Question

1. You see a large glut of commercial real estate in your town and a realtor you know talks to you about buying a small strip mall at a discount rate of 10%. You toss the idea around with Mary and here are the choices you decide on. Which one would you pick?

1. 10% is a nice return given the 1% T note rate which implies a spread of 9%, and if you wanted a return of 12% you would be paying more for the strip mall
2. Having low vacancy affects revenues which will affect the denominator of valuation models.
3. Real estate is not a good investment under any circumstances
4. If I feel there is way more risk than my realtor says than I should want a return or discount rate of let’s say 15% or more meaning I’d pay less than the original asking price.
5. None of the above

Answer 1

If I feel that there is a higher risk than what is being projected by my realtor, then I would be demanding a lower price and that lower price can be achieved through higher risk premium and higher rate of expected return which could be taken at discounting calculation of cash flows from the future and a higher discounting rate will always lead to a lower net present value of the project so I would be paying lower through higher rate of return.

All the other options are not representing the true fact and they are not true.

Correct answer will be option (D)if I feel there is risk more than my realtor says then I would want a return or discount rate of 15% or more meaning I would be paying lesser for the original asking price