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In May of 2008, Roberto Charvel sees an opportunity to buy a residential property in his hometown of Mexico City. The building is located at 510 Seneca, in Polanco, a luxurious, urban neighborhood in the city. Built in 1954, the purchase price for the five story, nine-unit residential building is listed at Mex$14.7 million. In addition to purchasing the property, renovations are planned due to the age and poor upkeep of the building. The planned purchase would be taking place during a time of economic crises and financial uncertainty. The acquisition of the 510 Seneca building should not be pursued due to the 2008 financial economic crises. At the time of purchase, the valuation of the building is overpriced for the questionable income stability, extensive renovations required, and for the uncertain future occupancy plans.
The acquisition of 510 Seneca will not be financially beneficial at its current valuation due to the real estate market’s collapse that occurred in 2007. In short, the high-priced United States housing market began to take a steep turn in 2007. The housing price impact in 2007 quickly spread to Europe and globally. The crisis continued to jeopardize financial institutions and banks in 2008. Mexico and the US have strong economic, political, and social ties, making Mexico susceptible to fluctuations in the US economy. While mortgages had grown in Mexico since the 1994-1995 financial crisis, 2007 started a time where many foreign banks were declaring bankruptcy. This is not a good indication to take out a loan or invest in the housing market, even if the loan is not from a foreign bank.
After renovations, the building could struggle to make a profit due to financially unstable and inconsistent tenants, and the decreasing prices in the housing market. All of the apartments are three bedrooms and two baths, ranging from 190 to 200sqm. The safe, urban core lifestyle means Charvel should expect many of the tenants to be younger families or recent graduates working in the area (it’s also likely an older couple seeks the area). Renting out the apartments on a yearly basis, especially to younger people is risky. Charvel should expect a higher turnover rate. Young tenants are less likely to sign a lease after the year. They are constantly changing their career paths. The higher turnover would require him to frequently update the apartment units to remain attractive for new tenants. Owning the property also runs the risk that tenants will fall behind on rent. There is an even bigger concern for tenants’ financial stability due to the falling economy. If Charvel decides to help eliminate the risk by resorting to monthly rent payments through credit card payments, he will have to increase rent to supplement for credit card commissions. Demand for the space would decrease due to increased rent. With the housing crises, the option of selling the units does not look much better. Charvel may have to significantly lower the price to sell the units. This may force him to lose credibility with investors and his bank. The time and capital put into the property does not logically seem to pay off. The renovations to the property are too expensive when considering the building’s price. They are estimated to be about 43% of the acquisition costs. A lot of the renovations include replacing older utility systems such as the gas installation, plumbing, and electrical systems. The management fee happens to be budgeted as the most expensive part. While the plan to hire a good project management and construction team adds quality to the property, the building finishes completion during a poor, unpredictable economy. It may seem fair to assume these factors are considered in the purchasing price, but in reality, an estimated cap rate of 5% is too low of a rate for acquisition. The value of the property needs to be lowered in order to fulfill the renovations.
Though the property has some positive attributes, given the high purchase price and perilous economic climate, the risks outweighs the financial reward. The global economy is a reason to fear the property’s future demand. The valuation price and renovation fees will require a lot of capital for a time of little demand. The acquisition of the 510 Seneca building is not economically smart to be occupied in the near future.
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