Use the following information to answer the questions. Commercial Property Lease

Question

Use the following information to answer the questions. Commercial Property Leaseable space= 300,000 sqft Cap Expenditures = 20% of EGI Average Annual Rent = $17.00/Sqft LTV = 80% Average Annual Growth = 2.5%/year Loan Interest Rate = 6% V&C Losses = 8% of PGI Amortization = 30 yrs Operating expenses = 35% of EGI % Bldg/Total Value = 75% Miscellaneous Income = $1.50/sqft Corporate tax rate = 30% MI annual growth = 2%/year Cap Gains tax rate = 15% going-out cap rate = 10.5% accum dep tax rate = 25% discount rate = 6% purchase price = $22.5M What is the operating expense ration? A 24% B 32% C 27% D 35% What is the going-in cap rate? A 12.9% B 8.10% C 14.85% D 7.60%

Explanation / Answer

I. Effective Gross Income = Potential Income produced by the property - Vacancy & Collection Costs

Operating Expense Ratio = (Operating Expenses)/(Potential Gross Income - V&C Costs) i.e.= (Operating Expenses)/(Effective Gross Income)

Operating Expenses = 35% of EGi [Given]

Hence, Operating Expense Ratio = 35% [ Option D]

II. Going-In Cap Rate = (Projected Net Operating Income for the first year)/((Purchase Price)

NOI = (Rental Income + Misc Income) - (Operating Expenses + Loan Repayment) - Applicable Taxes

For Income,

Projected Income = (17+1.5)*300,000 = 5,550,000

For Expenses,

V&C Costs = .08 * Projected Income

Therefore, EGI = .92*5,550,000 = 5,106,000

Operating Expenses = .35*EGI = 1,787,100

Loan EMI per month can be calculated as [P*R*((1+R)^N)]/[((1+R)^N)-1] = 107,919

P=LTV*22.5m = 18,000,000; R = .06/12=.005; N = 30*12 = 360

Therefore, annual loan expense = 107,919*12 = 1,295,029

Corporate Tax = .3*(Projected Income - Projected Expenses) = .3*(5,550,000 - 1,787,100 - 1,295,029) = 740,361.3

Therefore, Net Operating Income = 1,727,509.7

Therefore, going-in cap rate = 1,727,509.7/22,500,000 = 7.6% approximately

Hence, Option D.

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