A real estate investor has the following information on an office building: Purchase price is $1,250,000 with acquisition costs of $60,000 45,000 leasable square feet Initial rent of $10/sq. ft. per year and will increase 1.0 percent per year Vacancy rate of 8% of gross rent per year Operating expenses are 42% of effective gross income Three financing choices: All equity without any financing; Mortgage with 75% LTV ratio, 15 years, annual payments and 3.5% contract rate; Mortgage with 95% LTV ratio, 15 years, annual payments and 6.0% contract rate; Expected increase in value is 3.0% per year. Holding period is 15 years, and 5% selling expenses For simplicity, assuming that no capital improvement over the entire holding period 75% depreciable Investor’s tax rate is 28%, and capital gain tax rate is 15%. Questions: What is the equity after-tax return (internal rate of return) for each financing choice? How much percentage of the IRR comes from cash flows from operations and how much from sale for each financing choice? Which financing choice is the best and why? I would pick option 1 will be the best choice because it has the highest IRR

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter19: Lease And Intermediate-term Financing

Section: Chapter Questions

Problem 8P

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Related questions

Question

A real estate investor has the following information on an office building:

Purchase price is $1,250,000 with acquisition costs of $60,000

45,000 leasable square feet

Initial rent of $10/sq. ft. per year and will increase 1.0 percent per year

Vacancy rate of 8% of gross rent per year

Operating expenses are 42% of effective gross income

Three financing choices:

All equity without any financing;

Mortgage with 75% LTV ratio, 15 years, annual payments and 3.5% contract rate;

Mortgage with 95% LTV ratio, 15 years, annual payments and 6.0% contract rate;

Expected increase in value is 3.0% per year. Holding period is 15 years, and 5% selling expenses

For simplicity, assuming that no capital improvement over the entire holding period

75% depreciable

Investor’s tax rate is 28%, and capital gain tax rate is 15%.

Questions:

What is the equity after-tax return (internal rate of return) for each financing choice?
How much percentage of the IRR comes from cash flows from operations and how much from sale for each financing choice?
Which financing choice is the best and why?

I would pick option 1 will be the best choice because it has the highest IRR

Definition Definition Tax imposed by the government on the "gain" or increase in the value of an asset at the time of its sale by the owner. Capital gain is computed based on the purchase price and sale price of the asset. If the sale price of the asset is more than the purchase price, there is a gain on the sale of asset. A tax is imposed on such gain in accordance with the applicable tax rates at the time of sale.

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