Learning Goal: I’m working on a real estate exercise and need the explanation and answer to help me learn.
Valuation Practice
Unless stated otherwise, you are to assume all annual rent payments are made in arrears. State your assumptions used in your calculations where necessary.
Question 1
Mr A owns a 1,800-sf grade B office property with a remaining land lease tenure of 85 years. It was leased three months ago for a two-year lease at a monthly gross rent of $8 psf. Mr A is now asking you to value his property for mortgage purposes.
Below are the two most recent office property transactions that have taken place:
- A similar-grade 1,700-sf office property in the immediate vicinity was sold for $3.40 mil (ie $2,000 psf) five months ago. It has a remaining land lease tenure of 80 years. The buyer immediately spent $300,000 on the building improvements before renting it out at a monthly gross rent of $9 psf last month.
- A vacant 1900-sf freehold grade B office property nearby with similar building conditions as Mr As property was sold for $4.18 mil (ie $2,200 psf) two months earlier.
- Show how you would analyze the all-risks yields or cap rates in the two recent market transactions.
- Using the direct capitalization method, estimate the market value of Mr. As property.
Question 2
A 1,000-sf freehold retail property is available for sale. It is presently let at $16,000 per month under a triple net lease for three years that is expiring in two months.
- If you were asked to value the property for the owner, what information would you need?
- If the market cap rate for similar freehold retail properties is 3.4%, how would you estimate the market value of the property?
- Investor A is interested in buying the property. If he were to seek your advice on the value of the property based on his required return of 9%, how would you value the property?
- How would you know if Investor As required rate of return of 9% reflects the market discount rate?
- If during the inspection of the property, you discovered a building defect that has to be rectified, discuss if you would value the property differently.
Question 3
Your client is considering if he should invest his $1 mil in a government bond that yields 3% pa over a 5-year period or in a 5-year leasehold interest in an industrial property that is leased for:
fixed net income of $200,000 every year for the first 2 years, and
fixed net income of $300,000 every year over the balance 3 years.
- How do you compare the rates of returns from these two alternative investments?
- How would you advise your client on which is a better investment?
- If your clients required return from the leasehold investment is 10%, should he invest in the leasehold property?
Question 4
A freehold logistics warehouse owned by PQ Co has been leased to ABC Co under a 6-year triple net lease which commenced on 10 Mar 2020. The contract rent under the lease is as follows:
$250,000 pa wef 10/3/2020, and
$300,000 pa wef 10/3/2023
You have estimated that the warehouse can fetch a net rent of $400,000 pa if it were to be leased today. You may assume the cost of capital for both PQ Co and ABC Co to be 7% and that rentals of warehouses are expected to grow at around 3% every year in the foreseeable future.
- Does ABC Co own any valuable interest? How would you value ABC Cos interest as at today?
- Value PQ Cos present interest in the property, assuming freehold market cap rate of 4%
- If a potential buyer of the warehouse were to require PQ Co to deliver vacant possession of the property, how much might PQ Co be prepared to pay ABC Co as compensation for the surrender of his lease now?
Question 5
The State is leasing a recreation property for 30 years. It has received proposals from three prospective lessees – A, B and C.
- The State asks you to evaluate the proposals and recommend the proposal which offers the highest payments. You may assume the States cost of capital is 5%.
- If you were asked to estimate the market value of the 30-year lease assuming the current market net rent of the property is $240,000 a year, how would you value it?
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Payments under each proposal |
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Proposal by A |
Upfront premium of $600,000 plus net rent $150,000 every year for 30 years |
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Proposal by B |
Upfront premium of $1.8 mil, plus another premium amount of $3 mil payable after 10 years |
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Proposal by C |
Fixed net rents as follows: $200,000 pa for first 10 years, $300,000 pa for the next 10 years, and $350,000 pa for the last 10 years |
.
Question 6
The HDB offers a Lease Buyback Scheme that allows certain groups of elderly flat owners to sell the tail-end lease of their flats to HDB, to help them monetize the value of their real estate assets while they continue to stay in their flats for a significant duration.
A HDB flat owner is now seeking your advice on the valuation of the tail-end lease of 35-years to HDB. The details are as follows:
- Room type : 5-room in Ang Mo Kio
- Balance lease: 65 years
- Market value: $800,000
While HDB flats are meant for owner-occupation, the housing authority does allow subletting of flats under certain circumstances. You have ascertained that the flat could fetch a market net rent of $4,000 per month if it were to be let. Show how you would conduct your valuation of the tail-end lease.
Question 7
An office property was bought for $10 mil 5 years ago and is now sold for $16 mil. The investor had leased the property for the following net rental income in the first 3 years before he used it as his investment office in the last two years prior to leasing it out for a net rent of $40,000 a month.
Year 1: $418,000
Year 2: $453,000
Year 3: $394,000 (higher vacancy due to Covid)
Year 4 & 5: owner-occupied
Calculate the investors IRR from this investment.
