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Question - Taha is searching for an investment opportunity in North Riyadh. He came across an advertisement where the property is a newly built office tower, which consists of 6 floors. Each floor has a rentable area of 500 square meter. The current market rent is SAR1,400 per square meter per year for such property. The selling price as advertised is SAR30million and could be negotiated. Based on Taha's knowledge, he knows that the average vacancy rate for similar office space in the area is 8%. If he purchase the property, he is planning to hold the property for ten years and will have the following arrangements for his tenants: - Rental: rental is fixed for the first three years. Rental will increase in the fourth year with a rate of 3% per year. - Estimated operating expense is 38% of effective gross income - Estimated capital expenditure allocation is 5% of effective gross income Other important information include: - The capitalization rate (R0) of similar property in the area is 8.5%. - The expected terminal capitalization rate (Rt) is 8.6%. - The discount rate that will be applicable for this investment is 10% - The selling cost is estimated at 3%. Based on the above information, you are required to:
a) Estimate the value of the subject property using the direct capitalization method.
b) Estimate the value of the subject property using the discounted cash flow method.
c) Based on your answers in (a) and (b), provide at least two reasons which may contribute to the differences in value indicated by each method. Which method is preferred by you? State your reasons.
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