Hi. Am working on a fractional ownership project (vacation ownership -
where one home is sold in tenths to ten different owners. each owner
is guaranteed one month of use of their home and the remaining 85 days
at the end of the year can be used as space available time free of
charge).
question is: i would like to know which makes more sense: as a
developer, should i rent the home every year or should i sell it to
ten different owners (assuming this is a hot market).
All figures in USD
Givens: Construction cost for the home is $1,000,000 USD
Sales Price for the home is $250,000 per fraction * 10 fractions =
$2,500,000 (this is a one time fee)
Maintenance Dues every year for perpuity is $5,000 per fraction * 10
fractions = $50,000. Assume a price increase of 5% year on year.
interest rate approx 12%.
with regards to renting the home assume: i expect a +ve cash flow of
$100,000 USD in renting the home per year. interest rate approx 12%.
Operating expenses for both purchase and rent would approx be the same
so you can disregard.
Can you use the necessary financial tools (npv/dcf/irr etc) to give me
an educated response. Thanks very much. |
Request for Question Clarification by
omnivorous-ga
on
19 Jul 2005 11:39 PDT
Blogjob --
A couple of things deseerve clarification here:
1. the sale generates immediate tax consequences -- do you have any
assumptions on taxes, given a sale?
2. alternately, keeping the house and renting it generates potential
depreciation (but only on the structure and not the land). Again, any
assumptions about tax bracket?
3. in the rental assumption ($100K/year) you don't forecast any
increases in rental income -- though you have maintenance rising at 5%
per year. Note that after about 14 years your rental income will be
less than your maintenance with those numbers.
Best regards,
Omnivorous-GA
|
Clarification of Question by
blogjob-ga
on
19 Jul 2005 12:17 PDT
1. not sure what the tax implications are as of now. ignore tax
assumptions? wld just like a ballpark estimate.
2. ignore.
3. rentals shld go up approx 5% a year as well.
|
Blogjob ?
This project strongly favors the sale model, both because of the
strong income in year 1 ? and because of maintenance revenues that add
to the annual cash flow.
The annual rental at 12% interest is ONLY positive after 20 years IF
you assume that you?re netting $100,000 per year AFTER maintenance.
If you add $50,000 each year to maintenance in the rental situation,
the project does not have a positive NPV as a rental.
The following spreadsheet has two sections, one with no taxes ? and
one with an assumption of 33% in taxes. The rental situation improves
in the latter case thanks to depreciation, but sale is still strongly
preferred. I have not figured an IRR for the sale case in either but
it will be an impressive number. If you wish an IRR for the no-tax,
sale case, just let me know via a Clarification Request.
Finally, note that the numbers in the TOTAL column don?t include the
$1 million invested upfront in year 0. Thus the value of the rental
in the no-tax situation shows it being $35,630 ? barely positive. The
net present value of the sale is $1,749,958. Even if you do what I
did in the taxed assumption and eliminate maintenance as an income
creator, the sale has a positive NPV of $1,232,143. It?s strongly
preferred over rental and if maintenance contributes any income, it
will be even stronger.
?Fractional Ownership?
http://www.mooneyevents.com/fractional.xls
If we?ve missed anywhere in the assumptions, please let me know and
I?ll change the spreadsheet for you.
Best regards,
Omnivorous-GA |
Request for Answer Clarification by
blogjob-ga
on
19 Jul 2005 15:40 PDT
hi this looks grea.t will go thro but if you could run an IRR that wld
be great. your analysis matches somewhat my calcs, but just wanted to
check the irr. thanks.
|
Clarification of Answer by
omnivorous-ga
on
19 Jul 2005 16:16 PDT
Blogjob --
I've modified the spreadsheet, using an IRR factor instead of allowing
Excel to do it automatically, as it has always given me some
difficulties. When the IRR produces an NPV = 0 ($1 million in cash
flow matching the original $1 million invested), you've arrived. It
takes a BIG number -- 158% return -- because of that strong cash flow
at the end of year 1 from the sale of the property:
"Fractional Ownership"
http://www.mooneyevents.com/fractional.xls
Here again are some factors that could reduce the difference between
SALE and RENTAL:
* taxes paid on the sale reducing net cash flow
* spending on maintenance to counter the annual income in the Sale
scenario. Indeed, this is a reasonable assumption, particularly in
the outlying years.
* depreciation providing tax benefits in the Rental scenario
* assumptions of appreciation in the rental property, so that it's
worth more should you sell it in year 5 or 10 or 20.
* higher rental income each year
Best regards,
Omnivorous-GA
|
Request for Answer Clarification by
blogjob-ga
on
20 Jul 2005 09:37 PDT
omni
couple of questions on the last version you sent me with the irr etc.
1. what does the IRR show me here? can i decide if this project is a
go or a no go only on NPV or do i have to consider IRR as well? if so,
how can i make that decision?
2. Is it possible to calculate the payback period from the last excel sheet?
3. how did you factor 750K for depreciation? how do you calculate
depreciation? on the construction cost of the asset?
4.and finally, how did you calculate the tax benefit of 30% on the depreciation?
thanks. hope to heasr from you soon.
|
Clarification of Answer by
omnivorous-ga
on
20 Jul 2005 10:12 PDT
Blogjob --
1. Classic finance theory says that any project with an NPV that's
positive using your 12% cost-of-capital is a go (even the Rental,
which was barely positive after year 20). But obviously a higher NPV
is better and it produces a higher IRR. The IRR in this case is
phenomenal; in fact your bank might find you over-optimistic. Again,
it's large because the sale produces so much cash at the end of
construction.
2. The payback period is simply how long it takes to cover the $1
million investment. Obviously for the Rental it will be just over 9
years -- just add up each year's income. The payback on the sale
comes immediately at the end of year 1 when units are sold. In fact,
if you pre-sold units during construction, the Sale scenario would
have a payback period of less than 1 year.
3. My depreciation assumption was just an estimate: that land would
cost you 25% of the project and construction 75%. You can obviously
change that to fit the circumstances. And depreciation then was
straight-line over 20 years.
4. Since depreciation is a non-cash loss, if you or your business are
paying taxes, it can be used to reduce taxes. With the highest U.S.
marginal tax rates in the 31%-35% range, I used 30% capture most of
the value. It could be adjusted upwards slightly (and possibly
include state taxes too) and there are also the possibilities of other
tax credits resulting from construction. Note too that we haven't
figured in any property taxes in this example. They'd be paid by the
owners in the Sale situation and by you in the Rental situation.
Best regards,
Omnivorous-GA
|
Request for Answer Clarification by
blogjob-ga
on
20 Jul 2005 10:43 PDT
thanks
in reply to your last submission - i assumed 5% of the constrn
depreciation so it wld be 50,000 in depreciation per year for 20
years. is this correct? also i assumed 33% tax benefit.
cld you pls. run the maintenance dues in the sale scenario as being
12% of the existing (12% is the mgmt fee that my company collects if
we sell it off). i wld like to compare it to my numbers.
also cld you run an irr for the w/tax sale and rental scenarios.
also finally, can i email you at an attchment please to check. how wld
i do that? can i upload or email it to you? thanks for your help.
|
Clarification of Answer by
omnivorous-ga
on
20 Jul 2005 11:35 PDT
Blogjob ?
U.S. tax law allows the building to be depreciated, but not the land.
If construction costs will be $1 million, your depreciation
assumptions are good ? but presumably you?ll have the real estate
costs that should be added to the property. In most urban
residential developments it?s 20-30% of the sale price.
Note that I?ve changed line 40 on the spreadsheet ? though my notes
indicated a 33% tax rate, I?d actually plugged in 30%. It?s now
corrected to 33%.
Could you clarify what the 12% maintenance applies to in the Sale
scenario? Should that income be 12% of the $50,000 collected every
year (my assumption is that the other 88% would go to maintenance
expenses, so that seems reasonable.)
I?ll hold off on an IRR in the Sale with Taxes case until that?s
cleared up but the IRR for the Rental with Taxes is 13.6%, as you'll
see in the bottom portion of the updated spreadsheeet --
?Fractional Ownership?
http://www.mooneyevents.com/fractional.xls
Unfortunately Google Answers rules prevent researchers from contacting
people via e-mail but if you can find a website to post your
spreadsheet, I?d be glad to examine the assumptions.
Best regards,
Omnivorous-GA
|
Request for Answer Clarification by
blogjob-ga
on
20 Jul 2005 14:15 PDT
Omni.
The project is in Mexico.
Instead of the $50,000 that I said would be collected every year, I
forgot to mention that I receive only 12% of that (as a management
fee/management company. the 12% is just a fee i receive for managing
and operating the project). the remaining stays within the project
among the "owner's association". the other 88% does go to maintenance
etc and cld also be used towards small capital improvements if the
association so decides.
If you cld just post one more final excel sheet with all these
assumptions etc i can take a look at it.
Thanks v much.
|
Clarification of Answer by
omnivorous-ga
on
20 Jul 2005 14:43 PDT
Blogjob --
The numbers are updated, with an IRR figured for the new maintenance
income AND for the Sale scenario with maintenance income. The IRR
without taxes is 152% and it declines to 102% with taxes, due to a tax
bill of almost $500,000 in year 1. Still, strongly preferred over the
rental scenario -- but as mentioned before rental could look more
attractive if the property appreciated and could be sold for a higher
price at some point in the future.
Best regards,
Omnivorous-GA
|
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