Question: (NPV-Based Front Door & Back Door) This problem revisits the proposed 20,000-squarefoot office/warehouse flex space development first introduced in Problem 28.9 and gets you to apply an NPV-based back-door financial evaluation related to the approach recommended in this chapter. Market rents are about $15 per square foot and the local area has a 5% vacancy rate. All operating expenses are passed through to tenants except property taxes, insurance, and management, which you estimate at $5 per square foot per year. Construction costs are estimated at $1,030,075 including construction loan interest, and hence this figure is the estimated construction loan balance at the end of the projected one-year development/ construction phase (assume that the construction loan is riskless so that the lender's expected return equals the construction loan interest rate). Lease-up is assumed to be instantaneous and the projected cap rate on the completed stabilized property is 10%. The development phase opportunity cost of equity capital invested at time 0 is 15%.
a. Use an NPV-based back-door approach to estimate the maximum land acquisition costs that can be supported by this project, assuming there are no other up-front development costs or fees other than land acquisition.
b. How does your answer in part (a) compare with the answer to Problem part (a)? Which one is the better indicator of the true economic value of the site, and why? What information that is used in the SFFA approach is not used in the NPV-based version, and what is the significance of this?
c. Now apply an NPV-based front-door investment evaluation of the development and derive the required rent assuming the up-front land acquisition cost (inclusive of any other upfront development fees) is $700,000, and that this figure represents the developer's time 0 equity investment.
Problem: You wish to build an office/warehouse project, also known as R&D space or flex space. Market rents seem to be around $15 per square foot per year with a 5% vacancy rate in the local area. All expenses are passed through to tenants except property taxes, insurance, and management, which you estimate at $5 per square foot per year. Mortgage rates are 11% for a 20-year loan with a five-year balloon. Construction costs for your planned 20,000-grossleaseable-square-foot project are estimated at $1,030,075 in total. All 20,000 SF are rentable. The debt service coverage ratio required is 120%, and the maximum LTV ratio is 75%.
a. Use the SFFA back-door procedure to determine what you could pay for the land.
b. Now assume total construction and site acquisition costs (i.e., total development costs) are $1,300,000. Use the front-door SFFA procedure to determine what the required rents would be per square foot. Recalculate the required rent assuming a vacancy rate of 15%.