RES 9776 – Spring 2015
Real Estate Finance
Stephen J. Pearlman
Case Study - Angus Cartwright III
Qinqin (Renee) Yang
Analysis and Assumptions
I. Case Overview
Angus Cartwright III, an investment advisor, was asked to provide investment advisory services for two clients, John DeRight and Judy DeRight. They both wanted to purchase a property that (1) is large enough to attract the interest of a professional real estate management company and (2) has a minimum leveraged return on their investments of 12% after tax. Their major goals are: Diversification of investment portfolio
Protection from future inflation
Take some tax advantages (especially for John)
Mr. Cartwright selected four properties and performed various financial analyses to best match the needs of his clients with the characteristics of the properties and the returns they offered.
II. Assessment of the Analyses and Assumptions:
Cartwright employed three stages of analysis: Preliminary Analysis (Exhibit 1 to 3), Risk Analysis (Exhibit 4) and Financial Analysis (Exhibit 5 to 10). Preliminary Analysis starts with gathering key facts and data such as purchase prices, current and future income, depreciation, estimated sales price and cash flows, loan and its rate and amortization, taxes and etc. The 1st year setups (Exhibit 2) for each property were developed and major comparable statistics (Exhibit 3) were calculated. Such analyses serve as a foundation for identifying directions and strategies for further detailed analysis, including financial analysis, physical inspection and an examination of day-to-day operations of potential investment properties. Risk Analysis consisting of a review of financial leverage (loan to value ratio) and operating risk (debt coverage ratio) can help a real estate investor to weigh the level of risks in relation to his investment objectives. In this case, Fowler had the highest leverage of 74.47%, while Alison Green had the highest Debt Coverage Ratio of 2, followed by Ivy Terrace(1.92), Stony Walk(1.46) and Fowler(1.26). The cushions they had are all sufficient for most lenders. The Break-Even Analysis, shown in Exhibit 4, was valuable to understand how a small change in occupancy levels can make a corresponding change in a property’s financial performance; most real state analysis assume the initial occupancy rate to remain at the same level through the investment period. Once all the relevant and key financial data is gathered, a number of effective financial analyses were performed; they are capitalization rate on both purchase and sale, cash-on-cash return rate, Internal Rate of Return (“IRR”), Net Present Value (“NPV”), Profitability Index and Cash Flow Analysis. The Quality of the financial analysis outcome heavily depends on the quality and accuracy of implicit assumptions used. However, applying financial analysis is still the best way to estimate the future performance of investment properties and comparing or prioritizing multiple investment opportunities. IRR is the most important and frequently used investment analysis indicator. Understanding various components of an IRR (Exhibit 8, 9 and 10) can help to carefully plan the timing, the sequence and size of events within an investment that will impact the performance/outcome of the investments. In his analysis, Cartwright used the following assumptions:
Annual increase in cash flow from operations: 4% for Fowler and 3% for the others. Vacancy rate: 5% for Alison Green and Stony Walk, 7% for the others. Capital reserve: $250 per apartment p.a., timing of when to disburse the reserve and its tax implication Sufficient funding of the equity investment
Tax laws remain stable with ordinary tax...
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