SouthPark IV Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

SOUTHPARK IV

Investment Memorandum

Introduction

This Memorandum is intended to provide detailed analysis of investment opportunity available in the real estate industry that I have recognized recently. This property is known as SouthPark IV Distribution Center (SouthPark), which was constructed in the year 1980 and covered 100 acre area of SouthPark Industrial Center. This property contains dedicated finished area of 15% for office space; meanwhile, SouthPark building has a dedicated space for parking 80 cars and is equipped with easy access to rail services, which increase the value of this investment property. However, overall condition of building is fine but since the building was constructed a decade ago; hence, its roof needs to be repaired in order to maintain its conditions. Moreover, the building already generates revenues under the lease term of around $200,000/- operating cash flows in the year 1989 that makes it a more attractive investing opportunity. Initial price of this property has been $1.5 million that has been calculated using three approaches, i.e. replacement cost, present value of future cash flows and comparables. Since, the bank in charge of this property and it is under government pressure to sell the property in order to pay and close the bankruptcy case of its owner; therefore, the bank is willing to offer purchase money mortgage for a sum of $1.2 million at more favorable terms than the current market terms of similar loan facility. Thus, this investment property can be purchased within the available funds of $450,000/-.

However, since the valuation property has been carried out by the bank so according to their point of view its worth is $1.5 million but the reasonableness of this price and fair value of this property needs to be evaluated and the evaluation has been carried out using the project cash flows which are based on some assumptions and the actual results of the year 1989.

Analysis

The initial investment appraisal can be carried out using free cash flows that this property will generate during the period for which the property will be acquired by us, however, the cash flows forecasted by the bank are not relevant for our calculation so we have prepared the cash flows including all the relevant cash flows from this property during the five year project. The very first thing that derives the cash inflows is revenue from lease tenants, which is based on the price per square feet and existing tenants are willing to renew their lease agreement at $2 per square feet. On the other hand, since the occupancy and rental rates have some relation as showm by the competitor; hence, rent rates that are higher vacancy rates leads to lower rental rates. Since, SouthPark has a vacancy rate of 5% that is assumed to be realistic, hence, rates applied by competitors and percentage of vacant area and competitors with vacant area of between 3% to 2% are charging between $2.15 to $2.5 per square feet. Thus, an average of three competitors price of $2.28 can be adjusted to $2.25 per square feet in order to incorporate the vacant area of 5% for SouthPark property. Furthermore, the cash flow projection is based on a number of assumptions such as revenues and expenses are assumed to grow by 3%, tenant will honor their commitment that they will renew their lease agreements, exit capitalization rate will be 8.42% and is based on the original operating cash flows and purchase price of $1.5 million along with rehabilitation expenditure of $15,000/- each year is assumed to be incurred because the building is 10 years old and requires more repair and maintenance work; however, cost of repairing the roof s assumed to be reasonable. In addition to this, cost of managing the property is assumed to be 4% of net income and cost of capital of 15% is assumed for discounting the projected cash flows. In addition, the repayment of mortgage and interest will also be relevant cash flows for valuation of property investment.

However, based on the assumptions stated above and cash flows projection made using these assumptions, the net present value of the investment project is negative ($26,720/-), meanwhile, the return on equity is 3.95%, which is also not in accordance with the return required by equity investors. Therefore, investment on SouthPark will not be a profitable investment and it is not recommended to invest in this property.

In addition to this, if it is assumed that the agreement with existing lease holders will not be renewed then new tenant will be sought and new tenant acquisition cost will be 15% of their first lease rentals and additional cost of $2.5 per square will also be required to sight new tenants. However, this option also does not generate positive cash flows as calculated in spread sheet, meanwhile, this option generates return on equity that is higher than that of using the existing lease holders for renewal of their contract.

However, based on the analysis of different ....................

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Young entrepreneur sees an 80,000-square-foot office / warehouse building as a potential purchase. The building is now fully leased, but all four lease expires soon. In response to changing market conditions, the main character has to look at the current market conditions, as well as attempts to estimate future conditions in order to complete its analysis. Case is designed to study the key issues in real property valuation. The emphasis is on simple configuration based on the cash flows of the project, and then learning how to return and value depend on changes in certain assumptions. "Hide
by William J. Poorvu, Richard E. Crum Source: Harvard Business School 10 pages. Publication Date: April 25, 1990. Prod. #: 390181-PDF-ENG