11 Aug 2009

Sample Essay: Southpark IV Case

Basically, the investment that Laflin wants to acquire is a good one since there is a positive net operating income that results even after his conservative estimates and added deductions to ensure that his projections can absorb unexpected incidents and lower results in the operating income that was expected in the first place. The idea of whether or not the investment is a good one basically depends on the perception of his fellow investors if the kind of returns shown in the financial projections is acceptable to them. Take note that it depends on their opinion and not on the fact that they are actually making a good investment in the first place.

The assumptions made by Laflin in his calculations for the investment includes a potential loss of rental income at 5%, a management fee of 4% and a yearly expense intended for the rehabilitation of the structure at  $15,000 with the net operating income of $68,060 all in all. His final operating cash flow from the operation after taxes is $36,000. The changes that I would make in his assumptions are to include the depreciation costs of the buildings which is $38,095 on a 39 years basis. He can then ad this deduction on a per year basis to his projected income on a per year basis. Also, his estimated vacancy loss at 5% should also be changed into the lowest possible rate that the competitors are experiencing. Since there is a competitor in the area that is experiencing a vacancy loss of 65% at the lowest it would be conservative enough to use the next lowest vacancy loss at 47%. This is used in order to come up with a more realistic projection as compared to the previous 5% that Laflin had used in order to project his income. Another major change in the projections that Laflin had used is the kind of rental income that he assigned to his units. He should change it to the currently lower rental rates as opposed to his previously higher rates. This should have a major impact on the kind of calculations that he previously came up with. This can mean the definition whether or not his intended investment is going to be an attractive one or not based on the revised conservative estimates as compared to his previously optimistic estimates.

As of the current asking price of the building and the revised income that was suggested above, the kind of returns that Laflin and his investors would have is actually a negative return. This was mainly influenced by the second to the lowest occupancy rate that was used but since the likelihood of this thing happening is most likely, then Laflin and his group should take care to renegotiate the asking price of the building in the first place.

The suggested asking price of the building in order for them to at least break even is $511,729. This is the maximum price that they should pay for the building and not more than this in order to achieve a realistic rate of return. This is the figure that Laflin should use as a ceiling in bidding for a lower price of the building from the bank. It is recommended that he should ask for a price lower than this.

The reason why there is such a wide variation in the prices of the real estate prices is because there are a number of factors that affect its value in the future. One of them is the possibility that the rental income would increase or decrease, if the area within the real estate investment is deemed to increase in population and employment, then the value of the property will rise as there are going to be more tenants that will demand for the space offered by the real estate investment. The second factor will be the kind of structural maintenance that the building currently needs or will need in the future. This can simply be included in the initial calculations however and the investor can decide right away if the investment is still attractive in their eyes. Another factor that can also affect the valuation of the real estate investment is the initial price that was paid to the bank or the original owner in the first place because this will dictate the kind of returns that the investor will have even if the other numbers are fixed. If the asking price for the property is high, then the investors will have significantly less returns no matter how robust the economy is or how attractive the rental rates will be and the level of occupancy. On the other hand, if the asking price is considerably low, then the investors will enjoy very high returns on their investments since the lower capitalization costs can absorb the lower rates and even the lower occupancy that will occur on down economies even on a prolonged basis. It is just a matter of numbers but one can be sure that it is to the favor of the investor as long as the initial capitalization price is already low enough. It can absorb a lot of negative impacts to the investment later.

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