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
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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
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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
