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% |
|
Afteryear2 |
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.