Cap Rate Homework Assignment – Due Monday, September 28

|841 E. 4th Street |217 Broadway |1 W 4th Street |
|Office Building |Office Building |Office Building |
|Sale Price: $240,000 |Sale Price: $298,000 |Sale Price: $3,220,000 |
|Date: August 2009 |Date: Feb 2009 |Date: May 2009 |
|Sqft: 3314 |Sqft: 3200 |Sqft: 23,000 |
|Built: 1920 |Built: 1934 |Built: 1925 |
|NOI: $22,800 |NOI: $31,200 |NOI: $289,800 |
|0.04 acres |0.1791 acres |0.1377 acres |
|.095 |.104 |.09 |

You have researched a few recent sales transactions of similar buildings in South Bethlehem (see the table above). You are estimating the value of a small office building in South Bethlehem. It was built in 1932 and is about 4800 square feet. The date is September, 2009, and you estimate the NOI for the building at $52,300. Using the comparable sales transactions, estimate a cap rate for small office buildings in South Bethlehem, and briefly explain how you arrived at that estimation

Note: This method of determining cap rates is called the market extraction approach.

|The average of the cap rates: .096 |
|The average of the cap rate will be a sufficient estimate because two of the buildings are very similar to the size of the building we are |
|considering buying and the average of the cap rates is particularly close to the first comparable buildings cap rate of .095 therefore it |
|reflects the current market because the first building was bought in August and it is only September now. The cap rate is somewhat inaccurate |
|because these buildings sizes are much different especially the third buildings and the third buildings value is much larger than the other |
|two comparable buildings as well. Therefore the estimated cap rate is brought somewhat astray because of the disparity in their values, size |
|and thus the NOI of each building is much different. |
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|Value= NOI/CAP=52300/. 096 = 544791.66 |
|I used the average of the cap rates to estimate the cap rate of the proposed building it is important that the average cap rate is similar to |
|the cap rate of the first building which was bought a month before we plan to purchase the new property additionally, the building is close to|
|the same size as the building we plan to purchase. However, it is important to the note that the building we are planning to buy over a |
|thousand feet larger than the first two comparable building and is much smaller than the third building. Therefore, the values of each of |
|these buildings are not truly comparable. |
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Now, using the NOI for the subject property, estimate the Market Value of the subject property using the cap rate you have generated.

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Caveats:

Cap rates change over time, and are different for every market area. The cap rate for Class A Suburban Office in the Lehigh Valley market is much different from the cap rate for Class A suburban office in the Philadelphia market. You must have transactions from similar properties, in the same market area, and in the same time frame in order to estimate a valid cap rate.

Also, the quality of the tenants needs to be similar. (Example: Consider two buildings with identical NOIs, one rented to Shaky Sam’s Computers while the other is rented to Microsoft. The building with the better tenant is less risky, so it will have a lower cap rate and will be priced a bit higher.)

You are trying to estimate today’s cap rate for a suburban office building in the Lehigh Valley. What if, due to the market slow-down, you have no sales transactions for similar buildings more recent than 9 months ago?

|I believe having information that is 9 months old is not useful or comparable for evaluating a new investment because the economy |
|can be extremely volatile, as we have seen in the past year. Instead of using. Instead of using outdated comparable data, I would |
|recommend using the band of investment technique to figure out the cap rate. This formula is based on market equity. Therefore, |
|comparable cap rates are not essential enough to use outdated statistics. However, there is risk assumed when investors decide to |
|use the band of investment technique. This is because the formula relies on an equity rate return which has to be calculated and |
|extremely accommodating to the investors financial needs, other wise the cap rate generated will not be useful. It would be |
|important to not that the total amount of debt required to finance the building and the total amount of equity are also factors in |
|this equation therefore the cap rate will be adjusted to the specific investors financing plans. Overall, this method can be |
|affective if market data is outdated however the estimation of return on the investor equity is crucial. |
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Fill in the following sensitivity table with Estimate Market Values:

|Property Value |Cap rate |
| |.07 |.09 |.11 |
|Annual NOI |$60,000 |857142.85 |666666.66 |545454.54 |
| |$75,000 |1071428.57 |833333.33 |681818.18 |
| |$90,000 |1285714.28 |1000000 |818181 |