Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

You run the corporate real estate division of a life sciences company. Your firm wants to build a manufacturing facility in the Inland Empire, close

image text in transcribed

image text in transcribed

image text in transcribed

You run the corporate real estate division of a life sciences company. Your firm wants to build a manufacturing facility in the Inland Empire, close to the laboratories at Caltech and USC and the offices in Downtown Los Angeles. You have identified 1835 Wright Avenue in La Verne as your top candidate. In order to evaluate this prospective investment, you download data to analyze the property from CoStar. You can find these data on Canvas in the PDFs labeled 1835 Wright Ave" and Property Analytics." With the information below, you will prepare four pro formas to identify the best investment strategy. 1. First, consider the assumptions you will make for all four pro formas: The current annual rent for this submarket (note: focus only on 1-3 star properties) is given in the Property Analytics for year 0. According to this report, the rent is forecasted to grow 7.5% in year 1, followed by 7%, 5%, and 3.5% in the subsequent yearsand 3.0% all years thereafter. (Even though you are purchasing this property to use for your own manufacturing, the corporate real estate division will lease it out to the manufacturing division. So you treat it as a rental property.) The current vacancy rate for this submarket is also given in the "Property Analytics report. This vacancy rate is not forecasted to change for the foreseeable future. You conservatively forecast operating expenses at 40% of EGI. . In the first year of operations, you will need to invest $1 million to fit out the space with the equipment needed for manufacturing your products. In all the other years, you will set aside $100,000 annually for updating the plant and equipment. . The market cap rate is given in the "Property Analytics report. This cap rate is not forecasted to change over the foreseeable future. You assume that you will sell the property after 6 years, at which point you will incur selling expenses equal to 6% of the resale price. 2. Second, consider the capital stack you will need to finance this property. Assume that you pay the sale price for which the property is currently being offered. If you partner with a publicly traded multinational bank, you can get a 75% LTV, fully amortizing loan for 15 years with an adjustable rate, calculated as a composite of the 10- year Treasury bond rate and a spread of 225 basis points. The current bond rate is 1.5%. It is forecasted to fall to 1.3% next year, after which you expect that it will increase 25 basis points every year thereafter. If you partner with a local private lender, you can get a 60% LTV, IO loan for 7 years with a fixed rate of 2.4%. If you partner with a large private equity firm, they will invest $2 million in equity with a preferred IRR of 15%. (This means a 15% preferred return each year, after which the promote kicks in.) Beyond that hurdle rate, you are entitled to a 50% promote. If you finance the project without any partners, you pay the entire investment yourself. 3. Finally, consider the relevant discount rates. As a publicly traded firm, your investors expect to earn at least 9% annually. . As a conservative lender, the publicly traded multinational bank expects to earn at least 5% annually. As a more specialized firm willing to take more risk, the local private lender expects to earn at least 7% annually. . As a more aggressive risk taker, the private equity firm expects to earn at least 11% annually. 4. Given all this information, you can use your four pro formas to answer the following questions: . What are the NPV and IRR for your equity investment? . What are the NPV and IRR for everyone's total investment in the property? Which option is most favorable to you? Why? . Which option is most favorable to your partner? Why? Extra Credit: Do you agree with all of these forecasts (rents, vacancy rates, Treasury bond rates, cap rates)? Based on your expectations for the future path of the economy and this market, would you change any of these assumptions? Why or why not? How would your new assumptions affect your assessment of the investment? You run the corporate real estate division of a life sciences company. Your firm wants to build a manufacturing facility in the Inland Empire, close to the laboratories at Caltech and USC and the offices in Downtown Los Angeles. You have identified 1835 Wright Avenue in La Verne as your top candidate. In order to evaluate this prospective investment, you download data to analyze the property from CoStar. You can find these data on Canvas in the PDFs labeled 1835 Wright Ave" and Property Analytics." With the information below, you will prepare four pro formas to identify the best investment strategy. 1. First, consider the assumptions you will make for all four pro formas: The current annual rent for this submarket (note: focus only on 1-3 star properties) is given in the Property Analytics for year 0. According to this report, the rent is forecasted to grow 7.5% in year 1, followed by 7%, 5%, and 3.5% in the subsequent yearsand 3.0% all years thereafter. (Even though you are purchasing this property to use for your own manufacturing, the corporate real estate division will lease it out to the manufacturing division. So you treat it as a rental property.) The current vacancy rate for this submarket is also given in the "Property Analytics report. This vacancy rate is not forecasted to change for the foreseeable future. You conservatively forecast operating expenses at 40% of EGI. . In the first year of operations, you will need to invest $1 million to fit out the space with the equipment needed for manufacturing your products. In all the other years, you will set aside $100,000 annually for updating the plant and equipment. . The market cap rate is given in the "Property Analytics report. This cap rate is not forecasted to change over the foreseeable future. You assume that you will sell the property after 6 years, at which point you will incur selling expenses equal to 6% of the resale price. 2. Second, consider the capital stack you will need to finance this property. Assume that you pay the sale price for which the property is currently being offered. If you partner with a publicly traded multinational bank, you can get a 75% LTV, fully amortizing loan for 15 years with an adjustable rate, calculated as a composite of the 10- year Treasury bond rate and a spread of 225 basis points. The current bond rate is 1.5%. It is forecasted to fall to 1.3% next year, after which you expect that it will increase 25 basis points every year thereafter. If you partner with a local private lender, you can get a 60% LTV, IO loan for 7 years with a fixed rate of 2.4%. If you partner with a large private equity firm, they will invest $2 million in equity with a preferred IRR of 15%. (This means a 15% preferred return each year, after which the promote kicks in.) Beyond that hurdle rate, you are entitled to a 50% promote. If you finance the project without any partners, you pay the entire investment yourself. 3. Finally, consider the relevant discount rates. As a publicly traded firm, your investors expect to earn at least 9% annually. . As a conservative lender, the publicly traded multinational bank expects to earn at least 5% annually. As a more specialized firm willing to take more risk, the local private lender expects to earn at least 7% annually. . As a more aggressive risk taker, the private equity firm expects to earn at least 11% annually. 4. Given all this information, you can use your four pro formas to answer the following questions: . What are the NPV and IRR for your equity investment? . What are the NPV and IRR for everyone's total investment in the property? Which option is most favorable to you? Why? . Which option is most favorable to your partner? Why? Extra Credit: Do you agree with all of these forecasts (rents, vacancy rates, Treasury bond rates, cap rates)? Based on your expectations for the future path of the economy and this market, would you change any of these assumptions? Why or why not? How would your new assumptions affect your assessment of the investment

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

A History Of Accountancy In The United States

Authors: Gary John Previts, Barbara Dubis Merino

98th Edition

0814207286, 978-0814207284

More Books

Students also viewed these Accounting questions

Question

What are employee assistance programs and wellness programs?

Answered: 1 week ago