Scenario Doctors William and Joan Carpenter are considering the acquisition of a commercial property. The Carpenters would like to invest in the growing southwestern community in which they have settled. After acquiring an apartment complex in this neighborhood they are convinced that there is demand for a retail plaza. The area has demonstrating strong economic growth in all sectors. It has a mixed population in terms of age and excellent public services, parks and schools. The median income is over $40,000. Because of corporate growth, many executives and managers move to the town and rent for a while before buying a house.

After viewing many retail centers, the Carpenters have asked you to provide a complete cash flow analysis for a 50,000 square foot property, in the upscale neighborhood of Indian Trials. The two-year-old property is in excellent condition and it is unlikely that it will require any major repairs in the near future, however the Carpenters would like to create a capital account of 4% of EGI (above the line) as a reserve against future repairs. The Carpenters expect a 9% unlevered first year return from NOI on the purchase price. The Carpenters would like to know what price they should offer if their investment expectation is a levered 15% per year. They will purchase on the first day of year one and sell on the last day of year five. The appraisal indicates a ratio of 80% of the purchase price allocated to structures/improvements and 20% to land.

Working with your mortgage broker sources, the Carpenters received a commitment for a loan for the lesser of 75% or a DSCR of 1.20. The loan will have a 25-year term, a 8.25 percent annual interest rate, and monthly payments as well as a 1% loan fee payable to the bank. Assume there are 2% of non depreciable purchase price closing costs for the acquisition. They are anticipating buying the property on the first day of the year and plan to hold the property for five years. The project disposition will occur on the last day of the year.

The Carpenters have asked you to be conservative in your analysis.

The Rent roll is as follows Tenant Square Feet OpEx Recapture Rental Rate (sq ft per year) Rent Increases per year Sals Steak House 10,000 Full $17.00 3% Bobs Bikes 5,000 Up to $2.20 per sq ft $10.50 3% Freyas Fashion (men and womens clothing boutique) 7,500 Full $8.00 plus percentage rent of 6% No annual increase to base rent The year of acquisition (year 0) Freya's sales were $500,000 Freya's sales revenue is projected to grow at 4% per year Veggie Fresh Grocery 20,000 Up to $1.75 per sq foot $6.25 $0.50 Petes Pet Store 2,500 Full $12.00 3% Pauls Pizza 2,500 Up to $2.45 per sq foot $11.00 3.50% Nancys Nails 2,500 Full $11.50 3% The Operating Expense is projected below Category Year One Expense Annual Increases Property Taxes 32,500 2% Insurance 54,000 2.75% Electric 78,000 1.50% Water 62,500 1.50% Garbage Removal 15,000 2% Janitorial 24,000 2.80%

You explained to the Carpenters that your forecast of market capitalization rates for this kind of property five years from now would be in the 10.5 percent range. A 10.5 percent cap rate will be applied to year six NOI to calculate the sales price at the end of year five. Sale closing costs will be 6%.

Your analysis will include a five-year forecast of the annual before- and after tax cash flows from operations and before-and after tax sales proceeds from the projected disposition. Finally, you will present the Carpenters with the IRRs the investment is projected to generate on a before-and after tax basis with both a levered and unlevered scenario. Their accountant told them that they are in the 28% ordinary income tax bracket, their depreciation recapture tax rate will be 25% and they will have a capital gains rate of 20%. The Carpenters would like to know what cash they will receive after paying taxes at sale and what the wealth effect of this investment will be at a 11% discount rate.

The Carpenters are looking forward to receiving your complete cash flow analysis of the retail plaza to determine if they should purchase the property, and if so, at what price.