Question

Stargaze Properties is evaluating the purchase of two apartment complexes built in 1994.
Failure to maintain the properties in recent years has prevented increases in rents for the last
four years, with occupancy rates falling below 80 percent. Stargaze plans to purchase both
complexes at a combined cost of $30 million. The complexes will ultimately be sold to
investors as limited partnership units. Prior to resale, both complexes will be renovated,
which should increase occupancy rates to 95 percent so that rents can be increased to market
levels. The proposed renovation will take one year (during which time both complexes must
be vacant) and require an immediate investment of $10 million. The complex having the
more desirable location can be sold at the end of one year for $28 million. The second
complex will be sold for $18 million at the end of three years, with expected rentals during
year 2 and year 3 of $3 million. Assuming there are no taxes on limited partnership
investments in real estate and that cash flows received at date 1 and date 2 can be reinvested
at 2.5 percent, determine the reinvested rate of return for the limited partnership and explain
why the reinvested return is greater or less than the internal rate of return for the project.

Answer 1

IRR calculations are generally tricky. You can use the formula and put random value and smartly check in what direction the result of below formula goes. It will a trial and error till formula gives you 0.

While the reinvestment is only giving 2.5% return and project is giving 15.07% return. IRR is higher for this project