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Athena Investment Company is considering the purchase of an office property. After a careful review of the market and leases that are in place, Athena believes that next year’s cash flow will be $100,000. It also believes that the cash flow will rise in the amount of $5,000 each year for the foreseeable future. It plans to own the property for at least 10 years. Based on a review of property sales of properties that are now 10 years older than the subject property, Athena has determined that cap rates are in the range of 0.10. Athena believes that it should earn an IRR (required return) of at least 11 percent.
What is the estimated value of this office property (assume a 0.10 terminal cap rate)?
What is the current, or going-in, cap rate for this property?
What accounts for the difference between the cap rate in (b) and the 0.10 terminal cap rate?
What assumptions are being made regarding future economic conditions when using current comparable sales to estimate terminal cap rates?
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