CHAPTER 15

FORECASTING AND ANALYSING RISKS IN PROPERTY INVESTMENTS

ANSWER TO REVIEW QUESTIONS
QUESTIONS
15.1 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.
Table 15.10 Lease terms for suburban office building
Tenants
First floor

Floor
area (m2)
321.7

Current gross
rent ($)
67,500

Second floor

460.4

87,500

Lease terms
Leased 3 years ago for a fixed rent; lease expires
at the end of next year.
Leased last year for 5 years; with a fixed 10%
per annum increase at the end of this year and a
market rent review at the end of next year.

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 / m2 per annum.
Table 15.11 Market data for suburban offices
Years

Gross Rents
($/m2 p.a.)

-10
-9
-8
-7
-6
-5
-4
-3
-2
-1
0
1
2

$165.00
$165.00
$170.00
$180.00
$200.00
$215.00
$215.00
$205.00
$195.00
$190.00
$190.00

Time trend in
Difference
rents($/m2) from time trend
($/m2 p.a.)
$173.41
$176.73
$180.05
$183.36
$186.68
$190.00
$193.32
$196.64
$199.95
$203.27
$206.59

-$8.41
-$11.73
-$10.05
-$3.36
$13.32
$25.00
$21.68
$8.36
-$4.95
-$13.27
-$16.59

Workbook 15.6

17

Estimat
ed
vacant
%
12
11
8
3
4
7
9
12
17
11
8

New building
(m2)
7,000
11,000
8,000
9,000
21,000
29,000
36,000
19,000
17,000
6,000
7,000
12,000
9,000

(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 cent 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 years 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/m2 per annum in operating expenses for
the property. These can be assumed to increase at the projected rate of
inflation. Allow for 6 months loss of rent (or an equivalent leasing incentive of
6 months rent free 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 5 th year at a
capitalisation rate of 8.5 per cent applied to the 6 th years forecast operating
cash flows before tax (less 3 per cent costs of sale). Using this information,
work out the property cash flows before tax. At a discount rate of 12 per cent
per annum on the property cash flows before tax, would you recommend the
purchase?
ANSWERS
Answers to all parts of this question are provided in the Excel file titled Q 15.1 Excel
Solutions.xls

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