PP&E
Let's say a company is expanding into a certain region of the United States, and is looking to build a 150,000 square foot warehouse to hold certain items for a distribution center. Now, they need to build this building from scratch. When the company decides this, do they finance the construction of the building themselves, and then own the building? How could a company lease a building that needs to be built?
I was thinking about this today and couldn't come to a definitive answer. Would the building be owned by a third-party contractor who raises capital for the project and then leases it to the company for X years, or does the company itself actually finance the construction of the building and fully own the building? Besides calculating cost per square foot, how can you accurately estimate the cost of the warehouse?
Not sure I comprehend the question. If they own it, it's capital expenditure under PP&E. If they don't assume the risk of ownership, it's usually treated as an operating expense;
See; http://pages.stern.nyu.edu/~%20adamodar/New_Home_Page/AccPrimer/lease.h…
The management would need to essentially decide this in the beginning (whether or not they want to own the building or not). If they don't want to, then they will have to seek out investors who will fund the project. There are companies that will pay for and own the building until construction is complete, then immediately try to sell it.
I am trying to model this scenario out, and I am having a hard time figuring that part out. If the building costs $10 million to construct, that $10 million would be capitalized on the leasers balance sheet with 10% amortization payments each year for 10 years? (for this scenario). Would that make sense, or is that not really how it works?
I still don't understand the question.
Option 1: The Firm has enough own capital (or access to debt capital) and decides to complete the project on its own. The Firm buys or leases land, then the Firm hires architectors and pays fees to them (might be expense or CapEx) then the Firm hires contractor (construction company) to build warehouses and pays the contractor for work (CapEx). Once the building is complete, it's fixed asset on the Firm's balance sheet.
Option 2: The Firm doesn't have enough capital (or doesn't want to spend), so the Firm finds Investor to construct. The most typical arrangement at least in Europe is the following: Investor and the Firm sign the agreement under which the Investor at its own cost (hiring architectures, construction company, taking it on its balance sheet) completes the project and the Firm is obliged to rent it at pre-defined rent rate for a pre-defined period of time. The type of lease may be actually financinial lease or operational lease - depending on how the parties want it. The accounting will be usual for leases, you can read about this anywhere. This option 2 is interesting for Investor, because it guarantees the income so the yield is quite clear (once you know the cost of construction). The option 2 is interesting for the Firm because it doesn't require debt raising and doesn't require any large initial CapEx. Agreement between Investor and the Firm often includes either call option for the firm to buy back the ready building, or put option for Investor to sell the building to the Firm, or both.
Who can be investor? Anyone - REPE firm, HNWI, Construction and development company, institutional investor (like pension fund) that wants to allocate some money to stable real estate asset.
Answering question about estimation of costs, if it's just an early stage (the Firm has only idea and nothing else) then estimating the area and applying per-foot averages is the only thing you can do.Further into the project (if you have architecture plan, if you start collecting offers from construction companies) it becomes way clearer.
Last thing here, how exactly would you figure out the lease expense per year if the company were to get an outside investor to build the building? Is it usually a % of the total value of the asset?
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