Question

Allen Benedict is thinking of buying an apartment complex that is offered for sale by the firm of Getz and Fowler. The price, $2.25 million, equals the property's market value. The following statement of income and expense is presented for Benedict's consideration:

The St. George Apartments Prior Year's Operating Results, Presented by Gertz and Fowler, Brokers

30units, all 2-bedroom apartments, $975/month		$351,000
water & dryer rentals		10,000
gross annual income		$361,000
Less operating expenses:
Manager's salary	$10,000
Maintenance staff (1 person, part-time)	7,800
Seedy landscapers	1,300
Property taxes	13,500	32,600
Net operating income		$328,400

By checking the electric meters during an inspection tour of the property, Benedict determines the occupancy rate to be about 80%. He learns, by talking to tenants, that most have been offered inducements such as a month's free rent or special decorating allowances. A check with competing apartment houses reveals that similar apartment units rent for about $895 per month and that vacancies average about 5%. Morevoer, these toher apartments have pools and recreation areas that make their units worth about $20 per month more than those of the St. George, which has neither. The tax assessor states that the apartments were reassessed 12 months ago adn that the current taxes are $71,400.

Benedict learns that the resident manager at St. George, in addition to a $10,000 salary, gets a free apartment for her services. He also discovers other expenses: insurance will cost $6.50 per $1,000 coverage, based on estimated replacement cost of about $1.8 million; workers' compensation ($140 per annum) must be paid to the state; utilities, incurred to light hallways and other common areas, cost about $95 per month for similar properties; supplies and miscellaneous expenses typically run about 0.25% of effective gross rent. Professional property management fees in the market area typically are about 5% of the effective gross income.

1) Develop a prior-year's reconstructed operating statement, assuming typically competent, professional management. Based on the reconstructed net operating income adn the current market value, determine the capitalization rate.

2) Assuming that the capitalization rate will remain constant, develop an estimate of the property's market value at the end of the projected holding period.

3) Suggest some reasons why the capitalization rate might not remain constant. Why might it become larger or smaller than the currently prevailing rate?

Answer should follow this model:

quantity

x rent

= GPI

Less: vacancies and collection losses

Less: free rent and concessions

+ other income

= EGI

Less: COE

= NOI

Do not subtract after-tax cash flow from EGI.

Answer 1