In September 2003, John DeRight and Judy DeRight, both cousins, decided that they both wanted to invest in real estate. The cousins felt that real estate would allow them the “benefits of diversification, protection from future inflation, and tax advantages.” John, a risk averse person, was a retired businessman and was willing to spend $9 million in this investment. John would rely on stock dividends and other income that totaled approximately $1 million. On the other hand, Judy was a risk tolerant businesswoman who owned her own chemical company and had $16 million of funds available for investment. Judy’s after-tax income came out to be approximately $1.1 million.
The cousins contacted Angus Cartwright …show more content…
Based on calculations, 42.5% of total benefits will be derived from cash flow while 66% of total benefits will come via future value. This property has the lowest after tax cash flow but has the highest increase in capital value, gain on sale, capital gains, tax benefits. Of the four properties, the Fowler Building will have the least amount of taxes paid per year and taxable income per year.
Recommendation John should invest in Alison Green. It has a higher IRR than Stony Walk, but is actually less risky than Stony Walk. Since John is a risk averse person, this makes the most sense. John’s primary requirement for a property was that it be large and that the return is at least 12% after tax. Alison Green meets both requirements and is the least risky because it is a fully constructed property. In addition, it has a 74% before tax cash flow, which makes this property less risky because John will get a portion of the benefits upfront every year. Alison Green also has the lowest breakeven which indicates that even if the market is weak, it still remains profitable. Of the four properties, Alison Green has the highest debt coverage ratio (2.0), meaning this investment has the highest ability to generate enough income to cover the mortgage payments and operating expenses, in addition to 100% more income than is required.
Judy should invest in Fowler Building because it has the highest IRR of 15.38%. Since Judy is risk tolerant,