You’ve had your eye on an old, run-down duplex in your neighborhood. The out-of-state owner never puts any work into the property so it’s in very poor condition and rented at significantly below market prices. You decide to try to purchase the property from the owner.

From your market research you conclude that, if the property could achieve market rents, it would generate a profit of $68,000 per year (after all expenses) on an on-going basis for the foreseeable future.

After speaking with a few brokers, you are confident that the appropriate capitalization rate for properties like this in your market is 8.0%.

A general contractor you know estimates the renovations required to achieve market rents would cost about $180,000. Since it’s a slow season, they can get the work done right away (though, of course, you’ll have to pay the $180,000 immediately upon purchasing the property).

2(a). You ask the owner how much they’d accept for the property as-is. After many discussions, she tells you she’ll sell it to you for $550,000. What is the Net Present Value of this investment? Show your work and explain your reasoning.

2(b). Still assuming a purchase price of $550,000, what is the Internal Rate of Return on this investment? Show your work and explain your reasoning.

2(c). You call the owner to accept their price….only to have her tell you there is another buyer interested in the project. The owner asks both you and the other buyer to bring her your “highest and best” offers by noon tomorrow.  

What is the highest price you’d be willing to pay for this property? Show your work and explain your reasoning.