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Case Study-Multi-Use Commercial Property

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24 views3 pages

Case Study-Multi-Use Commercial Property

Xs

Uploaded by

Ahmed Mousa
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Case Study: Acquisition and Valuation of a Multi-Use Commercial

Property Background

You are a financial analyst working for a real estate investment firm,
GrowthSphere Properties. Your team is considering purchasing a multi-use
commercial property that includes retail spaces and residential units. Your
task is to evaluate the property’s valuation using multiple approaches and
determine whether the investment is feasible given your firm's financial and
strategic objectives.

Property Details

1. Location: A suburban area with growing demand for rental properties.

2. Structure:

a) Retail Units:
Two units on the ground floor:

 Unit 1: Occupied by a pharmacy (2,000 sqft), currently leased at


$28/sqft/year with a 5-year lease. Rent increases by 5% annually.
 Unit 2: Occupied by a coffee shop (3,000 sqft), leased at
$30/sqft/year with a 3-year lease renewal option at a 10% higher
rate.
Both tenants share property tax and insurance expenses on a pro-rata
basis.

b) Residential Units:
 8 studio apartments @ $1,000 per month.
 8 one-bedroom apartments @ $1,400 per month.
 4 two-bedroom apartments @ $1,800 per month.

3. Expenses:

Annual operating expenses for the first year are estimated at:

 Maintenance and Repairs: $18,000


 Property Taxes: $45,000
 Insurance: $12,000
 Electricity (Common Areas): $6,000
 Property Management: 6% of Gross Operating Income (GOI)
 Miscellaneous: $8,000
Expenses are expected to grow by 2.5% annually.
Financing Details
 75% Loan-to-Value (LTV) financing available for 20 years at a 6.5% fixed
rate.
 A Debt Service Coverage Ratio (DSCR) of 1.2 or higher is required.
 Loan requires a closing cost of $15,000 and an origination fee of 1.5%.

Valuation Assumptions
 Recent market transactions suggest a 9% capitalization rate for similar
properties in the area.
 Property asking price: $3.8 million.
 The holding period is 10 years, with a sale at the end based on NOI and
the cap rate at that time.
 Discount rate: 10%.
 Inflation rate: 2.5%.

Your Tasks

1. Valuation and Purchase Price:

o Estimate the property’s valuation using the Direct Capitalization


Approach.

o Determine if the asking price of $3.8 million is reasonable.

2. Cash Flow Analysis:

o Develop a 10-year projected cash flow model, including:

 Gross Operating Income (GOI)

 Operating Expenses

 Net Operating Income (NOI)

 Loan Payments

 Free Cash Flow


Solution Steps:

Task 1: Valuation and Purchase Price

1.1 Direct Capitalization Approach:

1. Gross Operating Income (GOI):


o Calculate the annual income from all units (retail and residential).
o Include rent escalations for retail units (5% annually for the pharmacy, 10%
renewal rate for the coffee shop after 3 years).
2. Net Operating Income (NOI):
o Deduct operating expenses (Maintenance, Property Taxes, Insurance, etc.) from GOI.
o Consider the growth rate in expenses (2.5% annually).
3. Direct Capitalization Value:
o Use the formula: Property Value=NOI / Capitalization Rate
4. Evaluate the Asking Price:
o Compare the property’s value using the Direct Capitalization Approach to the
asking price of $3.8 million.

Task 2: Cash Flow Analysis

2.1 Projected Cash Flow Model:


1. Gross Operating Income (GOI):
 Calculate annual rents for retail and residential units over 10 years.
 Adjust rents for growth rates and renewals.
2. Operating Expenses:
 Start with first-year expenses and apply the annual growth rate (2.5%).
3. Net Operating Income (NOI):
 Subtract operating expenses from GOI each year.
4. Loan Payments:
 Calculate annual debt service:
o Use a 20-year amortization schedule at 6.5% interest for 75% of the property
value.
o Include closing costs and origination fees.
5. Free Cash Flow (FCF):
 Subtract loan payments from NOI to determine free cash flow.

2.2 Debt Service Coverage Ratio (DSCR):


 Ensure the DSCR remains above 1.2: DSCR=NOI / Debt Service

2.3 Sale at End of Year 10:

1. Estimate the sale price:


o Use the projected NOI in year 10 and the capitalization rate.
2. Calculate proceeds from the sale:
o Deduct any remaining loan balance from the sale price.

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