Question

You are considering purchasing an office building for $2,500,000. You expect the potential gross income (PGI) in the first year to be $450,000; vacancy and collection losses to be 9 percent of PGI; and operating expenses and capital expenditures to be 42 percent of effective gross income (EGI). You will finance the acquisition with 25 percent equity and 75 percent debt. The annual interest rate on the debt financing will be 5.5 percent. Payment will be made monthly based on a 25-year amortization schedule. Required:a. What is the implied first year overall capitalization rate

Answer 1

The value of the implied first year overall capitalization is given as 9.5%

How to solve for the overall capitalization

We have the potential gross income =  $450000

We have to multiply the loss of 9 percent by this value

0.09 * 450000

= $40500

We have the operating expenses to be 42 percent

Next we have to solve for the operating income

Net operating income =  450000-[450000*0.09]-[450000-(450000*0.09)]*0.42) =

This would give us $237510

The implied first year capitalization would be given as 237510/2500000 = 9.50%

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