Question

You recently closed on a property for an acquisition cost of $10 million at an 8% capitalization rate. The 10-year Treasury note was quoted at 75 basis points and you expect the property’s net operating income to grow at 2% in perpetuity.

What do you expect net operating income to be in years one and two? What is the discount rate and risk premium that were applied at acquisition?

Answer 1

Acquisition price of property = 10,000,000

Capitalization rate = 8%

Acquisition price of property = Net Operating Income / Capitalization Rate

10,000,000 = Net Operating Income / 8%

Net Operating Income = 800,000

Net Operating Income at Year 1 = 800,000* (1+Growth %)

Net Operating Income at Year 1 = 800,000*(1.02) = 816,000

Net Operating Income at Year 2 = 816,000* (1+Growth %)

Net Operating Income at Year 2 = 816,000*(1.02)= 832,320

Discount Rate = Capitalization Rate + Growth Rate

Discount Rate = .08 + .02 = 10%

Risk Premium = Discount Rate - Treasury Bond Rate

Risk Premium = .10 - .0075 = 9.25%