Question

You are planning on building a 30 unit apartment building. You believe the building will last for 35 years and have asalvage of 10% of its construction cost. The cost of the land will be recovered in full at the end of the 35 years. The land will cost $3.2 million, the building will cost $4.8 million to construct, and the building will cost $70,000 per month,to operate and maintain. Property taxes and insurance are 0.5% per month of the initial investment. You believe the occupancy rate will average 88%. You want to earn at 15% rate of return. a. What is the required monthly lease cost for each unit? b. You believe that if you convert 2 of the units into an exercise facility, the occupancy ate will increase to 93%. Should you do this?

Please show all work for the solution

Answer 1

a. What is the required monthly lease cost for each unit?

Ans:

The initial investment required is the sum of land cost and construction cost, which is $8 mn. They are depreciated over a period of 35 years. Through, Straight Line Method of depreciation, the depreciation expense calculates to $228,571.43 / year. O&M expenses per year are $840,000. Taxes and Insurance cost calculates to $480,000/ year. The total expenses in a year is sum of O&M, Depreciation, Taxes and Insurance, which works out to $1,548,571.43 / year. The income is a factor of number of units, occupancy rate and lease revenue per unit. To find out the monthly lease revenue per unit, expected rate of return of 15% and salvage value of $480,000 is provided. With the above information, to achieve an internal rate of return of 15%, monthly lease revenue per unit should be $8700.

b. You believe that if you convert 2 of the units into an exercise facility, the occupancy rate will increase to 93%. Should you do this?

Ans:

Yes. The revenue is a factor of occupancy rate, hence, higher the occupancy rate, higher the revenue. However, the question does not give the additional investment and additional O&M expense, which may require for conversion of the units into exercise facility. The same is to be considered while taking a decision.