Question

At site "A" the best current construction project is a retail plaza that would cost $3,000,000 to build (exclusive of land cost) and would then generate net rents of $400,000/yr, expected to grow at 2% per year indefinitely. At site "B" the best current construction project is an office building that would generate net rents of $500,000 per year, expected to remain constant. Construction of the office building would cost $4,000,000 (exclusive of land cost). Suppose investors require a cap rate (current net income as percent of investment) equal to 10% minus the expected annual growth rate in the net income.
If the natural vacancy rate is 10% and the current vacancy rate is 15%, then you would expect:
(a) Current rents are falling.
(b) Current rents are rising.
(c) Current rents are stable.
(d) With so little information the wise student would not hazard a guess about what might be happening to current rents.

Answer

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