Analysis of Johnson Building Contract
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Exercising Bill Thompson’s Call
The contract between Al Johnson and Bill Thompson featured a call option on the part of Bill Thompson for 25% of the equity in the Johnson Building. In the context of this illustration so far, this option was never exercised because the investment was not sufficiently attractive.
However, it is possible that exercising this option would prove attractive under conditions of a stronger market for office space. If the office space at the Johnson Building were to rent at a premium $45 per square foot after four years—the exercise period for Mr. Thompson— NOPAT would be $2.041 million (Table 15.23) and net income (Table 15.24) would be $1.415 million. Under states of solid interest it might be sensible to esteem the office building at 10 times income bringing about a bargain cost of $14,145,872 (Table 15.25A). The offer of the property at the value is seen to produce a total profit of $4.541 million. That’s why it would be a good deal for Bill Thompson to practice his $1 million choice and earn an immediate paper profit of $135,000.
The best way to analyze the Johnson building from a break-even point of view would be to cast income as a function of dollars of rent per square foot. Like most of the real estate costs of the Johnson Building will be fixed (that means it will not change with rent). Economic visibility of office building will be driven by variation in demand. As explained above taxes, insurance and cost of maintenance were passed through to the tenants by the leases so these costs won’t be considered as fixed in following analysis.
Incomes at the Johnson Building are equal to 95% (allowing for vacancies) of 90,000 sq. ft. times the lease. A fixed part of income will be the 10,000 sq. ft. of space apportioned to Al's Super fresh at $10 for every square foot.
TC = $1,298,518
Net fixed cost for the Johnson Building would consist of the property management charges ($25,000), legal formalities and accounting costs ($25,000) and mortgage payment (P&I) of $1,248,518. There are no variable costs for the Johnson Building. Reduction in value does not consider an expense on the grounds that it doesn't speak to an outï¬‚ow of cash
TC = $1,298,518
BEP = TR – TC; = (R ´ 0.95 ´ 90,000)+ 100,000 – $1,298,518
Solving for R:
0.95 R = ($1,298,518 – $100,000)/90,000; R = $12.65
Thus BEP for R is $12.65. One thing should be noted here that is rent allows for a 5% vacancy rate and assumes taxes, insurance, and maintenance are passed through to the tenants.
As business sector leases in this case are well above this level, there seem to be little risk in this investment. In spite of that a better gain one with a satisfactory risk-return outcome—seems to need a longer holding time than Al Johnson might prefer.
Johnson Building Conclusion
For better location of his office Al John undertook into developing an office building to seek out investment profit, a potential tax shield and better location for his office as suggested by foregoing analysis that if there are potential gains for Al, they are defiantly tempered by his exposure to risk. This does not mean that it was a bad investment.
In the formerly said emphases of conceivable results, the allure of this kind of speculation could be seen to hinge on upon Al Johnson's taste for danger. Perhaps the most important feature of the investment from this point of view was getting of a put to the building developer during the first five years of the project if things did not go according to expectations Al Johnson could probably get out more or less whole.
It seems that potential for a tax shield was mistaken. The underlying money making concerns of an office building imply that assuming that you are set to run a charge misfortune owing to devaluation, you will most likely encounter a net money outï¬‚ow. This thing is different to housing residential market (Chapter 6), where an important feature of the investment activity is the obtainment of a tax shield. It was seem to generate a low amount of economic value due to Al’s decision to obtain a perfect site for the office. How-ever, area in this building and cachet—particularly the "Johnson Building"—may well have significant psychic worth for Al John
Office buildings are great opportunities investors who are disconcert to reap great gain for the risk involved. The size of office building does not matter important thing is that process of successfully investing in this market are the same. Location should be attractive to potential tenants, design of a building should meet tenant’s needs, secure lease, and you have to arrange finance for construction of the building. Seek out permanent financing, construct the building, and then manage the building in according to tenant’s needs.
Hazard in the business sector for office building space hails from the business sector's proclaimed cyclical example. This foreseeable cyclical example gives chances for shrewd speculators. The low purpose of the cycle might normally constitute an amazing time to either create an office building or purchase one that is now assembled, yet in a bad position. Incomprehensibly, numerous moguls enter the office building business at the highest point of the cycle, when everything appears extraordinary. Lamentably, when that building is built the cycle may well be on the downswing with inhabitants hard to find at monetarily reasonable with other real estate investments, from investors point of view office building goes through stages such as acquisition stage, a holding stage, and a disposal stage.
In acquisition phase a suitable piece of land has to be found, feasibility analysis has to be done. The location property must attractive to tenants and it must be compliance with local zoning and environmental laws. The possibility study endeavors to accommodate the expenses of development with the potential occupant interest both regarding the amounts of inhabitants and predominating business rental rates. Basically financing consists of both loan taken for construction and permanent financing. Banks frequently oblige preparatory renting duties from trustworthy occupants.
There is completion attracting and retaining tenant based on location, the utility of the office building relative to tenant requirements, and a right price. Issues of critical mass and synergy among center tenants is critical which is exactly opposite of shopping centers. The focus of prospective talent is on extent to which a given office building meets their needs in terms of its location, amenities, design, layout, prestige, and cost. Unfortunately, having the “right” building is only a necessary, but not a sufficient, condition for investor success. Most important factor in determining the success of a real estate investor is proper timing in entering this market.
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