Realty R Us

Realty R Us M To: From: Date: Re:

E

M

O

R

A

N

D

Dr. Dan Xu Mary Lane and Taresa Downey 4/26/06 Angus Cartwright III

John DeRight, currently in retirement, will have $9 million from the sale of stock to invest in a property. He is comfortable with his retirement savings, but would like to diversify his retirement funds in real estate. He requires a 12% return. Judy DeRighthas $16 million available to invest. She is at the peak of her career and is likely interested in longer-term possibilities compared to John. She also requires a 12% return on her investment. Exhibit 1 expresses the different characteristics of the properties in an easy to interpret table. The quantitative foundation of our analysis is set up in this table. Like any investment, some aspects can’t be represented quantitatively. This summary will follow later. The most pertinent information in Exhibit 2 is the before-tax cash flow calculations. Of the four properties, Alison Green has the greatest before tax cash flow at $434,300 annually. Ivy Terrace came in second with $336,080 in before tax cash flow. This property has longer term potential and the cash flows are less reliable because it’s a new development. Stony Walk, an established office building, brought in returns of $331,060. The Fowler Building, another new project, had the smallest before tax cash flows of $90,250. Based on these cash flows, Alison Green and Ivy Terrace had the best cash flows with the least uncertainty. Exhibit 3 gives us some ratios to compare the properties to each other. The apartments compare best with each other, as they are listed by number of units. Likewise the office buildings compare best with each other, which are compared by rentable square foot. Stony Walk and Ivy Terrace have the greatest expenses per SF or unit. These properties also perform more poorly in terms of operating expenses compared to revenue. The break-even analysis in Exhibit 4 explains what thresholds cannot be exceeded in order for the properties to continue to operate. The break-even occupancy is sustainable according to the estimated rates. Alison Green has the lowest break-even point at 64.84%. Ivy Terrace, the other apartment building, is 67.07%. Stony Walk and the Fowler Building, the two office complexes, are at 76% and 85.92%, respectively. This allows very little room for economic fluctuations in the office buildings.

U

M

A NPV analysis, with the assumption that the properties would be sold in 10 years, gave the following numbers: Properties: NPV: IRR: Alison Green $734,300 14.93% Stony Walk $699,920 14.54% Ivy Terrace $619,600 15.13% Fowler Building $688,640 15.38% The NPV analysis relies on an estimated final sales price, injecting some uncertainty into these calculations. However, with the many years of real estate savvy under his belt, we feel that Cartwright’s estimates are as accurate as possible. (Exhibit 5) The major drawback of using IRR analysis is that it assumes the cash flows will be reinvested at the IRR. Interest rates fluctuate over time, so this is an unrealistic assumption. Thus, the NPV analysis is the best projection for these properties. Risk is absent from the analysis presented in Exhibit 6. However, the ratios do offer a good comparison among properties. The profitability index offers a comparison of NPV to initial investment, which John and Judy would both find helpful in their decisions. In Exhibit 7, we’ve ranked the properties based on their performance in Exhibit 6. The Fowler Building comes out ahead of the others. We believe this to be the case because the analysis doesn’t take risk into account, something the FowlerBuilding has in abundance. Alison Green and Ivy Terrace do perform better than Stony Walk, which was expected. The findings in Exhibit 8 are summarized in Exhibit 9. Income from the properties is sheltered from taxes at the rates presented. Stony Walk has the greatest amount, at -26.65%. The Fowler Building has the smallest tax shelter at -8.26%. The future values are based on estimates, but they give a good comparison between properties. The Fowler Building appears to have the greatest increase in future value, with Ivy Terrace showing the least. Stony Walk performs well in this analysis, showing a high future value of 61%. The office buildings have the greatest future values, which could be an indication of greater risk in their estimated final sales price. Exhibit 10 shows us the net cash from the sale of each of the properties, taking into account the initial investment, the mortgage, and capital gains tax. Stony Walk has a huge gain, which may partially be due to a larger recaptured mortgage amortization relative to the others. Of all the calculations, those that incorporate the estimated future value of the properties are the riskiest. While Cartwright may have a great deal of expertise and knowledge of the areas, the ongoing cash from operations is a much more solid number to base decisions on. Calculations involving future sale value are also important, but are less so than the ongoing returns before the sale. As a retiree, John’s future income is limited to whatever returns he’ll receive from his investments. He requires an investment that can shelter some of his income and produce reliable future resources. We recommend Alison Green for his needs. Judy has more income earning potential, more years before retirement, and even more equity to invest in properties. This opens her up to potentially riskier investments, and possibly longer-term properties. With Judy’s ability to invest in higher-risk properties, she would get higher returns and shelter more income by investing in Stony Walk. Stony Walk

has the greatest shelter, shows very solid returns both in the operating cash flow analysis and in the final sales price.