Real Estate Finance – CFO Position
Based on the information provided in the case study below, make a recommendation in not more than 2,500 words excluding tables and attachments if any to the CEO of the firm.
The assignment carries 70 marks of the total module assessment marks of 100.
You are allowed to make any reasonable assumptions that may support your analysis and recommendation.
CASE STUDY OF A MIXED-USE DEVELOPMENT.
SL Property Investment Company Limited (SLPICL), a very reputable international property company has acquired a freehold interest in a piece of land at a prime location of a suburb of a metropolitan city for a mixed-use development. Dr. Siew Lan, the CEO of SLPICL, is a very shrewd, charismatic and successful property developer and investor who is very well connected to high-net-worth individuals, businesses and financial institutions. The CEO has more than twenty-five years track record in property development and investment. Supported by a very strong marketing and asset management team, SLPICL has grown from strength to strength over the past two decades under the leadership of Dr Siew Lan although SLPICL is struggling under the current pandemic environment. Given the excellent suburban location of the land and the forecasted favourable socio-economic and political indicators for the suburban area after the current pandemic, the CEO wants this mixed-use development to be a financial success in relation to its impact on shareholders’ wealth after accounting for risk
DEVELOPMENT STRUCTURE AND COST
The development will have two levels of retail and a 30-storey office tower as well as 400 car parking lots. The retail component will provide a total net floor area (net leasable area) of 20,000m2 while the office tower will provide a total net floor area of 36,000m2.
The total cost of the whole development – land acquisition, development and construction (ADC) – (excluding finance cost) – is estimated at £400 million. Land acquisition and development costs of £80 million has been paid by SLPICL. The construction will take 2 years to complete to coincide with forecasted post-pandemic economic recovery.
FUNDING
The total cost of the whole development is to be funded by 40% equity and 60% debt although SLPICL can fund 70% of the total cost with debt. A consortium of financiers has agreed in principle to provide the 60% debt financing at a cost of 8 % per annum monthly compounding and a fee amounting to 2% points. Under the loan agreement, disbursement of funds will be as follows:
MONTH AMOUNT DISBURSED
1 – 6 £5,000,000
7 – 18 £15,000,000
19 – 24 £5,000,000
The project will be held for a period of 10 years after completion. Therefore, a permanent loan must be arranged before the construction loan is sealed, signed, dated and delivered. SLPICL has been offered the following financing packages.
FIDELITY INSURANCE COMPANY (Senior Debt)
80% of the total construction cost at 7.0% per annum interest monthly compounding amortised over 20 years plus 2% points with no prepayment penalty; or
100% of total construction cost at 7.5% per annum interest monthly compounding amortised over 20 years plus 3% points with no prepayment penalty.
AMICABLE BANKING GROUP (Subordinate Debt – 2nd Charge/Lien)
20% of the total construction cost top-up loan at 10% per annum interest monthly
compounding amortised over 20 years plus 3% points and a prepayment penalty of
1% of outstanding loan.
PROVIDERS OF THE CONSTRUCTION LOAN
100% of total construction cost at 6% per annum interest monthly compounding amortised over 10 years plus 2% points.
ASEDA PENSION FUND
100% of total construction cost at a teaser interest rate per annum of 5.5% for Years 1 and 2, followed by 8% per annum interest rate for Years 3 and 4 and thereafter at 10% per annum interest rate. All the intertest rates are compounded monthly over a loan term of 25 years. The package comes with 3% points levy and a prepayment penalty of 2% of the outstanding loan.
SLPICL may sell a 10-year, 7% coupon (annual interest) corporate bonds, each with a par
value of £1,000. The flotation cost for the bond issuance is 5%. SLPICL expects to receive
net proceeds from the corporate bond sale that equate the amount owed to the construction loan
provider when construction is completed.
Furthermore there is an additional £20 million indirect cost associated with the project that is not funded under any of the financing options which must be paid when construction is completed.
ADDITIONAL INFORMATION
Below is the remaining relevant information about the investment:
The retail space will be let at an annual rental of £1,850/m2. The rental will be reviewed upwards at the end of every 5 years at a long-term growth rate of 5% per annum.
The office space will be let at an annual rental of £850/m2. It will be reviewed upwards at the end of every 5 years at a long-term growth rate of 4% per annum.
The development is expected to have 80% occupancy for the first two years followed by 90% occupancy for the next two years and 100% occupancy thereafter for the remaining 10-year holding period. Dr Siew Lan has validated documentary evidence that the project is already 60% pre-let. Negotiations with reputable tenants are far advanced to ensure that the remaining 40% of leasable space will be let as projected. However, it is advisable to assume that vacancy and uncollectable rent will account for 5% of the potential gross income (PGI) when the project is fully let.
Due to strong demand for parking space in the locality, the 400 car parking lots will be fully let at £350 per lot per month. The rental for the parking lots is forecast to increase by 5% per annum.
Operating expenses account for 30% of the effective gross income (EGI)
The terminal capitalization rate for the investment is 6%
Selling expenses are estimated at 4% of sale proceeds.
Capital gain at disposal of the investment (Sale) is treated as income and taxed at the corporation tax rate of 18%.
After-tax required return on shareholders’ invested capital (RROE) is 15% on condition that solvency is maintained throughout the holding period.
As the Chief Financial Officer of SPICL, you are required to analyse all the permanent loan packages in relation to all the information provided and advise the CEO of SLPICL on which one to accept, and under what conditions. Furthermore you are required to advise the CEO on what the company could do to increase the return on the shareholders invested capital subject to the company’s investment criteria.
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