A real estate investor has the following information on an apartment building:
Purchase Price is $1,125,000 with acquisition costs of $50,000·
33,600 leasable square feet·
Initial rent of $1.5/sq. ft. per month and will increase at the beginning of each year for 5 percent per year. For example, the first year rent from month 1 to month 12 is $1.5/sq. ft., the 2nd year rent from month 1 to month 12 is $1.575 ($1.5*(1+5%)), and so on.·
Vacancy rate of 5% of gross rent per month.·
Operating expenses are 25% of effective gross income·
Three financing choices:·
1. Mortgage with 75% LTV ratio, 20 years, monthly payments and 5% annual rate;
2. Mortgage with 80% LTV ratio, 20 years, monthly payments and 6% annual rate;
3. Mortgage with 85% LTV ratio, 20 years, monthly payments and 6.5% annual rate;
Holding period is 3 years (36 months) and the capital improvement expenditure is assumed to be $20,000 at the end of the first year only (12 months).·
Expected increase in value is 50% in total when sold in year 3 (36 months), 5% selling expenses·
80% depreciable with monthly depreciation.·
Investor's tax rate is 33%, and capital gain tax rate is 15%.·
Questions:
1. Compute equity after-tax cash flows from month 1 to month 36 for each financing choice.
2. What is the equity after-tax annual return (internal rate of return) for each financing choice and which choice would you like to make?