Real Estate Finance and Investment
Shady Trail case
Taco van der Hoest
This report provides an analysis and evaluation of the current and prospective profitability of the Shady Trails property. Methods of analysis include trend, horizontal and vertical analysis as well as calculations such as Return on Assets, Return on Equity, Loan-to-Value ratio and the Gross Rent Multiplier. All calculations are found in the appendices.
Using the original assumptions our initial results regarding the desired profitability of the Shady trail are positive: * Net Operating Income (NOI), Cash Flow from Operations (CFO) and Cash Flow after Financing (CFAF) are all positive. * A Loan-to-Value Ratio of 70% is acceptable for a small industrial property. * Gross Rent Multiplier (GRM) of 113 means the property has good market value. * Return on Assets (ROA) of 8.74% and Return on Equity (ROE) of 12.4% is positive. * Internal Rate of Return (IRR) is 19% and exceeds the investors’ expectations.
Results of the initial data analysis shows that all financial calculations and ratios are positive. The high ROE and ROA ratios and most importantly the high IRR ratio of 19% leads us to our initial conclusion: we believe that the Shady Trail property is a good investment opportunity for Mr. Lunsford and his investors.
After revising the initial assumptions, our consultants have suggested several changes to the original Shady Trail setup: Base rent
The base rent of $3.90 per square foot for Shady Trail is not conform the current market rents. * We advise to adjust the base rent to a more fair priced rate of $3.25 per square foot. Vacancy
The 5% vacancy rate does not reflect the industry and local avg. of 9.6% and 7.6% respectively. * As the future growth rates are mildly positive we suggest a vacancy rate of 7%. Structural reserve
Structural reserves on average equal to 1-2% of the property value or 10-20% of the NOI. * The current structural reserve for Shady Trail is undervalued and we recommend to increase the reserve to $60.000, which reflects a balance between the amount of risk taken and the amount of cash flow reserved for capital improvement expenditures. Management fee
The fee for managing a small property like Shady Trail ranges from $28.000 to $56.000 p.a. * We advise to either increase the fee to at least the accepted minimum if our client takes up the job or hire a professional proprietary manager to do the work for our client.
After reassessing the Shady Trail property based on our new assumptions our expectations regarding profitability have been moderated, yet we remain positive: * Even though Net Operating Income (NOI), Cash Flow from Operations (CFO) and Cash Flow after Financing (CFAF) have decreased by as much as 30%, these figures are all still written in green numbers. * Return on Assets (ROA) of 7.33% and Return on Equity (ROE) of 7.66% are less than in the original calculations, but still positive. * The Internal Rate of Return (IRR) has dropped to 11% and thereby performed less than the investors had expected. However, 11% is still a very positive IRR percentage and lies near the 12.5% IRR desired by the investors. Be it the case that there are no other investment opportunities at hand that yield a higher return, we would advise to invest in the Shady Trail property.
Original assessment of the Shady Trail property
Using the original assumptions our initial results regarding the desired profitability of the Shady trail are positive: Net Operating Income (NOI), Cash Flow from Operations (CFO) and Cash Flow after Financing (CFAF) are all positive numbers. Using the Gross Rent Multiplier (GRM) we can roughly estimate the value of the income producing property. For Shady trail the GRM is 113 (Table A3), which means it takes less than 10 years for the property to...
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