Assess the property cash flows before tax of a leased suburban office building that an investor is considering buying with a view to holding for five years. The property is leased to two tenants on the terms shown in Table 15.10.
Study the data for the suburban office market in Table 15.11. It can be used to help in forecasting market rents for the office building. Assume that this building is typical of those in the suburb and has a current gross market rent of about $$\$ 190 / \mathrm{m}^2$$ per annum.
(a) What has been the compound growth rate in office rents in the last ten years? During this period, the rate of increase in the index of consumer price inflation has averaged $2 \%$ per annum. Economic forecasters are predicting an average rate of inflation of about $4 \%$ per annum for the coming years. How might this impact your forecast for the next five year's rental growth?
(b) Work out the linear trend in rents over the next five years using simple regression to extend the time trend of the past ten years. How much of the past variation in rent is explained by the trend line?
(c) Study the table above to estimate how market cycles might influence the rent over the next five years. Consider the relationship between construction, vacancy and rental changes. Suggest a pattern for market rents over the next five years. Use this pattern and the details about the existing leases to project lease rents for a five-year analysis.
(d) The landlord is currently paying $$\$ 68 / \mathrm{m}^2$$ per annum in operating expenses for the property. These can be assumed to increase at the projected rate of inflation. Allow for six months' loss of rent (or an equivalent leasing incentive of six months' rentfree at the start of each new lease). Using this information, work out the operating cash flows before tax.
(e) The property can be acquired for $$\$ 1,200,000$$, plus $4 \%$ buying costs. It is believed that the property should be saleable at the end of the fifth year at a capitalization rate of $8.5 \%$ applied to the sixth year's forecast operating cash flows before tax (less $3\%$ costs of sale). Using this information, work out the property cash flows before tax. At a discount rate of $12 \%$ per annum on the property cash flows before tax, would you recommend the purchase?