What factors might cause the highest and best use of real estate to change during the course of typical lease term

$20.00

Why has real estate often been a key factor in corporate restructuring?

 

SKU: Textfu Category:

1i.The ABC Corporation is considering opening an office in a new market area that would allow it to increase its annual sales by $2.5 million. Cost of goods sold is estimated to be 40 percent of sales, and corporate overhead would increase by $300,000, not including the cost of either acquiring or leasing office space. The corporation will have to invest $2.5 million in office furniture, office equipment, and other up-front costs associated with opening the new office before considering the costs of owning or leasing the office space. A small office building could be purchased for sole use by the corporation at a total price of $3.9 million, of which $600,000 of the purchase price would represent land value, and $3.3 million would represent building value. The cost of the building would be depreciated over 39 years. The corporation is in a 30 percent tax bracket. An investor is willing to purchase the same building and lease it to the corporation for $450,000 per year for a term of 15 years, with the corporation paying all real estate operating expenses (absolute net lease). Real estate operating expenses are estimated to be 50 percent of the lease payments. Estimates are that the property value will increase over the 15-year lease term for a sale price of $4.9 million at the end of the 15 years. If the property is purchased, it would be financed with an interest-only mortgage for $2,730,000 at an interest rate of 10 percent with a balloon payment due after 15 years.

a.What is the return from opening the office building under the assumption that it is leased?

b.What is the return from opening the office building under the assumption that it is owned?

c.What is the return on the incremental cash flow from owning versus leasing?

d.In general, what other factors might the firm consider before deciding whether to lease or own?

 

1ii. What are the main reasons that corporations may choose to own real estate?

 

2i. Refer to problem 1. Suppose that five years ago the corporation had decided to own rather than lease the real estate. Assume that it is now five years later and management is considering a sale-leaseback of the property. The property can be sold today for $4,240,000 and leased back at a rate of $450,000 per year on a 15-year lease starting today. It was purchased five years ago for $3.9 million. Assume that the property will be worth $5.7 million at the end of the 15-year lease.

a.How much would the corporation receive from a sale-leaseback of the property?

b.What is the cost of obtaining financing with a sale-leaseback?

c.What is the return from continuing to own the property?

d.In general, what other factors and alternatives might the firm consider in order to decide whether to do a sale-leaseback?

(For Reference Problem 1)

The ABC Corporation is considering opening an office in a new market area that would allow it to increase its annual sales by $2.5 million. Cost of goods sold is estimated to be 40 percent of sales, and corporate overhead would increase by $300,000, not including the cost of either acquiring or leasing office space. The corporation will have to invest $2.5 million in office furniture, office equipment, and other up-front costs associated with opening the new office before considering the costs of owning or leasing the office space. A small office building could be purchased for sole use by the corporation at a total price of $3.9 million, of which $600,000 of the purchase price would represent land value, and $3.3 million would represent building value. The cost of the building would be depreciated over 39 years. The corporation is in a 30 percent tax bracket. An investor is willing to purchase the same building and lease it to the corporation for $450,000 per year for a term of 15 years, with the corporation paying all real estate operating expenses (absolute net lease). Real estate operating expenses are estimated to be 50 percent of the lease payments. Estimates are that the property value will increase over the 15-year lease term for a sale price of $4.9 million at the end of the 15 years. If the property is purchased, it would be financed with an interest-only mortgage for $2,730,000 at an interest rate of 10 percent with a balloon payment due after 15 years.

a.What is the return from opening the office building under the assumption that it is leased?

b.What is the return from opening the office building under the assumption that it is owned?

c.What is the return on the incremental cash flow from owning versus leasing?

d.In general, what other factors might the firm consider before deciding whether to lease or own?

 

2ii. What factors would tend to make leasing more desirable than owning?

 

3i. Refer to problem 1. ABC realizes that the benefits of leasing versus owning may be sensitive to many of the assumptions being made. Management wants to know how the return on the incremental cash flow from owning versus leasing is affected by different assumptions. (This problem is best done using a spreadsheet.)

a.How would the return be affected by the corporation being in a zero tax bracket?

b.How will the return be affected if the property value does not increase over time but remains constant?

c.How would the return be affected if the mortgage were at an 8 percent (rather than 10 percent) interest rate?

(For Reference Problem 1)

The ABC Corporation is considering opening an office in a new market area that would allow it to increase its annual sales by $2.5 million. Cost of goods sold is estimated to be 40 percent of sales, and corporate overhead would increase by $300,000, not including the cost of either acquiring or leasing office space. The corporation will have to invest $2.5 million in office furniture, office equipment, and other up-front costs associated with opening the new office before considering the costs of owning or leasing the office space. A small office building could be purchased for sole use by the corporation at a total price of $3.9 million, of which $600,000 of the purchase price would represent land value, and $3.3 million would represent building value. The cost of the building would be depreciated over 39 years. The corporation is in a 30 percent tax bracket. An investor is willing to purchase the same building and lease it to the corporation for $450,000 per year for a term of 15 years, with the corporation paying all real estate operating expenses (absolute net lease). Real estate operating expenses are estimated to be 50 percent of the lease payments. Estimates are that the property value will increase over the 15-year lease term for a sale price of $4.9 million at the end of the 15 years. If the property is purchased, it would be financed with an interest-only mortgage for $2,730,000 at an interest rate of 10 percent with a balloon payment due after 15 years.

a.What is the return from opening the office building under the assumption that it is leased?

b.What is the return from opening the office building under the assumption that it is owned?

c.What is the return on the incremental cash flow from owning versus leasing?

d.In general, what other factors might the firm consider before deciding whether to lease or own?

 

3ii. Why might the cost of a mortgage loan be greater than the cost of using unsecured corporate debt to finance corporate real estate?

 

4i.Excel. Refer to the “Ch15 Lease_Own” tab in the Excel Workbook provided on the Web site. How does each of the following affect the IRR on the ATCF difference from owning versus leasing?

a.The property can be leased for $175,000 instead of $200,000.

b.A loan can be obtained at an 8 percent interest rate instead of 10 percent.

 

4ii. Why might the riskiness of cash flow from the residual value of the real estate differ from the riskiness of cash flow from the corporation’s core business?  What would cause these cash flows to be correlated?

 

5. What would cause the rate of return for an investor that purchases real estate and leases it to the corporation to differ from the rate of return earned by the corporation on the incremental investment in owning versus leasing the same property?

 

6.Why might the decision to own rather than lease real estate have an unfavorable effect on the corporation’s financial statements?

 

7.Why is the value of corporate real estate often considered “hidden” from shareholders?

 

8.How does the analysis of a sale-leaseback differ from the analysis of owning versus leasing?

 

9.Why is the cost of financing with a sale-leaseback essentially the same as the return from continuing to own?

 

10.Why might it be argued that corporations do not have a comparative advantage when investing in real estate as a means of diversification from the core business?

 

11.Why has real estate often been a key factor in corporate restructuring?

 

12.Why might refinancing be considered an alternative to a sale-leaseback?

 

13.What factors might cause the highest and best use of real estate to change during the course of typical lease term?

 

14.Why should corporations have their real estate appraised on a regular basis?

 

15.What factors would tend to affect the value of a lease?

Reviews

There are no reviews yet.

Be the first to review “What factors might cause the highest and best use of real estate to change during the course of typical lease term”

Your email address will not be published. Required fields are marked *

Sorry no more offers available