate the annual net operating income (NOI) for this property.
PGI
-VCL
+OI
=EGI
-TOE
=NOI
Assume that the standard “going-in” capitalization rate (cap rate) for this type of property is 7%, what is the implied value of this property.
Using the amount to be borrowed from Question # 1, calculate the monthly payment for the loan assuming a 25-year term with a 5-year balloon and a 7% interest rate.
How much would you still owe on the loan in Question # 5 when the balloon payment becomes due at the end of 5-years (60 months)?
Calculate the IRR (Internal Rate of Return) percentage for this investment using the equity investment of $500,000 from Question # 1 as the initial cash flow and the annual BTCF (Before Tax Cash Flow) for each of the five years of the loan, and the amount above and beyond the outstanding mortgage payment as the terminal (reversion) value at the end of year 5 by using IRV (Income/Rate=Value) to compute the sales price using the year 6 NOI assuming a 5% “terminal cap rate.”
Calculate the NPV (Net Present Value) dollar amount for this investment assuming an 8% required rate of return for yourself.
Recalculate the IRR (Internal Rate of Return) percentage for this investment assuming that you had all of the funds necessary to initially pay cash for this investment without the need for any loan financing. (Hint: Use the initial maximum purchase price of $2,000,000 for initial cash outlay, the annual NOI for 5 years as the cash flows, and entire sales price added to year 5 cash flow, but derived by using a “terminal cap rate” of 5% applied to year 6 NOI.)
Recalculate the NPV (Net Present Value) dollar amount for this investment assuming an all-cash deal (no loan) as in Question # 9 and an 8% required rate of return for yourself.
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