Is there and adequate market in Gyor? Are rents adequate to support this development?
Gyor was chosen as the primary project site by ECE after careful consideration, under the assumption that its market was sufficient to support the project. Phillip von Wilmowsky base assumption were that Gyor enjoys strong demographic and economic potential, high accessibility and minimal competition. And more specifically, these were the main rational points underlined by von Wilmowsky assessment:
• Hungary’s Macroeconomic Condition † As of the case date, Hungary is in the midst of integration with the EU economy. Hungary enjoyed several years of high GDP growth, high employment rates and an appreciating currency. Hungary has still half …show more content…
ECE (within the range of an investor share of 50%-67%)
• The investor terms (preferred interest and upside share).
• The exit cap rate † I would try to test it in accordance to the 8.75% rate known in Budapest.
• The rent growth † I would test the model with a lower annual rent growth rate (due to expected competition) of 4%-5% (in line with Hungary’s real GDP growth).
• Base rent rate † I would test the base rent rate by as low as 70% of the assumed rate.
Von Wilmowsky should strive to achieve a 20% IRR for ECE and the equity partner under more harsh assumptions, as detailed above. It can be assumed that an IRR lower than 20% would undermine the viability of the project. A sensitivity test would show that on order to support such an IRR, ECE should cut costs dramatically.
Should Alexander Otto proceed with the deal?
In my opinion, ECE should go ahead with the deal only if it can achieve, and promise an equity partner, an IRR that exceeds 20%. A stress test conducted on the model detailed in exhibit 10, under an assumption of a 8.75% cap rate and 4.5% rent growth rate, and a partner upside share of 67%, would be able to exceed a 20% IRR only if planning scenario 3 is taken into account (see appendix A).
Therefore, if I were Alexander Otto I would only approve the project if von Wilmowsky manages to persuade Gyor’s authorities to approve planning scenario 3.
Appendix A: Viability test based on Exhibit 10