the ethical considerations

SA 21-1 Jeff Zengel is a financial consultant to Rae Properties Inc., a
real estate syndicate. Rae Properties Inc. finances and develops
commercial real estate (office buildings). The completed projects are
then sold as limited partnership interests to individual investors. The
syndicate makes a profit on the sale of these partnership interests.
Jeff provides financial information for the offering prospectus, which
is a document that provides the financial and legal details of the
limited partnership offerings. In one of the projects, the bank has
financed the construction of a commercial office building at a rate of
8% for the first four years, after which time the rate jumps to 12% for
the remaining 21 years of the mortgage. The interest costs are one of
the major ongoing costs of a real estate project.
Jeff has
reported prominently in the prospectus that the break-even occupancy for
the first four years is 60%. This is the amount of office space that
must be leased to cover the interest and general upkeep costs over the
first four years. The 60% break-even is very low and thus communicates a
low risk to potential investors. Jeff uses the 60% break-even rate as a
major marketing tool in selling the limited partnership interests.
Buried
in the fine print of the prospectus is additional information that
would allow an astute investor to determine that the break-even
occupancy will jump to 90% after the fourth year because of the
contracted increase in the mortgage interest rate. Jeff believes
prospective investors are adequately informed as to the risk of the
investment.
Comment on the ethical considerations of this situation.

 

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