Quote:
Originally Posted by Surrealplaces
What do you mean they had an economic failure? By what metric is a failure? The building is only a year old!
They have it rented, it's just going to take longer than expected to get the money back. Is Syncrude an economic failure?
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By the metric that if they spend 700 million dollars on a building that is now worth 600 million dollars it is a failure.
Those numbers are example only but office buildings are valued on their cashflow, and since the cashflow of EAP is based off below market rents it will therefore be valued lower, therefore it was not economically successful.
Waiting longer to get the money back doesn't work either for two main reasons:
1. typical office lease terms are 10 years, these rates are locked in for the foreseeable future, not allowing for erasing the mistakes.
2. The time value of money means that waiting to get your money back means that the money is worth less to you in the future. Waiting to get the money back is futile as the longer you wait the less that money is worth, making a rent bump in 10 years up to the market rate an insufficient increase to "make the money back".
Ultimately firms have what is called a hurdle rate which is essentially the acceptable return given the firms cost of capital and its ability to invest in risk equivalent projects with a given return. Since SITQ could go out and spend their hypothetical $600 million on an existing office and get a return of say 7%, building their own building, at a higher risk than buying an existing building, and getting only a 5% return is an economically poor decision. Certainly a failure if you ask me.
Sorry if my tone was at all condescending, I certainly didn't intend it to be, but I dont know the financial knowledge levels of people on this forum so I tried to explain/simplify the terms for those who do not have the required background.