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Project Background For over a decade now things had been quiet around Bardford Town. Many of the residents who had flocked to the city seeking employment in the industries surrounding cotton were now forced to leave their homes in search of other opportunities. With the town populations having surged in the early 2000's purely to support this rapidly growing industry, the retail centers that had been built to support this population were also now struggling. However, the summer of 2018 brought a resurgence of interest in taking on the business of growing cotton. The leaders of Bardford Town decided that this was the time to act. They worked with the area Chamber of Commerce to develop a media campaign that would highlight to those in other cities the incredible supply of cotton in their town, and the affordability of the city as the place to spend time growing cotton. They also decided to host a cotton tournament where they would provide free room and board for some of the legendary cotton masters from years past, encouraging younger people to come challenge these masters in the Bardford Town Grand Cotton Tournament. One of the residents, Amy Covington, who was one of the wealthier residents of a neighbor town, had purchased a retail center in Bardford Town during the downturn. While the vacancy in Amy's center was higher than she would like, she managed to keep enough tenants in her building to make a modest return while waiting for the day that the cotton excitement would bring people back to the area. However, the debt on her other properties would soon be coming to term and she would need to either refinance or sell her portfolio of the retail center. The Challenge Amy is asking your team to determine which of the following scenarios would be the best course of action for the retail center she owns: 1. Sell now while interest in the community is high. 2. Refinance and increase the debt, using the additional funds to improve the property in anticipation of improved market conditions in the future. There are many factors in the decision-making process that are known, but there are also many assumptions you will have to make using the information presented. You will have to rely on your combined knowledge, experience, and intuition to determine which of these scenarios would present the best path forward for Amy. On this project, you will need to remain focused on the task at hand so that you may provide Amy with a fully developed analysis of each of the above scenarios and deliver to her a thoroughly vetted recommendation that she may rely on in her decision making. Below is the information you have gathered. Bardford Town is historically one of the more affordable places to live. This city is currently feeling the boom the most as the young people are seeking out the affordability while they are in transition to their new life of growing cotton. Just outside of the city there was also a recent discovery of oil that has brought the potential for a rapid expansion of jobs in the oil industry, depending on the size of reserves found. The Bardford Town City Council has decided to focus their economic incentives on manufacturing companies, believing their low-cost of living and influx of young talent to be an advantage to them. The area is already known for manufacturing thanks to its neighbor cities and the hope is that Bardford Town can prove to be an equally attractive center for employers. The retail center Amy Covington owns in Bardford Town is called Bardford Town Central. It is a class C single story retail strip center that is located right at the center of Bardford Town. It is the only retail building in town, aside from a small convenience grocer. Residents of Bardford Town drive to other cities to visit department stores, but at the moment there is no local competition for retail space. The tenant diversity of Bardford Town Central is as following (Misc refers to miscellaneous, and SF means square foot): TENANT DIVERSITY BY COUNT TENANT DIVERSITY BY SF 7% 69 79 43% 18% 21% 199 21% 22% Food & Beverage Vacant Clothing & Accessories Health & Wellness Misc Food & Beverage Vacant Clothing & Accessories Health & Wellness Misc Regarding the property itself, Bardford Town Central is 30 years old. Amy Covington purchased the property five years ago for $1.6 million and financed it with a 30-year, 75 percent loan at 13 percent interest (monthly payments). Of the $1.6 million, the appraiser indicated that the land was worth $200,000 and the building was worth $1.4 million. Amy Covington has been using straight-line depreciation over 30 years (1/39 per year for simplicity). Five years ago, the property could generate $270,000 in NOI (i.e. Year 1), and both the NOI and property value were expected to increase by 1 percent per year for the foreseeable future. However, Amy estimates that if the property is renovated at a cost of $400,000 today, the NOI will be increased by 3% over for the foreseeable future with starting NOI of $320,000 after renovation (i.e. Year 6). If she does the renovation, she believes that she has two options to do the refinancing. Option 1: Amy could obtain a new loan that is equal to the balance of the existing loan plus 75 percent of the renovation costs. Option 2: Amy could obtain a new loan that is equal to 75% of the sum of the existing value of the property plus the renovation costs (this assumes that after renovation the value of the property will at least increase by the cost of the renovation). Assume that, for both refinancing options, the new loan has a 14 percent interest rate and a 30-year loan term (monthly payments). Also, if Amy does the renovation today, she plans to hold the property for five years and estimates that the terminal cap rate by the end of her holding period will be 15%. Assume that selling costs would be 6 percent of the sale price. Amy Covington is in the 28 percent tax bracket for both ordinary income tax and capital gain tax, and expects to continue to be in that bracket. Questions for the project: 1) What is the after-tax IRR on equity for the property Bardford Town Central over the past five years if the property is sold today? What is the Amy Covington's current equity dollar amount in the property Bardford Town Central (Use book value of the property)? 2) How do MRRs look like over the next 10 years (please calculate the MRR for each year from year 6 to year 15)? If Amy wants to sell the property, when should Amy Covington sell the property? If there is any assumption you need to make, please indicate in your response. 3) What is the incremental return for doing the renovation versus not doing the renovation? If Amy Covington wants to renovate the property, which refinancing option should she choose? Please justify all your responses. 4) Overall, what advice would you give to Amy Covington? Should she sell the property or renovate the property? Why? Project Background For over a decade now things had been quiet around Bardford Town. Many of the residents who had flocked to the city seeking employment in the industries surrounding cotton were now forced to leave their homes in search of other opportunities. With the town populations having surged in the early 2000's purely to support this rapidly growing industry, the retail centers that had been built to support this population were also now struggling. However, the summer of 2018 brought a resurgence of interest in taking on the business of growing cotton. The leaders of Bardford Town decided that this was the time to act. They worked with the area Chamber of Commerce to develop a media campaign that would highlight to those in other cities the incredible supply of cotton in their town, and the affordability of the city as the place to spend time growing cotton. They also decided to host a cotton tournament where they would provide free room and board for some of the legendary cotton masters from years past, encouraging younger people to come challenge these masters in the Bardford Town Grand Cotton Tournament. One of the residents, Amy Covington, who was one of the wealthier residents of a neighbor town, had purchased a retail center in Bardford Town during the downturn. While the vacancy in Amy's center was higher than she would like, she managed to keep enough tenants in her building to make a modest return while waiting for the day that the cotton excitement would bring people back to the area. However, the debt on her other properties would soon be coming to term and she would need to either refinance or sell her portfolio of the retail center. The Challenge Amy is asking your team to determine which of the following scenarios would be the best course of action for the retail center she owns: 1. Sell now while interest in the community is high. 2. Refinance and increase the debt, using the additional funds to improve the property in anticipation of improved market conditions in the future. There are many factors in the decision-making process that are known, but there are also many assumptions you will have to make using the information presented. You will have to rely on your combined knowledge, experience, and intuition to determine which of these scenarios would present the best path forward for Amy. On this project, you will need to remain focused on the task at hand so that you may provide Amy with a fully developed analysis of each of the above scenarios and deliver to her a thoroughly vetted recommendation that she may rely on in her decision making. Below is the information you have gathered. Bardford Town is historically one of the more affordable places to live. This city is currently feeling the boom the most as the young people are seeking out the affordability while they are in transition to their new life of growing cotton. Just outside of the city there was also a recent discovery of oil that has brought the potential for a rapid expansion of jobs in the oil industry, depending on the size of reserves found. The Bardford Town City Council has decided to focus their economic incentives on manufacturing companies, believing their low-cost of living and influx of young talent to be an advantage to them. The area is already known for manufacturing thanks to its neighbor cities and the hope is that Bardford Town can prove to be an equally attractive center for employers. The retail center Amy Covington owns in Bardford Town is called Bardford Town Central. It is a class C single story retail strip center that is located right at the center of Bardford Town. It is the only retail building in town, aside from a small convenience grocer. Residents of Bardford Town drive to other cities to visit department stores, but at the moment there is no local competition for retail space. The tenant diversity of Bardford Town Central is as following (Misc refers to miscellaneous, and SF means square foot): TENANT DIVERSITY BY COUNT TENANT DIVERSITY BY SF 7% 69 79 43% 18% 21% 199 21% 22% Food & Beverage Vacant Clothing & Accessories Health & Wellness Misc Food & Beverage Vacant Clothing & Accessories Health & Wellness Misc Regarding the property itself, Bardford Town Central is 30 years old. Amy Covington purchased the property five years ago for $1.6 million and financed it with a 30-year, 75 percent loan at 13 percent interest (monthly payments). Of the $1.6 million, the appraiser indicated that the land was worth $200,000 and the building was worth $1.4 million. Amy Covington has been using straight-line depreciation over 30 years (1/39 per year for simplicity). Five years ago, the property could generate $270,000 in NOI (i.e. Year 1), and both the NOI and property value were expected to increase by 1 percent per year for the foreseeable future. However, Amy estimates that if the property is renovated at a cost of $400,000 today, the NOI will be increased by 3% over for the foreseeable future with starting NOI of $320,000 after renovation (i.e. Year 6). If she does the renovation, she believes that she has two options to do the refinancing. Option 1: Amy could obtain a new loan that is equal to the balance of the existing loan plus 75 percent of the renovation costs. Option 2: Amy could obtain a new loan that is equal to 75% of the sum of the existing value of the property plus the renovation costs (this assumes that after renovation the value of the property will at least increase by the cost of the renovation). Assume that, for both refinancing options, the new loan has a 14 percent interest rate and a 30-year loan term (monthly payments). Also, if Amy does the renovation today, she plans to hold the property for five years and estimates that the terminal cap rate by the end of her holding period will be 15%. Assume that selling costs would be 6 percent of the sale price. Amy Covington is in the 28 percent tax bracket for both ordinary income tax and capital gain tax, and expects to continue to be in that bracket. Questions for the project: 1) What is the after-tax IRR on equity for the property Bardford Town Central over the past five years if the property is sold today? What is the Amy Covington's current equity dollar amount in the property Bardford Town Central (Use book value of the property)? 2) How do MRRs look like over the next 10 years (please calculate the MRR for each year from year 6 to year 15)? If Amy wants to sell the property, when should Amy Covington sell the property? If there is any assumption you need to make, please indicate in your response. 3) What is the incremental return for doing the renovation versus not doing the renovation? If Amy Covington wants to renovate the property, which refinancing option should she choose? Please justify all your responses. 4) Overall, what advice would you give to Amy Covington? Should she sell the property or renovate the property? Why