Investment firm eyeing industrial property in Baldwin Park

You work for an investment firm that’s eyeing this industrial property in Baldwin Park:
The owner, Richard Norlund, is offering to sell it for $4.25 million. Currently, it has no
vacancies, and the tenants are paying $19.35/SF (per year) for 17,434 rentable building area
(RBA). You contact a broker at CBRE, who gives you the following projections:
• In this submarket, rents are expected to grow 5.2% over the next year (i.e. year 1),
6.1% the following year, 7.1% the following year, and 5.3% thereafter.
• The average cap rate in this market is currently 5%. CBRE expects this number to
remain stable for the foreseeable future.
• The typical operating expense ratio for this type of building is 40%, and tenants
usually pay for half of that.
• The building was constructed in 1984, so you should probably set aside 10% of NOI
per year for renovations.
• This type of property usually requires selling expenses that are 4% of the sale price.
Before you build an entire financial model, you want to use relative valuation for some back-
of-the-envelope numbers.

1. What is currently the average net income multiple in this market?
2. If the market is fairly valuing this type of property with this net income multiple, and
   if Mr. Norlund is offering it at a correspondingly fair price, what NOI do you project
   for year 1 of operations?
3. Given what you know about operating expenses, what EGI do you project for year 1
   of operations?
4. Given your EGI projection and Mr. Norlund’s offering price, what EGI multiple is the
   property trading at?
   Now, to assess these projections, you decide to build a full pro forma.
5. Using the information from CBRE (not your projections in questions 1-4), please
   calculate the PBTCF for year 1 of operations.
   a. How much do the EGI and the NOI in your pro forma differ from your previous
   projections?
   b. Why are these two sets of calculations so different? Which one would you prefer
   to use in order to make an investment decision?
6. Assuming your firm plans to sell the property after five years of operations, what are
   the PBTCFs for the remaining four years of operations?
7. Based on your pro forma, what is the annual appreciation return of this property,
   from purchase price to resale price?
8. If you add together the cap rate and the appreciation return, what is the approximate
   total annual return on this investment?
   a. Do you think this is a good return? Why or why not? In finance, what’s the best
   way to judge such a return?