Lance Johnstone: Developing 3000 North Broad Harvard Case Solution & Analysis

Larry Johnstone
How would you evaluate Johnstone’s investment thesis? What are some of the risks?

Johnstone’s thesis can be evaluated by looking at the IRR, either that is higher than the cost of capital or not, if it is higher than the cost of capital then Johnstone should pursue this project and if it is lower than the cost of capital then Johnstone should not pursue this project.
In the 10 year cash flows, the IRR is 8% and the cost of debt is 7.25%, IRR is higher than the cost of debt, so it is beneficial to pursue this project.
The risks can be the rental projections, company has charged $1800 for the three bed room and $2400 for four bed room. It seems over estimated as the average rent for the three bed room is $1475, mentioned in the table A of case.
What are some of the strengths and weaknesses?
• Strengths
The plan developed by the Johnstone seems to be solid for this property, both the partners Johnstone and Galloway have conducted a detailed research on zoning and regulatory basis.
They have hired contractor who would be responsible for the construction plan of the project.
However the proposed plan for the development of buildings has been approved by the city, the bank loan has been approved of $1.7 million for the development of property.
Another strength is that the new property is situated in the hometown of Johnstone and he has conducted detailed due-diligence for the property.
He has talked to the people at the temple, about the future plans, he has also visited the whole place.
The university has 34,000 students, they have the housing shortage of the graduate students and it is the opportunity for Johnstone to grab that market.
• Weakness
The first weakness is the estimation of potential rent by Johnstone that was over optimistic. The average rent around that area is $1475 for the three bed room, but company is charging $1800 for three bed room and $2400 for four bed room.
Moreover the area is still full of many collapsing buildings and vacant lots.
Discuss his equity structure and his deal with Galloway. What issues/risks present themselves with this structure?
The total cost of project is estimated at $2,700,000 including construction budget of $2,075,000, land of $257,000 and soft costs of $368,000. Soft costs include insurance, survey, market and feasibility study, legal, taxes and other costs. Larry decided to invest $800,000 and the reaming amount of 1.9 million dollars will be taken from bank as a loan on 6.75% interest rate for 30 years with the monthly mortgage payment of $12,323. If we evaluate this capital structure, 70% of equity is the loan from the bank considered as liabilities and that amount is $1.9 million and only 30% is Larry’s own equity with the amount of $800,000.............

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