Week 10 _ John Agbo_Economic Analysis_Week 13_Lanre Giwa

Problem Recognition / Identification

My colleague at work was convinced through a bank to buy a set of apartment building at a cost of NGN30, 000, 000. From his personal savings, he was able to provide a down payment of NGN5, 000,000, meaning he had to take a loan of NGN25, 000,000 from the bank. The bank has advised him that he will pay NGN400, 000 annually to service his mortgage based on the agreed interest rate. Furthermore, his consultant estate manager informed him that he may spend an average of NGN 200, 000 annually for maintenance cost such as electricity bills, painting, and plumbing works. My colleague is overwhelmed with the high cost as he did not anticipate that and he is thinking of the best approach to sort himself.

Development of Feasible Alternatives/Solutions

The following are the alternatives available to my colleague:

Alternative 1:– Since the apartment building has 4 mini flats in it, he may rent out the four apartments.

Alternative 2:– He should resell the apartment building

Alternative 3: He should rent out three apartments and live in the fourth apartment.

Alternative 4 – Do nothing

Possible Outcomes and Cash Flow of Alternatives / Solutions

Alternative 1: The four mini flats can be rented out at a rate that will cover his annual cost with a marginal profit. This will make it possible to use the money earned from the rental to service his mortgage, maintain the property and make little profit on investment.

Alternative 2: Looking at the total cost of the building, mortgage and maintenance, he is considering reselling the property at a favourable price. The only risk is that the price will depend on the market demand and he stands to sell it at a loss if the demand is low.

Alternative 3: Since my colleague currently lives in a rented apartment with his family, he is also considering moving to one of the four apartments and renting out the remaining three mini flats. This will eliminate the amount he pays on rent and he would also get paid for the 3 other flats.

Alternative 4: The last option is just to maintain status quo by declining the offer. This will mean that he does not have to spend anything regarding the building other than the fact that he will still be paying rent in his current apartment.

Selection Criteria / Attributes of best solution

• Comfort and luxury of living in one’s apartment without harassment from Landlord
• Steady source of income to cover the cost of mortgage, maintenance and a marginal profit
• Minimise expected loss of money
• Improve credit rating in the Bank
• Improved reputation of owning a property.

Analysis and comparison of the Alternatives/Solutions

Analysing all the options available to my colleague, option 4 seems to be the least preferable as that is the current position and he decided to take a facility from the bank because he is not comfortable with his present situation. Secondly, with option 4, he will still continue to pay rents that are usually reviewed annually and this will impact on his salary. Furthermore, this will impact on his credit ratings with the bank.

Option 2 seems like a good choice. Since he did not envisage that there will be so many hidden charges on the building, he may take the advantage of reselling the building apartment to cover his investment and the mortgage and he would not need to bother on the maintenance cost. The low point to this option is that he has to consider the market demand at that point in time and consider minimising his loss. With high demand, he stands to make profit or break even at least. With low demand, he may sell the property at a loss or barely break even in his investment.

Options 1 and 3 look like the preferred alternatives in his current situation. Looking at both options, option 1 will make it possible to rent out the 4 mini flats and if calculated properly will cover his cost, mortgages, maintenance and he will still make a marginal profit over the years. For option 3, if calculated properly, he will fulfil his set criteria by stop paying rents by moving into one of the apartments and he will still cover his cost by getting rents form the three other apartments.

With the performance of a quantitative analysis below, Option 3 will successfully fulfil all the set criteria he has set up for himself.

S/No	Description	Amount
Assuming he is to service his mortgage over a period of 15 years
	His personal investment	NGN 5,000,000.00
	Mortgage	NGN25, 000,000.00
	Annual payment to service loan NGN400, 000.00 * 15	NGN 6,000,000.00
	Annual Maintenance Fee is NGN200, 000.00 * 15 = (Inflation not considered)	NGN3, 000,000.00
	Total Cost	NGN 39,000,000.00
	Cost per annum = NGN39,0000 / 15	NGN2,600,000.00

Meaning to cover his cost assuming that inflation and other external factors are not considered, the rent of an apartment will be NGN2,600,000 / 4 = NGN 650,000 ( Option 1)

Since he intends to live in one of the apartments, he will need to divide the cost of the building by 3 i.e NGN2, 600,000 / 3 and that will be NGN867, 000 (Option 3). This will cover his cost and indirectly a profit for him since his own rent will be borne by the three other flats. This is the minimum amount that will be recommended to him to adopt for rent of his apartment.

Best Alternative to be Selected

Based on the analyses of the options identified, I would recommend option 3 to my colleague as I am of the view that the third option will fulfil his set criteria above and will minimise his loss of money and stress.

Performance Monitoring / Post evaluation

For performance monitoring and post evaluation, my colleague would be advised to continue to monitor and review the rent of the three other flats viz a viz the value obtainable within the area. He should also continue to do an analysis periodically to ensure that he is successfully servicing his mortgage and he is making considerable profit after all the cost deductions.

References:

1. AACE International. Skills & Knowledge of Cost Engineering, 5^th Edition Revised.Chapter-9, pp.9.1-9.9 Edited by Dr. Scott J. Amos, PE. 2010. AACE International. Morgantown, WV, USA.

2. Sulliven, W. G., Wicks, E.M., Koelling, C. P., et al. (2009). Engineering Economy (14^th ed.), Chp 14 pp551 -570. New Jersey: Pearson Education.
3. Brassard M, Ritter D. The memory Jogger 2. Tools for Continuous Improvement and Effective Planning.2010.