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APPRAISAL PROJECT ASSIGNMENT INSTRUCTIONS OVERVIEW The goal of the Appraisal Project is to provide students with an opportunity to apply classroom knowledge to real world conditions in an analysis of the Water’s Edge Apartments case study. The student will calculate the Net Project Cash Flows and then calculate the NPV and IRR based on these cash flows. Use the Excel file: Appraisal Project Assignment – Case Study – Exhibit 1 for your calculations. INSTRUCTIONS In your report, include a written analysis of the Water’s Edge Apartments calculations as well as a discussion of the strengths and weaknesses of the NPV and IRR as valuation measures. Your report will need to be 1,000 words including an APA formatted title page and references page, and at least 5 scholarly references (e.g., peer-reviewed journal articles). You may also use non- scholarly references such as trade publications in addition to your 5 scholarly sources. Include a section in your report on a biblical integration of the topics.   THE WATER’S EDGE APARTMENTS The Opportunity In early 2008, John Francis and Donald White met to discuss a potential real estate development opportunity. The Water’s Edge property was created through the purchase of eight individual properties to create a single 9.66 acre footprint on the banks of the Mohawk River in Cohoes NY.  When complete, the development would contain 132 individual units in two mirrored buildings with a private street separating them.  The current developer of the project was experiencing financial difficulties and was seeking a buyer for the partially complete project.   John Francis is President of Francis Properties (FP), a real estate development and management firm specializing in multiple occupant facilities in the greater Capital District of New York.  FP’s projects include Greystone, a 38-unit senior living property and Windy Pointe, a 51-unit facility.   Donald White is Managing Director of Alliance Venture Partners (AVP) and is a seed-stage investor in early stage technology companies.  AVP also invests in commercial and residential real estate projects in metropolitan Boston and in the Capital Region of upstate New York.    Friends since childhood, John and Donald agreed to evaluate the acquisition of Water’s Edge property as a joint venture between FP and AVP. Their first concern is to evaluate the potential value of the opportunity. The Senior Housing Movement America is a quickly graying country, with nearly 8,000 Americans turning 60 each day according to the US Census Bureau.  The fastest growing segment of the US population is those over 85, with those of traditional retirement age (65) being the second fastest growth segment.   Immediately behind them come the Baby Boomers, a two-decade spanning group of over 70 million individuals with more wealth and inclination to spend it than any other time in US history. The Albany region has a shortage of attractive senior living alternatives.   Currently, senior living facilities in the area represent a total of less than 500 units. Potential customers prefer to
BUSI 482 Page 2 of 4 relocate nearby their homes in order to retain connections to their local communities. Unfortunately, there are a limited number of appropriate undeveloped spaces in proximity to the population centers. Only one other major project has been announced locally, a $14M project of roughly 100 units to be started in early 2009 in nearby Saratoga Springs. Acquisition Cash Flows The partnership would to acquire the property for $9.5 million, 70% of which would be financed through an interest-only bank loan. Once acquired, the group anticipates investing an additional $5.5 million (equity) in year 0 to complete construction. The partnership intends to sell the property after twenty years. Anticipated Project Cash Inflows The cash inflows for the project are dominated by the monthly rents. The maximum monthly rents for Water’s Edge would be $980 per unit per month by the end of Fiscal Year 2008. Assume no discounts for rent in Year 1 (2009, $1,500 per unit) and beyond, with rents increasing at 5% per annually.    Completion schedule 31-Aug-08 31-Aug-09 31-Aug-10 Building 1 units 30 66 66 Building 2 units 33 66 Secondary cash flow comes from an arrangement with Time Warner Cable to purchase internet, cable TV, and digital phone services at a discount and resell these services to the residents for a profit.  The current cost is $52 per month per unit. The services are resold at $100. The partners expect that 75% of the residents will purchase this service and that these costs and revenues will increase at 5% per year.   OPERATING COSTS Employees Based on his previous experience, Francis estimates that Water’s Edge will require one full time employee acting as property manager.  In the Capital District an appropriate individual for the demographics of Water’s Edge (45-55 year old, college educated, good communication skills) would be about $4,500 per month for salary, with employee benefits and taxes adding $1,500 for a total of $6,000 per month.  This number will increase at 5% annually for the term of holding of the property. Maintenance Initially, Water’s Edge will require little maintenance ($50,000, year 0).  Annual maintenance will increase in year 1 (2009) to $65,000. This value will increase $32,000 per year until the end of the holding period. Insurance Due to the design of Water’s Edge, insurance costs are not as much of a burden as to be expected with a facility this size.  The previous developer installed hydrants outside the buildings and sprinklers on every floor.  There are Fire Control Panels and full monitoring, and relatively close proximity to both fire and police. The current policy on Water’s Edge pre-completion is $45,000
BUSI 482 Page 3 of 4 per year, based on a $9 million value.  Using a full value of $15 million, the estimated insurance cost is $75,000 for the year.  Insurance costs are expected to increase at a 5% annual rate. Depreciation Calculations Normally a building is straight line depreciated over its usable life of 30 years.  While the simplest manner, it is not nearly the most tax efficient as components other than the building itself (carpets, light fixtures, etc) can be depreciated in as little as five years. Based on preliminary estimates, Water’s Edge enjoys $750,000 a year of accelerated depreciation each year for the first ten years of the project’s life. After that time, normal depreciation of the structures and other long-lived components gives $300,000 for the remaining years of ownership.   Expected annual depreciation expenses are shown in Table 1. Table 1:  Annual Depreciation Expenses Years of ownership Annual Depreciation 1-10 $750,000 11-30 $300,000 Taxes Taxes for Water’s Edge are on a per unit basis. As Water’s Edge is not 100% completed at this point, it does not carry the full tax burden, and the Pilot Tax Program is not yet in effect.  This tax incentive plan will go into effect upon assessment following completion and will last for ten years from that point.
The tax rate for the next two years is projected to be $8,333 per month until September 2009, when full assessment will be in effect.  This number shall be used for Year 1 calculations.  75% of this ($6,248) shall be used in Year 0. Full assessment shall be used thereafter.   At full assessment, the tax rate is $1,100 per unit per year, for a full value of $145,200 per year. Due to the fiscal constraints of the current economy, 5% per annum tax rate growth will be utilized annually from full assessment.
The Pilot Tax Program (PTP) is built into the deed of Water’s Edge.  The PTP is a tax credit for 50% of the property tax bill in the first year of full assessment, decreasing at 5% per year until it has been eliminated in year 11.  Tax calculations for the purpose of this analysis will take into account the PTP. Due to the tax schedule, September 1st shall be used as the start of the fiscal year for all calculations and projections for Water’s Edge. Annual tax estimates are shown in Exhibit 2.
Interest Charges Given the current credit markets, it is assumed that only 70% of the purchase value of Water’s Edge can be leveraged via mortgage.  An 8% assumption is used for interest only with a balloon beyond the holding time horizon.  
THE EVALUATION As the partners sat down to evaluate the project, White raised some of his concerns. “In order to determine the value of this opportunity, we’ll need to clearly understand all the cash inflows and outflows. Is this project really worth the $15 million price tag? Our overall cost of capital on this project is 14%. Will the investment create value? I am sure that our lender will want to see our estimates.”
Francis replied, “I agree that we need to value the project for the full twenty years, but I am concerned about the expiration of the Pilot Tax Program incentives. Should we consider selling after ten years instead?  I am also concerned about keeping the apartments filled throughout the project. Let’s plan on ninety percent occupancy in our calculations. We can use this format (Exhibit 1) as our guide.”
Francis replied, “I agree that we need to value the project for the full twenty years, but I am concerned about the expiration of the Pilot Tax Program incentives. Should we consider selling after ten years instead?  I am also concerned about keeping the apartments filled throughout the project. Let’s plan on ninety percent occupancy in our calculations. We can use this format 

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AppraisalProjectAssignmentCaseStudyExhibit1.xlsx

AppraisalProjectAssignmentInstructions.docx

Base-10

Water’s Edge Apartments: Capital Budgeting in Real Estate Development

Exhibit 1:

Part 1. Input Data
Ten Year Life

Acquisition costs

Acquisition cost (total)

Acquisition cost (equity)

Acquisition cost (balloon loan)

Additional construction costs

Total Acquisition value

Revenues
2008
2009

Rental rate/unit/month

Anticipated occupancy rate

Internet/Cable/Phone rate/unit/month

Utilization rate for Internet/cable/phone

Costs
2008
2009

Employee costs incl benefits/month

Maintenance

Insurance

Internet/Cable/Phone rate/unit/month

Anticipated growth rates

Rental revenue

Internet/Cable/Phone service

Employee costs

Annual maintenance increase

Insurance

Market (resale) value of property

Part 2. Projected Cash Flows
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018

0
1
2
3
4
5
6
7
8
9
10

Acquisition cost (total)
$ – 0

Additional construction costs
$ – 0

Operating Cash Flows

Rental units complete
30
99
132
132
132
132
132
132
132
132
132

Rental Revenue
0
0
0
0
0
0
0
0
0
0
0

Internet/Cable/Phone Revenue
0
0
0
0
0
0
0
0
0
0
0

Total Revenue
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0

Costs

Employees
0
0
0
0
0
0
0
0
0
0
0

Maintenance
0
0
0
0
0
0
0
0
0
0
0

Insurance
0
0
0
0
0
0
0
0
0
0
0

Internet/Cable/Phone costs
0
0
0
0
0
0
0
0
0
0
0

Depreciation
0
750,000
750,000
750,000
750,000
750,000
750,000
750,000
750,000
750,000
750,000

Earnings Before Tax
0
-750,000
-750,000
-750,000
-750,000
-750,000
-750,000
-750,000
-750,000
-750,000
-750,000

Taxes (from PTP sheet)
74,997
99,996
72,600
83,853
96,050
109,257
123,544
138,987
155,666
173,664
193,074

Earnings After Tax
-74,997
-849,996
-822,600
-833,853
-846,050
-859,257
-873,544
-888,987
-905,666
-923,664
-943,074

Terminal Year Cash Flows

Sale of Property

$ – 0

Less book value of property

$ (7,500,000)

Gain (Loss) on sale

$ 7,500,000

Taxes on gain (loss) on sale (40%)

$ 3,000,000

Balloon payment on loan

$ – 0

Net terminal year cash flow

$ (3,000,000)

Net Project Cash Flows
-74,997
-99,996
-72,600
-83,853
-96,050
-109,257
-123,544
-138,987
-155,666
-173,664
-3,193,074

Part 3. Project Evaluation

Discount rate (cost of capital)

Net Present Value

Internal Rate of Return

Pilot Tax Program

Pilot Tax Program
2008
2009
2010+

Tax assessment/month
$ 6,248
$ 8,333

At full assessment

$ 1,100
per unit per year

Tax assessment growth rate

5%
per year after 2010

Pilot Tax Program (PTP) credit

50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%

Year
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028

Tax assessment
$ 74,997
$ 99,996
$ 145,200
$ 152,460
$ 160,083
$ 168,087
$ 176,492
$ 185,316
$ 194,582
$ 204,311
$ 214,527
$ 225,253
$ 236,515
$ 248,341
$ 260,758
$ 273,796
$ 287,486
$ 301,860
$ 316,953
$ 332,801
$ 349,441

PTP Credit
0
0
$ (72,600)
$ (68,607)
$ (64,033)
$ (58,831)
$ (52,947)
$ (46,329)
$ (38,916)
$ (30,647)
$ (21,453)
$ (11,263)
$ (0)
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0
$ – 0

Net Tax Assessment
$ 74,997
$ 99,996
$ 72,600
$ 83,853
$ 96,050
$ 109,257
$ 123,544
$ 138,987
$ 155,666
$ 173,664
$ 193,074
$ 213,990
$ 236,515
$ 248,341
$ 260,758
$ 273,796
$ 287,486
$ 301,860
$ 316,953
$ 332,801
$ 349,441

,
BUSI 482
Appraisal Project Assignment Instructions
Overview
The goal of the Appraisal Project is to provide students with an opportunity to apply classroom knowledge to real world conditions in an analysis of the Water’s Edge Apartments case study.
The student will calculate the Net Project Cash Flows and then calculate the NPV and IRR based on these cash flows. Use the Excel file: Appraisal Project Assignment – Case Study – Exhibit 1 for your calculations.

Instructions
In your report, include a written analysis of the Water’s Edge Apartments calculations as well as a discussion of the strengths and weaknesses of the NPV and IRR as valuation measures. Your report will need to be 1,000 words including an APA formatted title page and references page, and at least 5 scholarly references (e.g., peer-reviewed journal articles). You may also use non-scholarly references such as trade publications in addition to your 5 scholarly sources. Include a section in your report on a biblical integration of the topics.

THE WATER’S EDGE APARTMENTS

The Opportunity
In early 2008, John Francis and Donald White met to discuss a potential real estate development opportunity. The Water’s Edge property was created through the purchase of eight individual properties to create a single 9.66 acre footprint on the banks of the Mohawk River in Cohoes NY. When complete, the development would contain 132 individual units in two mirrored buildings with a private street separating them. The current developer of the project was experiencing financial difficulties and was seeking a buyer for the partially complete project.
John Francis is President of Francis Properties (FP), a real estate development and management firm specializing in multiple occupant facilities in the greater Capital District of New York. FP’s projects include Greystone, a 38-unit senior living property and Windy Pointe, a 51-unit facility. Donald White is Managing Director of Alliance Venture Partners (AVP) and is a seed-stage investor in early stage technology companies. AVP also invests in commercial and residential real estate projects in metropolitan Boston and in the Capital Region of upstate New York.
Friends since childhood, John and Donald agreed to evaluate the acquisition of Water’s Edge property as a joint venture between FP and AVP. Their first concern is to evaluate the potential value of the opportunity.

The Senior Housing Movement
America is a quickly graying country, with nearly 8,000 Americans turning 60 each day according to the US Census Bureau. The fastest growing segment of the US population is those over 85, with those of traditional retirement age (65) being the second fastest growth segment. Immediately behind them come the Baby Boomers, a two-decade spanning group of over 70 million individuals with more wealth and inclination to spend it than any other time in US history.
The Albany region has a shortage of attractive senior living alternatives. Currently, senior living facilities in the area represent a total of less than 500 units. Potential customers prefer to relocate nearby their homes in order to retain connections to their local communities. Unfortunately, there are a limited number of appropriate undeveloped spaces in proximity to the population centers. Only one other major project has been announced locally, a $14M project of roughly 100 units to be started in early 2009 in nearby Saratoga Springs.

Acquisition Cash Flows
The partnership would to acquire the property for $9.5 million, 70% of which would be financed through an interest-only bank loan. Once acquired, the group anticipates investing an additional $5.5 million (equity) in year 0 to complete construction. The partnership intends to sell the property after twenty years.

Anticipated Project Cash Inflows
The cash inflows for the project are dominated by the monthly rents. The maximum monthly rents for Water’s Edge would be $980 per unit per month by the end of Fiscal Year 2008. Assume no discounts for rent in Year 1 (2009, $1,500 per unit) and beyond, with rents increasing at 5% per annually.

Completion schedule 31-Aug-08 31-Aug-09 31-Aug-10
Building 1 units 30 66 66
Building 2 units 33 66
Secondary cash flow comes from an arrangement with Time Warner Cable to purchase internet, cable TV, and digital phone services at a discount and resell these services to the residents for a profit. The current cost is $52 per month per unit. The services are resold at $100. The partners expect that 75% of the residents will purchase this service and that these costs and revenues will increase at 5% per year.

OPERATING COSTS

Employees
Based on his previous experience, Francis estimates that Water’s Edge will require one full time employee acting as property manager. In the Capital District an appropriate individual for the demographics of Water’s Edge (45-55 year old, college educated, good communication skills) would be about $4,500 per month for salary, with employee benefits and taxes adding $1,500 for a total of $6,000 per month. This number will increase at 5% annually for the term of holding of the property.

Maintenance
Initially, Water’s Edge will require little maintenance ($50,000, year 0). Annual maintenance will increase in year 1 (2009) to $65,000. This value will increase $32,000 per year until the end of the holding period.

Insurance
Due to the design of Water’s Edge, insurance costs are not as much of a burden as to be expected with a facility this size. The previous developer installed hydrants outside the buildings and sprinklers on every floor. There are Fire Control Panels and full monitoring, and relatively close proximity to both fire and police. The current policy on Water’s Edge pre-completion is $45,000 per year, based on a $9 million value. Using a full value of $15 million, the estimated insurance cost is $75,000 for the year. Insurance costs are expected to increase at a 5% annual rate.

Depreciation Calculations
Normally a building is straight line depreciated over its usable life of 30 years. While the simplest manner, it is not nearly the most tax efficient as components other than the building itself (carpets, light fixtures, etc) can be depreciated in as little as five years. Based on preliminary estimates, Water’s Edge enjoys $750,000 a year of accelerated depreciation each year for the first ten years of the project’s life. After that time, normal depreciation of the structures and other long-lived components gives $300,000 for the remaining years of ownership. Expected annual depreciation expenses are shown in Table 1.

Table 1: Annual Depreciation Expenses

Years of ownership

Annual Depreciation

1-10

$750,000

11-30

$300,000

Taxes
Taxes for Water’s Edge are on a per unit basis. As Water’s Edge is not 100% completed at this point, it does not carry the full tax burden, and the Pilot Tax Program is not yet in effect. This tax incentive plan will go into effect upon assessment following completion and will last for ten years from that point.
The tax rate for the next two years is projected to be $8,333 per month until September 2009, when full assessment will be in effect. This number shall be used for Year 1 calculations. 75% of this ($6,248) shall be used in Year 0. Full assessment shall be used thereafter.
At full assessment, the tax rate is $1,100 per unit per year, for a full value of $145,200 per year. Due to the fiscal constraints of the current economy, 5% per annum tax rate growth will be utilized annually from full assessment.
The Pilot Tax Program (PTP) is built into the deed of Water’s Edge. The PTP is a tax credit for 50% of the property tax bill in the first year of full assessment, decreasing at 5% per year until it has been eliminated in year 11. Tax calculations for the purpose of this analysis will take into account the PTP.
Due to the tax schedule, September 1st shall be used as the start of the fiscal year for all calculations and projections for Water’s Edge. Annual tax estimates are shown in Exhibit 2.

Interest Charges
Given the current credit markets, it is assumed that only 70% of the purchase value of Water’s Edge can be leveraged via mortgage. An 8% assumption is used for interest only with a balloon beyond the holding time horizon.

THE EVALUATION
As the partners sat down to evaluate the project, White raised some of his concerns. “In order to determine the value of this opportunity, we’ll need to clearly understand all the cash inflows and outflows. Is this project really worth the $15 million price tag? Our overall cost of capital on this project is 14%. Will the investment create value? I am sure that our lender will want to see our estimates.”
Francis replied, “I agree that we need to value the project for the full twenty years, but I am concerned about the expiration of the Pilot Tax Program incentives. Should we consider selling after ten years instead? I am also concerned about keeping the apartments filled throughout the project. Let’s plan on ninety percent occupancy in our calculations. We can use this format (Exhibit 1) as our guide.”
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