real estate development-memo writing
DESCRIPTION
This is a classwork. The work conducted an analysis of the investment performances according to a real estate rehabilitation project.TRANSCRIPT
Real Estate Development Planning | Xue Wood 1
WORKING SAMPLE Xue Wood, Planner
332 W Indiana Ave., St. Joseph, MO P: 646.401.4320 I E: [email protected]
Memo To: J. Smith, Director of Planning
From: Xue Wood, Planner
Date: November 23, 2011
Re: Recommended Action by the City for the Preservation of the Rainbow Building
Recommended: That the City negotiate with the developer of the Rainbow Building on the basis of rehabilitating
the building to a standard that will qualify the project for the use of Historic Rehabilitation Tax Credits. This may
require city intervention to ensure that operating losses are covered and recognition that a change in ownership is
likely within the first five years of operation.
A developer has proposed to demolish the Rainbow Building and to build 50 units on the site. Objections to
the demolition were voiced. As an alternative, the developer proposes to preserve some of the building and
to construct 46 units, mixing new construction and rehabilitation. This analysis shows that, if the developer will
rehabilitate the building to a standard that will qualify the structure for Historic Rehabilitation Tax Credits,
the developer will realize a higher return on investment despite the fact that only 42 units could be
accommodated in this alternative. The table below summarizes the investment performance of the different
development alternatives.
Investment Performance of the Development under Alternative Scenarios
Alternative Units Equity
Required Maximum IRR-AT
Maximum ROE
Year Sale
New Construction 50 $1,156,250 8.3% 1.0% 8+ Mixed New/Rehab 46 $1,150,000 7.5% -0.8% 8+ Historic Rehabilitation 42 $413,400 22.3% -14.6% 4
Each of the three development alternatives has been analyzed in terms of its investment performances. Only
the new construction alternative generates a positive cash flow at any time during the development’s
operation. The Historic Rehabilitation alternative fails to generate a positive cash flow, which will necessitate
an operating reserve funded by the owners to cover these losses over the years of operation. The mixed-new
construction and rehabilitation alternative does not generate a positive cash flow through eight years of
operation. Only the new construction alternative generates a sufficient return on equity from operating the
property that the developer will be interested in the long-term maintenance of the property. This suggests
that the City must stand ready to assist in the maintenance of the property over time. However, the
alternative involving the use of Historic Rehabilitation Tax Credits has several advantages, and one problem:
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The tax credits will generate funds at the beginning of the project reducing the amount of equity the
developer will have to acquire. The developer’s cash equity requirement will fall from over
$1,100,000 with the new construction and mixed construction alternatives, to about $413,000 plus
another $240,000 to cover operating losses during the first four year of operation with the historic
rehabilitation alternative. This should appeal to the developer.
The after tax internal rate of return will be higher with the Historic Rehabilitation alternative, peaking
at 22 percent. Unfortunately, this IRR will decline quickly over time, unlike the other alternatives
(Please see the following chart). This means that the developer will want to sell the property in order
to realize the highest possible profit. This could be as early as the 4th year after the completion of
construction. As a result, the City should anticipate that it will have to work with a different ownership
for this project only a few years after its rehabilitation. The City can strengthen its position by having
a right-of-first-refusal on the property with ongoing control over its management.
Chart Comparing Investment Performance of Three Development Alternatives
Attachment: Data Used in the Analysis of Alternative Development Proposals
Item Alternative
New Cons. His. Rehab Mixed
Residential units 50 42 46
Residential rents per month for year one 800 875 850
Resid. rent inflation per year 3.0% 3.0% 3.0%
Resid. vacancy loss per year 5.0% 5.0% 5.0%
Operating expenses per unit for year one $4,000 $4,500 $4,250
Operating expenses inflation per year 4.5% 6.5% 5.0%
Total development costs 4,625,000 4,620,000 4,600,000
Land value 675,000 500,000 675,000
New construction costs 3,950,000 0 2,000,000
Rehab costs 0 4,120,000 1,925,000
Loan to value ratio 75.0% 75.0% 75%
Market interest APR compounded monthly 7.0% 7.5% 7.25%
Loan term in years 30 30 30
Appreciation of property value per year 3.0% 3.0% 3.0%
Selling costs as percent of value 4.5% 4.5% 4.5%
Capital gains tax rate of owner 15% 15% 15%
Recapture Rate on Depreciation 25% 25% 25%
Income tax rate of owner 28% 28% 28%
Syndication net proceeds 90%
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