Development Investment Appraisal of a Property in Greater London - Case Study Example

DEVELOPMENT AND INVESTMENT APPRAISAL OF A PROPERTY IN GREATER LONDON By + Date Brief Description and Company Objectives The client is a mid-sized property company based in the United Kingdom. The company deals mainly in the buying of properties, selling and development of properties. The key objectives this particular company is to identify an investment and development opportunity in South East of England or the Greater London. The client is keen on identifying an investment opportunity that would maximize its profits in view of current market prices. The client has particular interest in brown field investment opportunities and regeneration areas with a special preference for mixed use developments. It was assumed that the client is keen on having the investment property grow in value, and the eventual capital value. It was also assumed that the client was interested in a property that close to a good transport network, and easily accessible. Additionally, it was assumed that the client would prefer a property is low maintenance. It shall also be assumed that the client intends to use the property to offer residential units and various shopping amenities for a period of 15 years. Process used to identify the investment opportunity and develop The process of identification was informed by the client needs. The client was interested in a property located in the greater London or South East England. An internet search was conducted using the goggle search engines where properties on sale located in the client’s areas of interest were identified. A list of available properties on sale within the client’s areas of interest was generated. Several factors were used in the event of evaluate each of the properties and the best property selected. These factors include the size of the property, and its type, the return on investment, cash flows, and risks associated with each of the available options. The decision on the final site selected was based on the evaluation of each of available options in light of the client’s objectives. For example the client was interested in a property that would increase the profitability of the company. As such, the property with the highest return on investment was selected after all other factors such as risk have been accounted for. The internet search conducted on available investments yielded the following properties the Broadway Stratford E15, Bermondsey Square London SE1, 77 Weston Hill Crystal Palace, W1, Dalston development Site, and Commercial property in Surbiton. The table 1 below summarizes some of the key features of these properties Property Location Size (Sq meters) Cost (£) Broadway Stratford E15 50 Frith Street, W1D 4SQ 420 POA (Price on Agreement) Bermondsey Square London SE Bermondsey Square, London 1200 to 36000 33,750,000 77 Weston Hill Crystal Palace 77 Westow Hill, SE19 250 750,000 W1 Between Old Campton and Bateman Street 467 POA Dalston development Site Kings Land High street 250 1,200,000 Commercial property in Surbiton Main High Street Surbiton 600 3,000,000 Table 1: depicting a summary of pertinent information regarding the available properties. Property W1 consists of 4 floors excluding a basement and is connected to a good transport network. It is close to the Piccadilly Circus, Oxford Circus, Licester Square and Tottenham Court Road underground stations. Other nearby stations include Covenant Garden, Euston, and Charring Cross. There is a crossrail network being built and this property would be a prime beneficiary. 77 Weston Hill Crystal Palace is a part of the Crystal palace Triangle which offers vast range of shopping amenities. The property is a five story building and comprises of a commercial unit, permitted rights to develop four one bedroom flats, and room for further residential development. The commercial unit can be reconfigured and another flat can be added. The property is close to 6 stations served by buses. Bermondsey Square London SE1 is a property that offers a diverse mix of office, residential, retail, and leisure uses. It is located close to six stations with London Bridge being the closest. Broadway Stratford E15 comprises of two freehold buildings. The property has two shops, offices, a large basement, and two roof terraces. It is well connected to the transport network with the Stratford station being the closest. Dalston development Site is located in the heart of Dalston. The property offers a selection of amenities for instance, mainstream shops, a plethora of bars, restaurants, pubs, and a large shopping supper store. Permission to renovate the 1st and 2nd floors from offices to residential units has been granted. The permission to make alterations on the second floor and erect a single storey extension at the rear of the first floor has also been granted. The Commercial property in Surbiton is a building with a large and successful bar in the basement, a ground floor with a large and successful restaurant, and on the first floor are two six bedroom flats plus a single two bedroom flat. The property is located the main commercial area of town and is connected to good transport infrastructure. Besides the location, size, and the cost of the premise, other factors were used in the process of arriving at the final choice of property. These factors were the expected cash flows, return on investment, risks associated with property development. There are different types of risk associated with different types of investment. It was assumed that the client is interested in a property that shall be used for residential units and providing a number of shopping amenities. There a number of risks faced investors in general and specifically investors who own rental units. Generally, any investor is faced with such risks as market risks, interest rate risk, liquidity risk, and unsystematic risks. In all of the available properties, the client faces a market risk. The assets that the client is interested in belong to a similar asset class. As such, these properties are subject to a similar market risk for example in the event of a market crash. Investing in properties over a longer period may allow a market enough time to recover in case it crashes. Having assumed that the client is interested in a long term investment of 15 years the market risk associated with each of the properties is minimized. The interest of the client is to secure an asset within the greater London or South East England. Acquiring an asset is associated with liquidity risk. The client may need to sell the property and recover money urgently for any given reason. This may present a challenge to the investor as selling of a property may proof to be a time consuming endeavor and the client may not be able to secure the money quickly. Looking at the investment opportunities available to the client, as guided by the client’s requirements, all the investments options belong to the same asset class and therefore are subject to a similar liquidity risk. The client also faces specific or systemic risk. Specific risk occurs when the client is unable to realize the expected returns on investment and I suffering a loss. Specific risk is mitigated through diversification but because in this case the client in interested in assets that belong to the same class and the use is the same, the specific risk associated with each of the investments will be similar for all the properties all factors kept constant. Other risks related to particular business that the client is interested in include bad tenants who would delay and or refuse to pay rent, the property could stay vacant for an unspecified period of time, and income from rent could stay static for long periods of time against interest rates that may be rising. A thorough evaluation of the associated risks weighed against the expected cash flows, return on investment, shall be used to identify the most favorable investment opportunity. Development Plan The development plan for each property reveals the number of residential units and shopping amenities that can be obtained from each of the available properties. The W1 property comprises of 5 floors. The basement, ground floor, and first floor shall be used to develop shopping amenities. The remainder of the floors shall be used to develop 8 four bedroom residential units. These developments shall be done at a total cost of £ 332,000. The Broadway Stratford E15 is a property comprises of two building that shall be developed in the following manner. One of the buildings shall be converted into 12 residential units each of 3 bedrooms and the next building shall be developed into a property with various shopping amenities that include a bar, a large restaurant with the rest of the space being occupied by 12 small shops selling different products. 77 Weston Hill Crystal Palace property is a five story building and comprises of a commercial unit, permitted rights to develop four one bedroom flats, and room for further residential development. The property, if secured shall be developed under the already secured development rights at a cost of £123,000. The Dalston development site property offers a variety of amenities such as mainstream shops, a plethora of bars, restaurants, pubs, and a large shopping supper store. Permission to renovate the 1st and 2nd floors from offices to residential units has been granted. As a start the development to be conducted shall be based on the permission already granted by the approving authority. The 1st and 2nd floors shall be converted into 20 two bedroom units per floor at a cost of £ 427,000. The Commercial property in Surbiton is property comprising of a bar, a restaurant, and two six bedroom flats and one 2 bedroom flats. This property shall be refurbished at a cost of £400,000. New and modern equipment shall be installed and repairs done in order to make the property a modern residential/shopping amenities complex. Bermondsey Square London SE1 is a property that offers a diverse mix of office, residential, retail, and leisure uses. The development plan involves converting the building into a residential and shopping amenities complex. All the offices and leisure areas shall be converted into residential units with the existing retail and shopping facilities being upgraded and refurbished at a cost of £ 7,000,000. Valuation Various methods for valuating property exists and have their own strengths and weaknesses. Some of the commonly used property valuation methods include investment method, residual method, comparative method, cost method and the repayment method Damodaran, 2012, pp. 9-341). For this particular case, a combination of two property valuation methods shall be used. The main purpose of using two property valuation methods is to capitalize on their strengths and reach a decision that is sound and most favorable to the client. The two property valuation methods that shall be used are the investment method, and the repayment method. Other property valuation methods include the residual method, comparative method, and the cost method. The table 2 below summarizes important information that shall be used in the valuation of each of the properties. Property Cost (£) Cost of development (£) Rental income/month Broadway Stratford E15 POA (Price on Agreement) avg cost £ 800,000 87,000 19,000 Bermondsey Square London SE 33,750,000 7,000,000 96,000 77 Weston Hill Crystal Palace 750,000 123,000 16,000 W1 POA avg cost £ 900,000 332,000 25,000 Dalston development Site 1,200,000 427,000 23,000 Commercial property in Surbiton 3,000,000 400,000 40,000 Table 2: a summary of the cost of acquiring a property, cost of developing it, and income per month The comparative method of property valuation offers a user an easy way of valuing property on sale. Using this method, the actual cost of similar properties within the locality was obtained and compared to the selling price of the property on sale. The cost of acquiring the selected properties was found to be most reasonable. The owners of the property had valued their property at a price that matched other similar properties within the locality. The cost of acquiring each property has been shown in table 2 above. The repayment period method establishes whether at the end of the 15 years, whether the client shall have made a gross profit and by how much. Table three below shows the valuation of each of the properties using the three commonest valuation methods. Property Cost (£) investment Repayment (£) Broadway Stratford E15 800,000 25.7% 3,420,000 Bermondsey Square London SE 33,750,000 2.8% 17,280,000 77 Weston Hill Crystal Palace 750,000 22% 2,880,000 W1 900,000 24.35% 4,500,000 Dalston development Site 1,200,000 17% 4,140,000 Commercial property in Surbiton 3,000,000 14.11% 7,200,000 Table3: valuation of each of the properties against initial cost The repayment method uses the following formulae = (monthly rent * 12 months * 15 years) The investment method uses the following formulae = = [(monthly rent* 12)/(asking price + development cost) * 100] The best property for the client is one that has the highest return and maximizes profit while at the same time being of the least risk. Using the repayment method the Bermondsey property is the least profitable. The remaining six properties are profitable going by the two valuation methods. However, the W1 property emerges as the most profitable of all the investment opportunities available. It is however worth noting that in these calculations tax has not been considered as well as depreciation costs. The methods have also not considered the lack of revenue in those periods that the properties shall be vacant. It has been assumed that the property shall be fully occupied during the period of tenure. The client has been advised to purchase the W1 property at a cost of £ 900,000 and develop it at a cost of £332,000. Below are some maps and plans of the selected property. References Damodaran, A. (2012). Approaches to Valuation and Understanding Financial Statements. In Investment Valuation: Tools and Techniques for Determining the Value of any Asset (3rd ed., pp. 9-341). Hoboken, N.J., Wiley. Read More