You are considering the purchase of an office building for $1.5 million today. Your expectations include the following: first-year potential gross income of $340,000; vacancy and collection losses equal to 15 percent of potential gross income; operating expenses equal to 40 percent of effective gross income and capital expenditures equal 5 percent of EGI. You expect to sell the property five years after it is purchased. You estimate that the market value of the property will increase four percent a year after it is purchased and you expect to incur selling expenses equal to 6 percent of the estimated future selling price
- What is estimated effective gross income (EGI) for the first year of operations?
- What is estimated net operating income (NOI) for the first year of operations?
- What is the estimated going-in cap rate (Ro) using NOI for the first year of operations
- What is estimated effective gross income (EGI) for the first year of operations?
Solution:
| Item | Amount |
| Potential gross income (PGI) | $340,000 |
| less: V&C allowance (at 15% of PGI) | 51,000 |
| Effective gross income (EGI) | $289,000 |
- What is estimated net operating income (NOI) for the first year of operations?
Solution:
| Item | Amount |
| Effective gross income (EGI) | $289,000 |
| less: Operating expenses (OE) | (115,600) |
| less: Capital expenditures (CAPX) | (14,450) |
| Net operating income (NOI) | $158,950 |
- What is the estimated going-in cap rate (Ro) using NOI for the first year of operations?
Solution: The overall cap rate is 10.6 percent ($158,950 / $1,500,000)
