Feasibility Study Of A Commercial Building Case Studies Example

Introduction

This is a case of a proposed commercial building, the Nergis Project that is being proposed to be established in one of the prime locations in Erbil, Iraq. The land in which the proposed commercial building is to be located is owned by Balla Company as of the moment. Balla managed to obtain this plot of land from the Kurdistan Region Government (KRG). The plot of land, being located in one of the busiest locations in the city had seven potential buyers, each of which have a particular interest in the possibility of establishing a towering commercial building in the area and earning a stable and handsome profit from it as it is indeed located in one of the main entrances of the city.
However, it appears that among those seven interested parties, only Balla Company managed to get KRG’s approval to buy the plot of land. One of the major reasons why the right to buy the auctioned land was awarded to Balla is because it agreed to abide by the KRG’s policy which requires it to allocate 75% of the land it purchased for green area and amenities and to allocate the remaining 25% to whatever type of building it wants. The total area of the land is around 44,000 square meters. This means that 11,000 square meters from this or roughly 1.1 hectare can be used for commercial and business purposes. Compared to most commercial buildings, this lot size allocation, no matter how small, can still be considered a plus for Balla because 11,000 square meters of land in a prime location in the city is a lot. It can in fact, use it to construct not just a single commercial building but a commercial building complex of two or even three buildings.
Despite the fact that Balla now owns the land, it faces a huge financial dilemma. Basically, before it can turn that piece of land located in a prime location into a revenue-generating business model, it has to be developed first. That is, a structure has to be built first. What the CEO of Balla plans to build in that area is a commercial building that has an in-building shopping mall and hypermarket, as well as commercial and office spaces for lease. Basically, these would be the main revenue-generating components of the proposed commercial building. However, in order to construct a building that grand, it needs to partner with another company or an investor who will provide Balla with the necessary financial support and funding to construct the building. Luckily, one party showed interest in working with Balla to develop the land and construct a commercial building.
Jean Magit, the expansion manager of a French hypermarket operator named Auchan, expressed his company’s interest in working with Balla in developing the land and constructing a commercial building. Sangar Khayat, the CEO of Balla, knows that he would need the help of an organization like that of Jean Magit for his plans to materialize. Just as the talks were ongoing between Khayat and Magit, another proposal came, this time from a representative of SI Retail, the investor group and retailer of Auchan in Iraq, the mother company of SI Retail in Iraq. This has led to the creation of another dilemma for Balla.
Basically, its CEO and board of directors have to discuss which proposal they are going to accept: the proposal from the SI Retail or from Auchan’s French Hypermarket chain? In this case study, the authors will discuss the different aspects that the Balla’s CEO must consider before making a final decision such as the expenses associated with the proposal, the revenue splitting mechanism after the commercial has already been finished, the payback, and the Net Present Value (NPV) of the building after five years based on the annual potential cash flow that the proposed commercial building may generate.

Literature Review

There are many ways how an individual can invest in the real estate market. Some of the common strategies that an individual or an institutional investor might make use of include but may not be limited to flipping a real estate property—that is, buying a property for a low price (i.e. introductory or pre-selling price) and then selling it later on after its total contract price considerably appreciates, renting the property out to residential tenants, or in the case of commercial buildings, renting out the office and commercial spaces where smaller businesses who want to get exposed to high foot traffic. Between the three, the third option appears to be the one of the most popular, if not the most popular.
There can be many reasons behind this. Firstly, it may be due to the fact that the third option allows the owners of the commercial building to have a secured stream of revenue. That is, they get to have a guaranteed form of revenue from the tenants of the office, store, and other commercial spaces they are renting out of their total commercial building’s floor area. Revenues generated from rent can be classified as a form of passive income mainly because they get generated even without any form of active supervision from the person or entity who owns the building.
This is, in fact, one of the main reasons why commercial building and space owners prefer to rent out their properties instead of selling them for even a price that is several folds higher than the buying price. Just like the price of real estate properties and other commodities, rent goes higher. However, it is important to note that rental prices also depend on the overall trend in the real estate market and that it may also be significantly affected by changes in the supply and demand curves.
This means that in economic cycles where the supply for rental properties greatly exceeds the demand, it may be safe to say that the rental prices may experience a sharp downturn, depending on how great the imbalance between the supply and demand for rental property is. These are some of the things that investors (i.e. commercial building owners including the prospective ones) must consider prior to engaging in a business process that aims to generate revenue either from selling commercial spaces or renting them out.
The principles of macroeconomics dictate that the law of supply and demand prevails in any type of commodity market, including the real estate industry. This has been supported in numerous literatures about the commercial office rental industry and from a larger scale, the real estate industry . In a study published in the Economic Journal in 2008, the authors examined the effects of office supply restrictions in one of the prime locations for offices in the United Kingdom .
However, that is not to say that the law of supply and demand should be the only variable or determinant that investors in the real estate industry must consider when making their investment decisions. For one, there are numerous ways how the rental prices for commercial properties and spaces may be determined. In an academic journal published in the Journal of Real Estate and Finance Economics in 2008, for example, the authors examined the possibility of using space syntax in understanding and determining intra-urban office rent prices and patterns . In order to arrive at an objective finding the authors used a trans-log hedonic model to solve a firm’s cost minimization problem—in order to test the space syntax usability. The results of their analysis showed that there is a good predictive power in explaining the variation in the log of the rent.
Just like in any other market or industry, knowing the market trend and from a more macro perspective, the characteristics of the present economic cycle are an important step to consider. In the commercial building and real estate industry, for example, there are certain trends that materialize as a result of the new and amended policies by regulatory and standardization bodies have passed and the changing market tastes and preferences for commercial building (e.g. changes in designs, specifications, features, and utilization) . One good example of a recent trend in the commercial building and real estate industry would be the continuously increasing prevalence rates of eco-labeling in the commercial office markets such as the ones hosted by organizations Leadership in Energy and Environmental Design (LEED) and Energy Star.
In general, the aim of eco-labeling standards such as the ones being regulated by these two organizations is to make the new and current commercial buildings more environmentally friendly and operationally sustainable—again from an environmental perspective. Naturally, buildings that are more environmentally sustainable and friendly would be given higher ratings. In a study published in the Journal of Ecological Economics, the authors investigated the effects of eco-labeling in commercial office markets on the rental prices of office and commercial spaces .
Another major consideration that individuals and institutions that are planning to invest a significant portion of their portfolio in constructing a commercial building would be the underlying regulations in the country or city where the building will be constructed . Commercial building regulations vary from country to country and at some point from city to city . Therefore, some countries or cities may be more business friendly than the others. Naturally, businesses and investors will flock towards the direction of the country or city that has a more lax set of commercial building regulations.
High property tax rates, for example, can be seen by prospective commercial building owners and corporations as a hurdle for establishing one in a particular country or city. In an article published by the Lincoln Institute of Land Policy in 2007, for example, the authors discussed the property taxes in developing countries and their possible impacts in the commercial building and real estate industry. All in all, the authors agreed and concluded that the increased accountability associated with decentralization of commercial building and real estate property tax regulation can only be assured when sub-national governments have an adequate level of autonomy and discretion in raising their own revenues . Nonetheless, this still supports the popular notion that high property tax rates are considered by commercial building owners as an obstacle in maximizing revenues.
Naturally, they would want to construct their commercial building in a country that has a lower property tax rate. After all, the reason why these individuals and institutions raise towering commercial buildings from the ground up is to generate profit and profits would certainly be affected negatively as a result of an above average property tax rate. In a book published in John Wiley and Sons database in 2009, the authors examined an information model mechanism for commercial and other types of buildings in an attempt to help architects, engineers real estate asset managers, and contractors have a more integrated set of information from which they can base their future projects on and even address the current real estate and commercial building problems plaguing the current ones established in any geographical location .
What the author presented is a framework for making the management and even the maintenance of commercial and other real estate properties in their target location. This can indeed be a good way to lower the impact of strict regulations such as skyrocketing property tax rates and even building revenue income taxes that certain government administrations impose.

Conclusions

Based on the two Company’s proposal, Balla’s CEO has two options. SI Retail basically plans on developing a higher, larger, and more expensive commercial building with a total cost of more than 67 million USD compared to that in Auchan Company’s proposal which only costs more than 27 million USD. Naturally, because of the larger floor area that the commercial building proposed by SI Retail, it is going to be the one that would be more profitable over the long run. However, one major downside of choosing this option would be the high initial cost of constructing the building which is almost three times the cost of the commercial building proposed by Auchan Company.
If Balla is after long term expansion and profitability and does not mind the high initial cost of constructing a larger, higher, and more modern building, then it should go with SI Retail’s proposal. By year five, the company’s proposed commercial building would have a cash flow of more than 80 million USD which is almost double the cash flow of Auchan Company’s proposed commercial building which by year five is only expected to be at a little over 48 million USD. All in all, the short and long term computations and forecasts suggest that Sangar Khayat must choose SI Retail’s commercial building proposal.

References

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