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You are part of the property funds management team with a major institutional investor. You have been asked to prepare a strategic report for consideration by your property investment executive team. Prepare a 10-page report (maximum) for the establishment of a new $500 million property fund.

Overview of Sunrise Property Fund

The Sunrise Property Fund will be aiming at investment areas in the residential and commercial properties in Australia. The investment areas where the company will be primarily focusing is on the commercial property where the fund structure would be primarily investing into the commercial properties and leasing the same (Hoesli & MacGregor, 2014). The source of revenue for the company will be coming from the sale of commercial properties and the leasing income generated by the leasing of the commercial properties of the assets held by the fund. The 500 million fund would be used in the residential and commercial properties by the sunrise property fund. The weightage given for the residential commercial area would be the highest around 60% of the total fund would be invested in the residential properties that is 300 million dollars and 200 million dollars would be invested in the commercial property. The revenue for the company will be growing at an average growth rate of around 5% p.a.. The growth in the 500 million property fund will be significantly depending on the economic and the business factor  under which the fund will be operating. The reason for selecting the commercial and residential property for the purpose of the investment is the growing Australian Property market. The favorable macro-economic conditions and the sustainability of the return generated from the property market is the key reason for selecting the specific fund style (Grimaldi et al. 2015). The key customers for the fund will be the commercial users and the high premium residential property buyers for the fund. The key focus for the company is to identify and explore the property market and alternatively identify the various sources of revenue generation for the company. The benefits for investing into the fund will be the diversification benefit the fund will be providing into the commercial and residential areas and the sustainability of the income would be insured by the income generated in the form of rent and rates collected from the leased property (Stobbs & Biernacki, 2017).

Investment Objective

Sunrise Property Fund will track a record of around 5%p.a on the average five-year investment period.

Fund Overview

The Sunrise Property Fund will be aiming at investment areas in the residential and commercial properties in Australia.

Investment Manager

Sunrise Investment Group

APIR Code

MF000789AU

Property Type

Commercial and Retail Property

Investment Type

Closed Ended, Unlisted property Type

Status

Open for Investment

Equity Target

$500,000,000

Management Cost

1.2% p.a

Team Experience

20 years

Investment Approach:

  • Active Management
  • Risk Management
  • Diversification

Asset Allocation

Location

Allocation

Sydney

50%

Melbourne

30%

Brisbane

20%

  The investment vehicle in which the Sunrise Property Fund will be investing is into the Australian Residential and Commercial Properties. The residential and the commercial properties in the Australian economy has the potential for growth and the same could be seen by the past trend growth rate of the company. The property will be focusing on the leasing services of commercial, residential property, and not directly engaging with the buying and selling of the properties (Weatherill et al. 2015). The 500 million property fund will be invested in the ratio of 60:40 ratio where the source of income generation for the company will be from capital gains and dividend income. 

Investment Approach

The fund primary objective will be identification of the key areas and the type of properties demanded by the customers. The same would enable the property fund managers identify the crucial factors for the progress of the company and the growth rate of the fund. The funds business will be comparatively less risky from direct investment into commercial and residential services as the income generated will be from leased properties. The income generated will be distributed to the unit holders of the fund in proportion of the units held by them (Poon, 2017).

The financing structure for the company will shows the amount of debt or equity exposure for the fund. The unit holders or the equity sources, which will compose of 80% of the overall capital of the company, will fulfill the fund primary requirement for the capital (Chandra, 2017). The debt exposure for the company will be done in order to get the tax benefit from the income generated by the fund, which will help the company have a lower effective tax rate (Chandra, 2017). The financing structure for the company will be on the basis of 80:20 ratio that is through equity and debt sources. 

The Property Portfolio will be constructed between the two key areas, which will comprise of the residential and commercial property group. Diversification is the key issue, which the fund will be facing; the fund should explore various other areas of asset class so that the sources of revenue generation for the company are diversified (Enever, Isaac & Daley 2014). The key risk analyzed in the fund pertaining to the business risk is the volatility in the leasing structure of the property revenue generated and the changing macro-economic structure of the economy.  The sustainability in the level of inflation and the rising GDP of the economy may be some of the key factors, which the fund should undertake while analyzing the prospect of the fund. The exposure of the debt with the cost escalation associated with property market are some of the key business risk, which the company should evaluate (Liao et al. 2015).

 The risk management of the fund will be done after the analysis of the key factors of the fund and the sensitivity factors for the fund, which influence the operations of the fund. The use of the sensitivity analysis is the key risk assessment tool, which the company should use which should incorporate the level of inflation, rent and rates structure and growth of the property market. The leasing structure designed by the fund should be such so that the same remains within the best interest of the fund in terms of changing business conditions and macroeconomic environment.

Asset Allocation

Sunrise will strictly adhere to the rules and regulations of the fund and certain other regulatory and legal compliance, which the company will be following. The fund should well operate within the mentioned rules and regulations of the company such as the fund should follow the primary objective of leasing property and should not engage in buying/selling properties. The same can affect the financials of the company but in the long term sustainability will be the key issues faced by the company unit holders in the form of income generation. 

The performance of the property market is highly correlated with the performance of the economy and the other macro-economic conditions. Key macro-economic factors like the level of interest rate in the economy, inflation forecast and the growth rate of GDP in the economy are some of the ley macro-economic factors, which the fund should take into consideration for deciding the future prospects of the company.

The future prospect of the company is highly dependent on the demand for the commercial and revenue properties created by the customers, which will in turn derive and generate the revenue for the fund.  The sustainability of the company will be seen, as the lease contract the fund will be offering for the property leased will be on a long-term contractual basis with several changes and modification in terms of maintenance cost and cost escalations clauses, which will be reviewed annually by the fund. Moderate inflation and the rising Australian economy would better incorporate the growth prospect of the economy (Smit, 2018).

The management of assets in the form of leasing the properties and maintain the leasing structure such as continuity of the services is the key issue which the fund may face. The business risk for the fund is the only prime concern which the fund should consider and evaluate other alternative strategies for the same. Leasing Structure and the agreement by the fund in the terms of the management of the properties are the critical issue, which the fund should undertake and evaluate.

The fund performance is predicted to remain sustainable depending upon the business structure of the fund. The growth for the company is primarily dependent on the performance of the company and the business environment of the fund. The level of interest rate for the fund is expected to remain sustainable which will be in favor of the fund. The fund is expected to outperform the benchmark index of S&P 500 Australian REIT Index. 

Financing Structure

The Charter Hall Residential Real Estate Investment Trust invests in Commercial Australian Supermarkets, which are primarily located in the metro and non-metro areas. The portfolio for the fund is highly diverse with different kind of commercial properties, residential, logistic and industrial properties under the portfolio of property. The property portfolio for the fund is distributed in all over the regions of the Australia where the demand for such properties are the most. The top tenant for the fund is the Woolworths Company, which contributes the highest amount of rental income for the Company. The primary significant objective for the REIT is property investment and the company has remained the core business activity since the incorporation of the same. The REIT considers various business and macro-economic conditions of the property before the investment into portfolio of properties. The primary assessment of the property include the assessment of the environment under which the property is situated, the geographic diversification of the portfolio and the long term demographic trend growth rate of the investment to be done are some of the factors to be considered before the evaluation of the investment. The key assets of the REIT includes the range of commercial, residential and industrial property where the value of the same changes with the changes in the economic conditions and the business factors under which the property operates.

The profit and loss statement for the company was forecasted for the Charter Hall Residential Company by looking at the past performance of the company in the past five years. The average growth rate was analyzed for the company and the various business conditions and the macro economic conditions like the level of interest rate, inflation rate in the economy and the growth rate of the Australian GDP are some of the key factors that were analyzed in the evaluation of the income statement for the company (Hasan et al. 2016). The revenue forecast for the company primarily depends on the tenancy collected by the fund in the form of rent and rates collected and the forecast for the same depends on the increase in the total assets of the company. The key expenses for the company is the operating expenses, which the company has to spend on the maintenance of the various kind of property group the fund has under the portfolio of properties. The company has a good amount of debt financing done in the form of long-term debt financing used by the company. The interest burden for the company also stand out to be the key expenses for the company as the level of debt exposure for the company stand out high. The same increase the financial risk for the company and as the business risk for the company it is advisable for the company to reduce the level of debt so that the financial risk of the company remains low. The Company has also sources for income from different sources other than the income earned from collection of rent and tenancy (Wu et al. 2016). The average profitability for the company was evaluated by taking into consideration the past five year financials trend for the company. The Earnings per share of the company was seen considerably grow at a constant growth rate of about 10% p.a. The outstanding share for the company also did not showed any major changes as the shares outstanding for the company on an average changed only about 2-3%p.a. The balance sheet of the company was also evaluated based on the average annual growth rate provided by the company in the past five year trend analyzed.  The changes in the non-current assets of the company which primarily constituted the properties did not show major changes for the company and the same grew about 5-6%p.a. annually. The annual growth rate of the receivable for the company has decreased, which shows a positive impact for the fund that they are been to realize the due amount more efficiently from the debtors of the company (Peng et al. 2017). The liabilities of the company includes the long term borrowings of the company which on an average has been increased by the company. The increase in the debt financing is expected to increase for the fund as the operations of the fund continues to grow. The common stock of the company also increased by about 1.23% on an average basis for the trend period analyzed. The same was forecasted for the company that the increase in the same will be at an average growth rate of about 1.23% p.a.

CHARTER HALL RESIDENTIAL REIT  BALANCE SHEET

Particulars

2019 (F)

2020 (F)

2021 (F)

2022 (F)

2023 (F)

Assets

Cash and cash equivalents

67540

74294

81723

89896

98885

Receivables

12668

12345

12031

11724

11425

Other assets

2868858

3053818

3250704

3460282

3683373

Total assets

2949066

3140458

3344458

3561902

3793683

Liabilities and stockholders' equity

Short-term borrowing

Long-term debt

1026143

1132103

1249004

1377977

1520268

Payables and accrued expenses

98994

105148

111685

118628

126002

Other liabilities

43700

38424

33785

29706

26119

Total liabilities

1168836

1275674

1394473

1526310

1672389

Stockholders' equity

Common stock

2285691

2313824

2342304

2371134

2400319

Other Equity

-

-

-

-

-

Retained earnings

-520880

-484320

-450326

-418718

-389329

Accumulated other comprehensive income

Total stockholders' equity

1764811

1829504

1891978

1952416

2010990

Total liabilities and stockholders' equity

2933647

3105178

3286451

3478726

3683379

Property Portfolio Construction Issues

CHARTER HALL RESIDENTIAL REIT  INCOME STATEMENT

Particulars

2019 (F)

2020 (F)

2021 (F)

2022 (F)

2023 (F)

Revenue

237131

248042

259455

271393

283880

Expenses

Operating expenses

90594

94663

98915

103358

108000

Sales, General and administrative

Total expenses

90594

94663

98915

103358

108000

Operating income

146537

153379

160540

168035

175880

Interest income

200

200

200

200

200

Interest expenses

-40495

-44561

-49035

-53959

-59377

Other income (expense)

42748

42497

42247

41999

41753

Income before income taxes

148989

151514

153952

156275

158456

Net income from continuing operations

148989

151514

153952

156275

158456

Net income from discontinuing ops

-

-

-

-

-

Net income

148989

151514

153952

156275

158456

Net income available to common shareholders

148989

151514

153952

156275

158456

Earnings per share

Basic

0.40

0.44

0.48

0.53

0.58

Diluted

0.40

0.44

0.48

0.53

0.58

Weighted average shares outstanding

-

-

-

-

-

Basic

414846

426089

437637

449498

461680

Diluted

414846

426089

437637

449498

461680

EBITDA

189071

195130

201383

207836

214496

The valuation of the stock was done using the dividend discount model to determine the value of the share price of the company. The share price for the company was taken for the last five year and the required rate of return was calculated for the stock using the formula:

Required Rate of Return: Risk Free Rate of Return + (Beta*(Return on Market- Risk Free Rate of Return)).

The benchmark considered for the calculation of the beta of the stock with respect to the benchmark fund was the ASX 200 REIT Index. The risk free rate of return taken for the fund was the ten year government bond yield which was around 2.64% that was taken as the risk free rate of return for the analysis portion. The return from the stock was around 11.99% which was evaluated after taking the five year performance of the company (Cornell, 2016). The beta for the stock was around 0.88 times which shows that the performance of the stock was highly correlated with that of benchmark performance. The risk associated with the company was calculated using the standard deviation of the stock. The dividend discount model analysis was forecasted for the five stage period which incorporated the use of forecasted dividends and the application of the same in determining the same. The terminal cap rate is the consistent growth rate taken for the company. The terminal cap rate was calculated for the company using the formula:

Terminal Cap Rate: Retention Rate* Return on Equity

The terminal cap rate was calculated for determining the terminal value of the valuation. The fair market value of the share price of the REIT was generated to be around $ 5.54. However it is crucial to note that the actual trading share price of the company was around $ 4.40 which shows that the actual value of the company is actually less. The derived market value of the REIT was much higher than the trading value of the company which shows that the potential of the company for better future prospects and growth is high.

Forecasted Share Price of CRF

Average Annual Return

11.99%

Standard Deviation

4.17%

Beta

0.880357482

Risk Free Rate

2.64%

Return on Market

7.97%

Required Rate of Return

Rf+(Rm-Rf)*B

Required Rate of Return

10.87%

Dividend Discount Model

Discount Rate

10.87%

Terminal Cap Rate

10.19%

DCF Analysis through NPV Method

Year

2018

2019 (F)

2020 (F)

2021 (F)

2022 (F)

2023 (F)

DPU (Cents per Share)

0.36

0.40

0.44

0.48

0.53

0.58

Step 1: Year 2022 Terminal Value

5.69

Step 2: Total Cash Flow

6.05

0.40

0.44

0.48

0.53

Step 3: Market Value Per Share

7.46

The future prospect of the company looks good with the growing profitability of the company and the sustainability in the operating income of the company. The forecasted revenue for the company seems to be growing and the growth trend for the same was seen increasing. The fair market value of the company was also high than the actual trading price of the stock which shows the relative undervaluation of the share price. The fund is diversified with the various kinds of commercial, residential and industrial properties which will help the REIT increase the property portfolio diversification reducing the unsystematic risk of the fund (Lane & Rosewall, 2015). 

Reference

Chandra, P. (2017). Investment analysis and portfolio management. McGraw-Hill Education.

Cornell, B. (2016). The Tesla run-up: A follow-up with investment implications.

Enever, N., Isaac, D., & Daley, M. (2014). The valuation of property investments. Estates Gazette.

Grimaldi, M., Cricelli, L., Di Giovanni, M., & Rogo, F. (2015). The patent portfolio value analysis: A new framework to leverage patent information for strategic technology planning. Technological forecasting and social change, 94, 286-302.

Hasan, M., Zhang, M., Wu, W., & Langrish, T. A. (2016). Discounted cash flow analysis of greenhouse-type solar kilns. Renewable Energy, 95, 404-412.

Hoesli, M., & MacGregor, B. D. (2014). Property investment: principles and practice of portfolio management. Routledge.

Lane, K., & Rosewall, T. (2015). Firms’ investment decisions and interest rates. Reserve Bank of Australia Bulletin. June quarter, 1-7.

Liao, W., Veeramachaneni, S., Quick, G., & Vachher, A. (2015). U.S. Patent No. 9,110,971. Washington, DC: U.S. Patent and Trademark Office.

Liu, L., & Cao, C. (2014). Who owns the intellectual property rights to Chinese genetically modified rice? Evidence from patent portfolio analysis. Biotechnology law report, 33(5), 181-192.

Peng, H., Li, D., Abboud, K., Zhou, H., Zhao, H., Zhuang, W., & Shen, X. S. (2017). Performance analysis of IEEE 802.11 p DCF for multiplatooning communications with autonomous vehicles. IEEE Transactions on Vehicular Technology, 66(3), 2485-2498.

Poon, J. (2017). Engaging sustainability good practice within the curriculum design and property portfolio in the Australian higher education sector. International Journal of Sustainability in Higher Education, 18(1), 146-162.

Smit, H. T. (2018). The flexibility value of strategic investments under competition. In New Directions in Finance (pp. 240-253). Routledge.

Stobbs, G. A., & Biernacki, J. V. (2017). U.S. Patent No. 9,710,457. Washington, DC: U.S. Patent and Trademark Office.

Tarnaud, A. C., & Leleu, H. (2018). Portfolio analysis with DEA: Prior to choosing a model. Omega, 75, 57-76.

Weatherill, G. A., Silva, V., Crowley, H., & Bazzurro, P. (2015). Exploring the impact of spatial correlations and uncertainties for portfolio analysis in probabilistic seismic loss estimation. Bulletin of Earthquake Engineering, 13(4), 957-981.

Wu, J., Al-Khateeb, F. B., Teng, J. T., & Cárdenas-Barrón, L. E. (2016). Inventory models for deteriorating items with maximum lifetime under downstream partial trade credits to credit-risk customers by discounted cash-flow analysis. International Journal of Production Economics, 171, 105-115.

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