Question

Net operating income (NOI) is expected to be level at $100,000 per year for the next five years because of existing leases. Starting in Year 6, the NOI is expected to increase to $120,000 because of lease rollovers and increase at 2 percent per year thereafter. The property value is also expected to increase at 2 percent per year after Year 5. Investors require a 12 percent return and expect to hold the property for five years. What is the current value of the property and implied going-in cap rate?

Answer 1

(A)

​​​​​Step 1:

Calculate future value after 5 years.

Residual or terminal cap rate = 12% - 2%

Residual or termial cap rate = 10%

* Applying this to Net operating income in year 6.

Given net operating income in year 6 = $ 120,000

Future value (FV) = $120,000/Terminal Cap Rate

Future Value (FV) = 120,000/10%

Future Value (FV) = $ 1,200,000

Step 2: Discount the level met operating income for first five years

Given PMT = $ 100,000

Rate of interest (r) = 12%

Number of years (N) = 5

Future Value (FV) = $ 1,200,000

Using the general financial formula:

Here, NP = number of periods

Using above formula, we can calculate present value.

Present value (PV) = $ 1,041,390

Therefore, current value of property = $ 1,041,390

(B) Implied going in cap rate = 100 × (PMT/PV)

Implied going in cap rate = 9.6025%