You have been asked to value an office building in Orlando, Florida with the following characteristics.
• The building was built in 1988 and has 300,000 square feet of rentable area.
• There would be an initial construction and renovation cost of $3.0 million.
• It will take two years to fill the building. The expected vacancy rates in the first two years are as follows.
|
Year |
Vacancy Rate |
|
1 |
30% |
|
2 |
20% |
|
After year 2 |
10% |
• The market rents in the building were expected to average $15.00 per square foot in the current year based upon average rents in the surrounding buildings.
• The market rents were assumed to grow 5% a year for five years and at 3% a year forever afterwards.
• The variable operating expenses were assumed to be $3.00 per square foot and are expected to grow at the same rate as rents. The fixed operating expense in 1994 amounted to $300,000 and was expected to grow at 3% forever.
• The real estate taxes are expected to amount to $300,000 in the first year and grow at 3% a year after that. It is assumed that all tenants will pay their pro rate share of increases in real estate taxes that exceed 3% a year.
• The tax rate on income was assumed to be 42%.
The cost of borrowing was assumed to be 8.25%, pre-tax. It was also assumed that the building would be financed with 30% equity and 70% debt.
A survey suggests that equity investors in real estate require a return of 12.5% of their investments.
a. Estimate the value of the building, based upon expected cash flows.
b. Estimate the value of just the equity stake in this building.