Back to School – Real Estate Development of Off-Campus Student Housing

Please answer the following questions using the Case Back to School: Real Estate Development of Off-Campus Student Housing

1. Qualitatively discuss the benefits and costs of choosing Madison as the target market for the proposed luxury student-housing development.
2. Explain the feasibility analysis provided in the case and critique it as a basis for decision-making. Your critique should include both a discussion of what is wrong with the technique, as well as what may be wrong with the assumptions within the specific application of the technique.
3. Suppose instead you were considering developing to a yield on cost. In other words, you would be willing to make an investment in the development project as long as the annual cash flow of the property was at least 5.2% of the total development cost, where cash flow is measured at project completion and the timing of the development cost is ignored (except for when calculating construction loan interest). Development costs include both hard and soft costs, as well as interest on any construction loan. Assume that Lenard can finance hard development costs with a construction loan that charges 6% interest to be repaid upon project completion. The first draw of the construction loan is made to pay for demolition, with 12 subsequent draws evenly spread to cover the remaining hard construction costs (excluding demolition). You may assume that the property’s Net Operating Income (NOI) is growing at 3% per year and that the property’s CapEx is 20% of NOI.
4. Discuss the merits and deficiencies of using this approach to determine the appropriateness of a real estate development project. Justify any additional assumptions you must make to complete your analysis.
5. Develop a proforma for the completed apartment complex and estimate its value at completion. Justify any additional assumptions you must make to complete your analysis.
6. Estimate the Net Present Value (NPV) of the development project as a function of the cost of land. Assume you will always pay the soft costs and that you will make the draws on the construction loan that you calculated in Question 3. Further, assume that the construction loan itself was zero NPV to the lender and that the risk-free rate is 3%.
7. How much can you pay for the land so the development is zero NPV? What Internal Rate of Return (IRR) will a developer achieve with a zero NPV investment into this development project? Justify any additional assumptions you must make to complete your analysis. 
8. Now consider the problem as a real option. Assume that a plot of land in Madison gives you the right, but not the obligation, to build this particular luxury fifteen-unit apartment building at any time during the next ten years. The strike price is the present value of the construction cost, which you calculated in Question 5. You should further assume that these costs are growing at 3% per year. The underlying asset value is currently the price of a property valued in Question 4 if it existed today. Using the binomial option pricing model, estimate the maximum price you should be willing to pay for the necessary land. At this price, is the NPV you calculated in Question 5 positive or negative? Qualitatively explain the relationship between the price of land that delivers a zero NPV in Question 5 and the price of land you calculate in Question 6. Assume a risk-free rate of 3%.
9. In light of your previous calculations (and any additional qualitative reasoning), describe whether or not you believe that Slater and Lenard will be able to earn an appropriate rate of return (or more) by pursuing the project.

Solution

1. Benefits and Costs of Targeting Madison for Luxury Student Housing Development

Benefits:

1. Strong Demand: The large student population at the University of Wisconsin, Madison, ensures a consistent demand for housing, which supports high occupancy rates.
2. Favorable Economic Conditions: Madison’s economic and demographic factors make it an attractive market, with a stable local economy and a growing population.
3. Prestigious University: The university’s reputation draws students who may seek luxury accommodations, making it easier to target this specific market segment.

Costs:

1. Risk of Market Saturation: If too many similar luxury housing projects are developed simultaneously, it could lead to reduced demand for each property, resulting in vacancies and lower returns.
2. High Competition: Madison’s student housing market is competitive, with many existing options. This makes it challenging for new developments to stand out and attract tenants.
3. Regulatory Challenges: Zoning laws and development restrictions may create hurdles, potentially delaying the project and increasing costs.

…Please click on the Icon below to purchase the FULL ANSWER at only $15

$15.00 – Purchase Checkout Added to cart