Real Estate Appraisal - Report Example

Real E appraisal The current value at which the property at Sulis House in Valpy Road in the of Reading is being offered on the market is£7 million. The returns that the investor seeks on this property are 8.5% of the purchase price, hence if the investor chooses to offer the asking price of £7 million, then after two years, a direct sale would need to yield a total amount of £7,595.000. This report will assess the market and potential for income existing in the real estate commercial property market in order to assess whether Northern Pension fund can consider offering the stipulated market price for the property Sulis House located at Valpy street in reading. The size of the residential market has shown a consistent increase from £753 billion in 2001 to £2369 in 2009 (www. ipd.com/linkclick.aspx). According to the UK IPD residential index of 2009, based on a sample of 11,143 properties covering £3.9 billion at the end of December 2009, the returns on residential complexes consistently increased in 2009. Moreover, out of the total capital market value of £3.81 billion for the UK property market, 20.9% is based in the south east, the zone within which the city of Reading falls into. In the south eastern area, the capital growth was 10% and income returns were 4.8%. Hence at the outset, it may be stated that this area generally appears to be a viable from the point of view of investment over a long term, because property values have generally been good over the long term. Income returns were 2.9% in 2009 and capital growth was 8.1 (www.ipd.com). For commercial properties, the income return was 7.4, but capital growth had dropped to -3.6. When returns are annualised over a period of five years, the south eastern region demonstrated income growth of about 5% but no capital growth (www. ipd.com/linkclick.aspx, p12). The commercial markets have not however performed as well, it may be noted that the investment performance for commercial properties in terms of the % of TR pa dropped by -10% (www. ipd.com/linkclick.aspx, p16). Taking into account a 5 year annualised TR, commercial property lets performed at only 3% as compared to 10% on commercial properties. For every £100 worth of investment, the cash return on commercial properties in the south east area of UK was £137 over a nine year period from 2000 to 2009. The levels of associated risk were also higher for commercial properties, i.e, 13.0 as compared to a return of 6.0 (www. ipd.com/linkclick.aspx, p21). Projections which have been made on real annualised returns from real estate show a loss of -11% over a three year period and -1% over a 5 year period, such that any proposal for the future on the Sulis property in reading needs to factor in some potential losses that could arise in the investment being considered. The real income growth has been steadily dropping in commercial real estate; when real capital growth in commercial property is taken into account over a fifty year period, i.e, inflation minus 1.2% per year for commercial property (www. ipd.com/linkclick.aspx, p24). Annualised rental growth over a nine year period was 0.78% for commercial properties. In terms of current asking prices for commercial property, the general commercial locations around Valpy street in reading are being offered at prices ranging from 650 to 700 per square foot and the asking price rents for offices are in the range of £1200 to £2500 depending upon the size of the individual units. The economic recession over the past four years has impacted upon the real estate market in reading, as in other parts of the country, by creating a glut of distressed properties being offered for sale because they are foreclosed and unable to keep up with payments. Interest rates have remained low, which has been a boon for those on mortgages with low interest payments. While low interest rates are advantageous for buyers at the present time because it allows them the opportunity to acquire a fixed rate mortgage, at the low rate, it also requires a much higher down payment, so if Northern Pension Fund opts to purchase the property on Valpy street, it must be prepared to pay a larger sum of money upfront as down payment. The high incidence of foreclosures and properties coming on to the market also means however, that the company could also opt to look into acquisition of a property being offered a lower market price. With the recession, more commercial property owners have also suffered from tenants exercising the break clause and opting out of their leases, which has produced losses. Bearing this in mind, the company must carefully consider the likelihood of existing clients opting out of their leases and also take into account vacancies due to former tenants already exercising the break option. Northern Pension fund proposes to purchase the property and wait for the existing leases to expire. It may be noted that one of the significant aspects that must be taken into consideration is the reduction in the average length of lettings from 5.9 to 5 years, as well as an increase in the incidence of break clauses in leases (BDF, 2010). This could potentially reduce the length of time that the Northern Point Pension Fund would need to wait to ensure that all leases have expired. With the losses which have been predicted on the annualised returns from commercial real estate over the next five year period, it is likely that the proposal for purchase being considered would need to also incorporate this loss potential into its purchase price. When projected losses in commercial property income are said to be about -11%, this would produce losses in both income and capital. The loss in capital growth needs to be incorporated into the purchase price, hence the asking price may be too high. Returns sought are 8.5% as opposed to projected losses over a five year period of between -11% to -1%, or an average of -5.5%. In order to achieve the desired return, Pension Fund would need to offer a purchase price that would be about 14% below stated price, i.e, £6,90,2000. Additionally, there may be additional costs associated with tenants exercising any break clauses, which could produce further losses in rental income and this needs to be incorporated into the purchase price, i.e. introducing a potential 10% loss for such expenses. This would bring the price down further to 6,211,800. Bearing these aspects in mind, a brief financial table is presented below to assess various financial ratios; rental income from the property is estimated at about £1200 per month for a period of approx 5 years. Total current assets: £5,000,000 Total current liabilities £90,000 Total long term assets £5,500,000 Total long term liabilities £168,000 Sales £500,000 Receivables £60,000 Interest expense £50,000 Operating expenses £100,000 Other income £100,000 Inventory £120,000 Based upon the figures estimated above, the following are the financial ratios: Profitability ratios: Gross profit margin 78% Operating profit margin 58% Net profit margin 68% Operating Ratios: Inventory turnover ratio 0.91% Sales to receivables ratio 8.33% Return on assets 0.3% Solvency ratios: Debt to worth ratio 0.03% Working capital 4,900,000 On the basis of the above figures, it may be noted that despite the present slump in the real estate market, the property is likely to prove to be a good investment, especially if a lower price is offered. However, one significant area of concern is the debt to worth ratio which is a low value of 0.03%. Large debts are more likely to be incurred if the company follows the policy of refurbishment. It may be possible to sell the property without incurring the expense of refurbishment. For instance, some minor decoration such as painting could improve the appearance of the property without necessarily going to the expense of refurbishment. This plan could reduce the debt and thereby improve solvency ratios, which are extremely important in a recessionary economy. References: “IPD UK Residential Investment Index 2009”; retrieved March 9, 2011 from: http://www.ipd.com/OurProducts/Indices/UnitedKingdom/UKAnnualResidentialInvestmentIndex/tabid/1006/Default.aspx IPD Residential Index launch 13/04//2010. Retrieved March 9, 2011 from: http://www.ipd.com/LinkClick.aspx?fileticket=e%2biDAwt1WKA%3d&tabid=1006&mid=8991 IBDF, 2010. “BDF Annual lease Review”, Read More