Assignment 1
The Assignment
In this assignment, you must assist Tom Wolfe do a valuation of Evergreen Centre. The
case describes the shopping centre, Tom’s situation and the assumptions necessary to do the
valuation. Your answer to the assignment must include the following:
?
?
A written valuation report indicating your valuation, all assumptions that are not given in the
case and a justification for those assumptions. You are free to change the assumptions in
the case, but if you so, you must justify the change.
A spreadsheet giving your calculations. You calculations should be annotated either in cells
on the left or right size of the calculations or using Excel comments (under Review on the
ribbon). Not all calculations must be annotated. You must use you judgement on
reasonable analyst would need explanation. You are free to you the Workbook containing
the Wyndham Park calculations as a base for analysis.
You will be graded on you completeness, accuracy and the quality of your explanations. The
assignment is worth 25% of your final grade, but I will mark it out of 100 points.
Introduction
Tom Wolfe was working late. He was reviewing the papers that accompanied his inheritance of a
neighbourhood shopping centre, Evergreen Centre. The centre is a thriving property in the wealthy,
leafy suburbs of Melbourne. It was developed by his father, Sam Wolfe, in 1988 and managed by
him until his recent death. The centre had always been a huge part of his father’s life. Tom had not
followed in his father’s footsteps, but had pursued the law instead. His career had prospered and he
was now a partner in large law firm on Collins Street. Tom’s dilemma is that he has neither the time
nor the inclination to manage the shopping centre.
Tom’s interest in selling peaked when he found among his father’s papers an unsolicited offer to
purchase the property for $15 million from a major developer that was dated six months ago. This
was just prior to his father’s diagnosis of progressive cancer. Since the offer was unsolicited, it was
probably a low-ball offer designed to entice his 67 year old father into further discussions. His father
told the developer that “he was not interested at this time.” Tom wondered: What the centre was
really worth? Could it be worth significantly more if redeveloped?
Evergreen Centre
Sam Wolfe was a born in 1948 – a true baby boomer and a true entrepreneur. He opened his first
shop in 1973 at the age of 25: Evergreen Premium Grocery. During his “overseas experience” he had
seem that premium grocery stores and delicatessens could do well in major centres if situated in
affluent areas with sufficient young and upwardly mobile clients. In Evergreen Premium Grocery he
sought to capture this market in Melbourne. His business degree taught him to do his market
research and this told him to locate in one of the leafy suburbs. His business degree also taught him
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to have a solid business plan. His was ambitious. To develop a reputation for excellence with his
small Evergreen Premium Grocery, but to move up to a larger site and possible develop a shopping
centre as soon as practicable.
Evergreen Premium Grocery was not an instant success, but was thriving after five years of hard
work. Sam began looking for a larger site, for financial backers and for a bank that would help fund
the project. Both came together in 1988 with the opening of Evergreen Centre. The centre was
anchored by a significantly enlarged version Evergreen Premium Grocery. The other shops were
selected to complement the grocery and all shops had to meet Sam’s vision of excellence.
The centre had done well from the beginning. The strategy of offering a wide range of quality
groceries in one location became increasing popular over time. Moreover, there was little
competition until recently. Sam paid his debt and financial backers for the project within 20 years.
He did a refurbishment in 2008 (20 years after opening) and has since paid his debt for this. The
centre is currently debt free.
The Property
The neighbourhood centre is located on a rectangular site of 3,504M2. The gross leasable area of
the specialty grocery store and related shops is 1,366 M2 (see Table 1); parking and parking
accessways occupy 620 M2; and 152 M2 is devoted to footpaths and other non-leasable space. The
centre is a classic L-shaped neighbourhood centre, with the specialty grocery located on the foot of
the L, the remaining shops located on the bar of the L and parking is located in the space to the right
of the buildings forming the L.
Zoning regulation requires 3.5 car spaces for every 100 M2 of leasable area or portion thereof. On
this basis, this shopping centre requires 49 car park spaces. Evergreen Centre just meets this
requirement, but any expansion of gross leasable area creates a parking problem.
The parking design results in the following allocation of space.
Parking
Accessway
Total
Spaces
Required
49
49
M2
200
420
620
The Leases
The rent roll in Table 1 indicates that shopping centre’s gross rental revenue is $1,058,818 per year
and has an average rental rate of $775 per M2 per year. This average rental rate is considerably
higher than the $595 per M2 per year for neighbourhood shopping centres in Melbourne as a whole.
However, the average rate in the centre is buoyed up by the $958 per M2 per year recorded for the
specialty grocery store. Since the specialty grocery owns the centre, it does not pay rent. Therefore,
the $958 is not a rent at all, but it is the net revenue from operating the store. Hence, it is the
maximum rent that could be paid for the space. The average rental rate for the other six shops is
$685 per M2 per year. While this is also higher than the Melbourne average, the 15.2% premium is
justified by the shopping centre’s premium location in an upper income area.
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Table 1: Rent Roll
Tenant
Number
1
2
3
4
5
6
7
Tenant
Specialty Grocery
Boulangerie/Pâtisserie
Bakery
Butcher
Seafood
Full Service Restaurant
Cards
Total/Average
GLA M2
450
178
150
127
127
230
104
1,366
Current
Rent
(per M2)
958
800
770
709
625
600
600
775
Current
Rental
431,100
142,400
115,500
90,043
79,375
138,000
62,400
1,058,818
Start
Date
(BOY)
na
2014
2013
2015
2011
2012
2013
2013
Lease
Term
na
5
7
5
5
7
3
5
Years to
Lease
Expiration
na
3
4
4
0
3
0
2
Table 1 also shows that that the shopping centre has signed tenants on varying dates with a mix of 3,
5 and 7 year leases, with the average lease signed in 2013 and being 5 years in duration. One aspect
of the leases that should be noted is that two of the leases are in their last year (0 years to
expiration) and the average lease has only two years to run.
All of the leases are subject to rent review, with the exception of the specially grocer. The dates of
the last rent review, the next rent review, the timing between reviews and type of rental adjustment
on review are given in Table 2. From the table, the leases are reviewed every two or three years and
all of pre-expiration leases are indexed to the Consumer Price Index (CPI) for food and non-alcoholic
beverages. The two lease that are due to expire will be marked to market on lease renewal or if a
new tenant is signed. Data for indexing the CPI indexed leases is presented in the Appendix in
Table 7. Projections of the index are given in the Appendix in Table 8. The shaded area in this table
contains data and the unshaded area contains forecasts.
Table 2: Rent Reviews
Tenant
Number
1
2
3
4
5
6
7
Tenant
Specialty Grocery
Boulangerie/Pâtisserie
Bakery
Butcher
Seafood
Full Service Restaurant
Cards
Last Rent
Review
na
2014
2013
2015
2015
2014
2013
Next
Rent
Review
na
2016
2016
2017
-2016
—
Rent
Adjustment
Timing
na
2
3
3
On renewal
2
On renewal
Type of Adjustment
na
CPI: Food and Non-Alocoholic Beverages
CPI: Food and Non-Alocoholic Beverages
CPI: Food and Non-Alocoholic Beverages
Mark to Market
CPI: Food and Non-Alocoholic Beverages
Mark to Market
The Tenants
Boulangerie/Pâtisserie
A specialty cake and pastry shop had been a fixture at Evergreen Centre since its opening. The
current Boulangerie/Pâtisserie is the second such shop. Emma’s Cakes was the first shop, but Emma
retired in 2013 and was replaced the current proprietor in 2014. While Emma’s Cakes had been a
successful business, the current product line for the Boulangerie/Pâtisserie has been dubbed “too
French” and “just not Emma” by some of the centre’s patrons. Evergreen Centre management need
to help this proprietor achieve success.
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Bakery
This bake shop focuses on artisan breads. Originally, Evergreen Premium Grocery supplied quality
breads made by bakers in Melbourne. However, artisan bread has become popular with customers,
so the centre approached a locally recognized baker and persuaded him to open a shop in 2013 on a
7 year lease. The shop has been an immense success and a considerable draw for the centre.
Butcher
The standalone butcher shop opened in 2015. Standalone butcheries have disappeared from many
shopping centres, replaced by vac-packed meats in your local supermarket. However, in the tide is
turning as more customers are worried about the use of growth hormones and other drugs in meat
production and as other customers worry about the quality of life for the animals themselves. The
birth of high-end butcher shops featuring quality meats began in the US and UK over five years ago.
The butcher in Evergreen Centre is in this mould. The initial response to this shop has been weak,
but this is a new venture that may fare better over time. BBQ season is coming. This will be a test.
Seafood
The standalone fishmonger is also a new venture designed to capture the market for quality
seafood. It opened in 2011, but has struggled. Customer surveys reveal that a significant number of
the centre’s patrons appreciate the shop, but even more would like the shop to do classic Australian
fish and chips. Sam Wolfe refused to allow this and made it a condition in the lease that proprietor
not become a “chippy.” He saw this as diluting his vision of excellence. In addition he suspected
that full service restaurant would object.
Full Service Restaurant
The restaurant is operated by Stavros, a friend of Sam Wolfe. The restaurant opened with the
centre in 1988. It has been a steady performer. It does especially well in the summer months when
it provides al fresco dining in its courtyard at the tip of the L in the centre. Sam always saw this as an
oasis of calm for the patrons of Evergreen Centre. A food court was not in Sam’s vision. While the
restaurant trades well, Stavros is 64 years old and may soon retire. The death of his friend Sam may
tip the balance.
Cards
Evelyn’s Card and Curios is another long-time tenant. The shop was added to the centre to provide a
service for patrons seeking last minute cards and gifts. It traded well for many years, but its
customer base has been declining. The original proprietor sold out in 2012. The new proprietor
lacks imagination and the shop struggles financially. One of Sam’s last acts before his illness was to
ask his real estate broker to look out for a replacement for Evelyn’s.
Tom’s Assumptions
1. Tom assumes that his specialty grocery will increase net revenue at the rate of food and
non-alcoholic beverage inflation. Tom questions the approach of booking net operating
revenue as rent in the financial analysis as done by his father. He believes it is overstates
gross potential income because net operating revenue includes a return to equity.
2. Evergreen Centre has always signed triple-net leases with its tenants and Tom plans to
continue this.
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3. An examination of the rent roll shows that all of the leases expire during the cash flow
forecast period. After examining his father’s notes in the tenant files, Tom believes that
there is a small chance that some of the tenants may not re-sign leases at the end of their
tenancy. His best estimates of the probability that a tenant will relet are given in the
Table 3.
Table 3: Re-lease Probabilities
New
Lease
Tenant
Years
Boulangerie/Pâtisserie
2019
Bakery
2017
Butcher
2020
Seafood
2016
Full Service Restaurant
2019
Cards
2016
Prob. of
Relet
80%
100%
70%
25%
60%
60%
4. If a tenant relets, the centre must renegotiate the lease. Tom believes that all leases should
be marked-to-market on lease renewal. However, this may increase the chance that the
tenant vacates the property. This is a judgement call that will be made at the time of
negotiation. In the valuation, Tom must decide to estimate value based on his market-tomarket view or suggest a different rent position.
5. Table 3 gives the probability that a tenant will renew at the end of the current lease. Some
leases will terminate twice during the forecast period. Tom must decide and justify a
probability of re-lease for these subsequent re-lease times.
6. The centre has always employed a commercial broker to help find new tenants and to help
negotiate new leases. A commercial broker charges 3 per cent of the total value of the lease
as commission. The total value of the lease is the simple sum of the rents to be paid by the
tenant over the term of the lease.
Technical Note: To help with setting rents and determining broker commissions, a rent
calculator and a commission calculator are supplies along with the assignment in the
spreadsheet Rent and Commission Calculators.
7. Tom has decided to follow the top-down approach to determining the potential for vacancy.
He consults a local real estate advisory to obtain estimates of the market vacancy rate from
2015 to 2015. These are given in the Table 4. In addition, the real estate advisory informed
him that there are 112,593 M2 of neighbourhood shopping centre space in his market area
other than Evergreen Centre and that there was no foreseen development of space until
2018/19 when about 2,500 M2 might be constructed.
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Table 4: Projected Market
Vacancy Rate
Year
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
Projected
Vacancy
Rate
2%
2%
3%
4%
5%
5%
5%
5%
5%
5%
5%
8. The financial statements for Evergreen Centre reveal the following centre expenses.
? Property taxes are levied at the $2.50 per $1,000 of net annual value, where net
annual value is the assessment of the net rental income from the centre. This value
is equal to effective gross income less the land tax insurance and maintenance costs.
The current state government has capped property tax increase by the rate of
inflation.
? Land tax for a property of this value is equal to$24,975+2.25%×Land Value. Land
value is approximate 60 per cent of the value of the property, so Land tax ?
$24,975+2.25%×60%×Property Value.
? The remaining cost figures come from the centres financial accounts.
? Tom will have to hire a top-fight grocery store manager to replace his father. The
current salary of a good, experienced manager is $100,000 per year and manager
salaries have increased by 2 per cent per year recently. Tom muses: Should the
manager’s salary have performance incentives?
? Technical note: The property taxes and land tax are approximated in Table 5
because they depend on the calculations. Start with these figures and replace the
approximate values with your own calculations later. In addition, since property
value is what you are trying to determine, the land tax cannot be determined until
you complete the preliminary valuation. Once you have a preliminary valuation,
substitute the formula and change your Excel options to enable iterative
calculations.
Table 5: Expenses
Base year expenses
Property rates
Land tax
Insurance
Maintenance
Administration
Total
$ $ per M2
4,000
2.93
250,000
183.02
35,000
25.62
175,000
128.11
20,000
14.64
484,000
354.32
Cost Inflation
2.5% per year
2.5% per year
5.0% per year
3.0% per year
5.0% per year
9. There are no expense reimbursements.
10. After a property inspection and discussions with tenants and staff, Tom realizes that centre
has not been refurbished since 2008. The centre is still in good shape, but many small things
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need to be attended. He estimates that an immediate expenditure of $250,000 is needed to
cure these deficiencies.
11. During his meetings with tenants, several tenants note that the local competition from the
high street is increasing and Evergreen Centre will have to pick up its game just to stay even.
Tom believes that at least $5 million will be need for a refit (including tenant incentives
during the refit). The refurbishment will take planning and council permissions will be
needed. The earliest date for the refit would be 2018. Tom plans to borrow as much of the
refurbishment cost as possible and to pay off the balance within five years (assume a 5 year
fixed rate mortgage.).
12. To complete the analysis, Tom used the following rates.
Table 6: Rates and Percentages
Rate
Appreciation rate
Going-out cap rate
Sales costs
Borrowing rate
Maximum LTV
Return to equity
Required rate of return
Per Cent
3.00%
8.00%
2.00%
8.50%
80.00%
7.50%
7.75%
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Appendix:
Table 7: CPI Indexed Leases
Percentage Change
Tenant
Number
1
2
3
4
5
6
7
Tenant Name
Specialty Grocery
Boulangerie/Pâtisserie
Bakery
Butcher
Seafood
Full Service Restaurant
Cards
CPI on Rent
Review
na
102.20
101.30
103.90
103.90
102.20
101.30
CPI
Today
(June
2015)
na
104
104
104
104
104
104
Years Since
Review
na
1.5
2.5
0.5
0.5
1.5
2.5
Figure 8: CPI Projections
Year
F&B CPI
2013 101.3
2014 102.2
2015 103.9
2016 105.0
2017 106.6
2018 108.2
2019 109.8
2020 111.4
2021 113.1
2022 114.8
2023 116.5
2024 118.2
2025 120.0
Since
Last
Review
na
0.98%
0.94%
-0.38%
-0.38%
0.98%
0.94%
Past 5
Years
1.53%
1.53%
1.53%
1.53%
1.53%
1.53%
1.53%