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Real Estate Finance & Investments (14th Edition)

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Ajax Investment Company is considering the purchase of land that could be developed into a
class A office project. At the present time, Ajax believes that the site could support a 300,000
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rentable square foot project with average rents of $20 per square foot and operating expenses
equal to 40 percent of that amount. It also expects rents to grow at 3 percent indefinitely and 0 questions remaining

believes that Ajax should earn a 12 percent return (r) on investment. The building would cost
$100 per square foot to build:

a. What would the estimated property value and land value be under the above assumptions? Snap a photo from your
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b. If rents are suddenly expected to grow at 4 percent indefinitely, what would the property value
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and land value be now? What percentage change in land value would this be relative to the land download link
value in (a)?

c. Instead of (b), suppose rents will grow by only 1 percent because of excessive supply. What 888-888-8888 Text me
would land value be now? What percentage change would this be relative to the land value in
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d. Suppose the land owner is asking $12,000,000 for the land. Under assumptions in part (a)
would this project be feasible?

e. If the land must be acquired for $12,000,000, returning to the assumptions in (a), how much of
a change in the following would have to occur to make the project feasible? (Consider each item
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one at a time and hold all other variables constant.)

(1) Expected return on investment (r).

(2) Expected growth (g) in cash flows.

(3) Building cost.

Real Estate Bond Bond
Finance &... Markets... Markets...
(4) Rents.
14th Edition 9th Edition 9th Edition

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Step 1 of 17
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Josh
Present value of property value can be calculated as total rent of the property less operating Ph.D. in Mathematics 1457

expenses. Then, the net operating income is discounted with the rate of terminal cap rate.

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MSU-IIT 2555
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Brown University 1400

Step 2 of 17

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(a)

The property value is the discounted value of NOI. The property value can be calculated as:

Particulars Amount

Total rent

(Rentable Square feet × rents per square foot)

Less: Operating expenses

Net operating income (NOI) $3,600,000

Terminal cap rate

0.09
(Required return – growth rate)

Present value of property

Construction cost

(Rentable Square feet × cost per square foot)

Thus, the estimated property value is $40,000,000 .

Comment

Step 3 of 17

Now, the land value is the difference between property value and building cost. Thus, the land
value can be calculated as:

Thus, the estimated land value is $10,000,000 .

Comment

Step 4 of 17

(b)

If the growth rate increases at 4%, then the terminal capitalization rate will decrease to 8%
. The present value of property can be calculated as:

Thus, the estimated property value is $45,000,000 .

Comment

Step 5 of 17

The land value can be calculated as:

Thus, the estimated land value is $15,000,000.

Comment

Step 6 of 17

The percentage change in land value from sub-part (a) land value can be calculated as:

Comment

Step 7 of 17

Thus, the percentage change in land value is 50% .

Comment

Step 8 of 17

(c)

If the growth rate decreases at 1%, then the terminal capitalization rate will decrease to 11%
.The present value of property can be calculated as:

Thus, the estimated property value is $32,727,272 .

Comment

Step 9 of 17

The land value can be calculated as:

Thus, the estimated land value is $2,727,272.

Comment

Step 10 of 17

The percentage change in land value from sub-part (a) land value can be calculated as:

Thus, the percentage change in land value is 72.73% .

Comment

Step 11 of 17

(d)

Under assumption is sub-part (a), the land value is $10,000,000. If the land owner is asking for
the rent of $12,000,000, then this project is not feasible, since the rent is higher than the value.

Comment

Step 12 of 17

(e)

If the land is acquired for $12,000,000, then the land value must be at least $12,000,000. Now,
the land value is the difference between property value and building cost. Thus, the property
value can be calculated as:

Hence, the property value should be $42,000,000 .

Comment

Step 13 of 17

(1)

Now, the terminal capitalization rate can be calculated as:

Thus, the expected return will be 11.57% .

Comment

Step 14 of 17

(2)

The capitalization rate as calculated in above part is 8.57%. If the expected return is 12%, the
growth rate can be calculated as:

Thus, the growth rate will be 3.43% .

Comment

Step 15 of 17

(3)

The land value is the difference between property value and building cost. Thus, the building cost
can be calculated as:

Hence, the building cost should be $28,000,000 .

Comment

Step 16 of 17

(4)

Calculate the average rent as follows:

Therefore, the average rent is .

Comment

Step 17 of 17

Working Note:

For calculating total rent you should go reverse from property value.

Property value:

Net operating income:

Operating expenses:

Total rent:

Comment

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