Question

) A small office building in Hutchinson is expected to generate annual NOI of $120,000 in each of the next five years. It can be purchased at a going-in cap rate of 12 percent. If you purchase the property, you will expect to hold it for five years. Your required rate of return on this investment is 15 percent. Estimate the property’s reversion value (V5) and current market value (V0) under each of the following assumptions:

a) The terminal cap rate based on comparable sales is 14 percent (assume NOI in year 6 will also be $120,000).

b) NOI will grow at a constant rate of 2 percent after the end of your holding period.

c) The property will appreciate by 3 percent per year over the initial purchase price (P0).

d) The property’s initial market value (V0) will appreciate by 3 percent per year.

Answer 1

Part A Going in-cap rate Trailing twelve months NOI/Purchase price $1,20,000 14% TTM NOI Going in-cap rate Purchase Price TTM NOI Going in-cap rate Purchase Price (after 5 years) $8,57,142.86 Reversion Value V5 8,57,142.86 Current Market Value VO = Value of NOI for 5 years/(1+Rate of return)AN umber of years + Reversion Value / (1+Rate of return)ANumber of years Rate of Interest 15% Year NOI Reversion Value V5 Present Value of NOI and Reversion Value Present Value of building Vo 0 4 $1,20,000 $1,20,000 $1,20,000 $1,20,000 $1,20,000 $8,57,143 $68,610 $4,85,813 $1,04,348 $90,737 $78,902 $8,28,410.10

Part B Since NOI will grow at the rate of 2% till perpetuity, then Reversion Value V5 will be nothing but present value of perpetuity with growth Reversion Value VS NOI1/(R-G) Rate of Interest R Growth rate G NOl1 Net Operating Income after first increase 15% 2% $1,22,400 Reversion Value V5 $9,41,538.46 Current Market Value VO = Value of NOI for 5 years/(1+Rate of return)AN umber of years + Reversion Value / (1+Rate of return)ANumber of years Rate of Interest 15% Year NOI Reversion Value V5 Present Value of NOI and Reversion Value Present Value of building VO 0 3 4 $1,20,000 $1,20,000 $1,20,000 $1,20,000 $1,20,000 $9,41,538 $68,610 $5,27,772 $1,04,348 $90,737 $78,902 $8,70,369.63

Part C Initial Purchase price PO can be identified by using Going in-cap formula Going in-cap rate NOI/Purchase Price Going in-cap rate NOI Puchase Price PO (NOI/Going in-cap rate) 12% $1,20,000 $10,00,000 Reversion Value V5 Purchase price PO(1+Growth Rate)ANumber of years Puchase Price PO Growth Rate Number of year $10,00,000 3% Reversion Value V5 $11,59,274.07 Current Market Value VO = Value of NOI for 5 years/(1+Rate of return)AN umber of years + Reversion Value / (1+Rate of return)ANumber of years Rate of Interest 15% Year NOI Reversion Value V5 Present Value of NOI and Reversion Value Present Value of building VO 0 4 $1,20,000 $1,20,000 $1,20,000 $1,20,000 $1,20,000 $11,59,274 $68,610 $6,36,025 $1,04,348 $90,737 $78,902 $9,78,622.71

Part D Current Market Value VO Present Value of NOI till perpetuity Rate of return NC)I Current Market Value VO 15% $1,20,000 Reversion Value V5 Current market price VO (1+Growth Rate)ANumber of years Growth Rate Number of year 3% S927,419.26 Reversion Value V5