Finance HW

Beachcomber Apartments

Instruction Supplement 2 April 26, 2017

I am calling this “Supplement 2” because I posted the first supplement as an announcement in BB the other day. I have appended it to this document to make it easier to keep together.

First, some clarifications to the original instructions.

1. Tax rate: I apparently forgot to give you the property tax rate. It is 1.17432%. Special assessments total $55 per year. Remember: the subject’s actual expense history for property taxes is irrelevant.

2. There is a typo in the Expense table in the original instructions. The 2016 utilities for the subject should be $45,401. That means the total in the instructions is also wrong. Use the numbers in the workbook I provided.

3. There is info in the yield capitalization section that I really should have provided in the underwriting section. “The bank will charge a 1% loan fee at the beginning of the term.” This should be considered when determining how much equity you will need.

Next are answers to some recurring questions:

1. Should I model reserves for capital improvements as an expense “above the line”?

a. I intentionally made this vague as the answer in the real world can go either way. How was the cap rate derived? Was it from comps that held reserves, or from comps that pay for capital improvements as needed out of general funds? We don’t know! Therefore we cannot know whether it’s appropriate to have reserves as an expense item. But there is this: most lenders will require you to show reserves in your proforma for loan purposes.

2. Should I just make up the expense amounts?

a. Operating-expense estimates should be reasoned selections.

3. Should miscellaneous income be subjected to vacancy deduction or not?

a. Either way is fine. I just wanted you to think about it.

4. I wrote this complicated formula to try to solve for the loan amount based on a given DCR. Is it right?

a. I don’t know. I did mine with Goal Seek, a function in Excel.

5. I’m having trouble “seeing” the direct capitalization structure because the example for Centre Point office building does not have itemized expenses.

a. On the following page is a sample direct-cap summary taken from one of my appraisal reports. It does not exactly match the instructions I gave you, so please continue to follow them, but it should help you with architecture.

Instruction Supplement 1

(repeated from 4/20/17 Blackboard announcement)

1. The directions are questionable in one respect. Vacancy should be applied to scheduled (i.e. potential) income from garage, carport, and storage rent because that theoretical income at 100% occupancy cannot be counted upon. But if the $10,000 for other income (typically laundry, converted security deposits, late charges) was based on actual collections over the past year, doesn't that already reflect vacancy? Should that item be below the vacancy line? I would argue that it could be, and if you are trying to make a project pencil, you look in dark corners for all possible revenue.

2. The estimate of operating expenses for the subject for Year 1 requires judgment. There is no one right answer.

3. I hope by now you understand that in California, the current taxes are irrelevant. The definition of market value presumes a sale, so ad-valorem taxes should be based on the appraised value - the value you come to via direct capitalization. You are reflecting what will happen when the assessor examines the sale and resets the base-year assessed value. 

4. The expense comps are provided for your reference. They do not have to be imported into your workbook. Of course, if you are doing your assignment within the workbook I provided and the expense comps are already in there, they aren't hurting anything.

5. The Centre Point office-building example does not have itemized operating expenses. Your analysis of Beachcomber Apartments definitely needs to have them itemized. 

6. I sense that the term "discount rate" is still new to some of you. When you do a present-value calculation and you use an interest rate to discount future dollars to current dollars, you are using a discount rate. You can use the rate to solve for value, or - if given a value (or equity investment) - you can use that to find the rate. When you solve for a rate in that fashion, you are solving for IRR. Therefore, IRR and discount rate are nearly synonymous.