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Shorenstein Company LLC
Real Estate Case Study
Presentation to Yale School of ManagementFebruary 1, 2005
Table of Contents
Real Estate Case Study
Questions for Discussion
Exhibit A: Investment Scorecard
Exhibit B: The Park Avenue Building
Exhibit C: The Lexington Avenue Buildings
Exhibit D: Debt Assumptions
Exhibit E: Glossary of Terms
1
8
9
12
18
24
26
R e a l E s t a t e C a s e S t u d y 1
Real Estate Case Study
Overview
In the summer of 2004, two office properties near Grand Central Terminal in Midtown Manhattan weremarketed for sale. Shorenstein Company, one of the country's largest and oldest real estate organizations,was interested in increasing its portfolio in New York City, and both properties represented attractive invest-ment opportunities with value-added or redevelopment potential.
The first property, located on Park Avenue (the “Park Avenue Building”), is a Class B+ building that presentedan opportunity to acquire a well-located asset with a stable, diversified, high-quality tenant base. The ParkAvenue Building also offered significant potential for additional long-term value creation through theredevelopment of the lobby and retail spaces.
The second property (the “Lexington Avenue Buildings”) consisted of two, interconnected Class B+ buildingsthat occupy an entire city block between Lexington Avenue and Third Avenue. The owner of the buildings, alarge pension fund, was also the lead occupier utilizing the property as part of its national headquarters.The pension fund was due to vacate over 50% of the net rentable area by December 2005, which presentedan opportunity to re-lease and redevelop an entire city block in the Grand Central submarket in Manhattan.
Company Overview
Shorenstein CompanyFrom its beginnings in 1924 as a regional brokerage and property management company, ShorensteinCompany has evolved into a fully integrated investment company, active on a national scale in all aspects ofownership, management, leasing, and development of high-quality office properties. Depending on invest-ment activity, the company’s portfolio usually consists of 20 to 25 million square feet of premier officeprojects around the country. It is privately owned and is headquartered in San Francisco, employing over250 professionals engaged in all aspects of real estate ownership.
Shorenstein seeks to generate appropriate risk-adjusted returns through investments in high-quality, well-located office properties in major urban centers. In seeking to achieve this goal, it approaches real estate asa long-term operating business set against a backdrop of powerful market cycles driven primarily by capitalflows. With this goal and orientation, Shorenstein has executed an investment strategy built on a numberof core principles:
■ Invest only in high-quality, well-located office buildings with demonstrated and sustainable leasingadvantages over their competition that allow Shorenstein to keep a property well occupied duringdownturns in leasing cycles.
■ Structure capital investments to mitigate downside risks.
■ Add value during the holding period through Shorenstein’s substantial in-house operating andleasing expertise.
■ Utilize prudent debt levels to enhance returns while protecting invested equity through marketcycles.
■ Maintain durable cash flow through a high-credit, carefully managed rent roll, and maximize tenantretention through the delivery of excellent service to tenants.
■ Closely monitor capital markets for advantageous dispositions or refinancings.
R e a l E s t a t e C a s e S t u d y2
The Fund Structure
Between 1992 and 2003, Shorenstein has sponsored six closed-end investment funds with a substantial
investment by Shorenstein in each fund. The investors are primarily college endowments, foundations, and
high net worth individuals. The funds had a total of $1.5 billion in equity capital; with leverage (averaging
approximately 65% loan-to-value ratios), this amounts to approximately $4.3 billion of transactions.
Shorenstein is currently completing the investment of its sixth fund (“Fund Six”). In 2004, Shorenstein
closed its seventh fund with $775 million in equity. This fund will begin investing once Fund Six is fully invested.
Fund Six was closed in August 2001 with $609.4 million in equity capital. At the time of this investment
decision, approximately 60% of Fund Six had been invested; the purchase of either the Park Avenue Building
or the Lexington Avenue Buildings would be its ninth investment and would result in Fund Six being
approximately 85% invested. The first eight investments by Fund Six are:
■ 500 West Monroe – a 45-story, 920,000 square foot Class A tower located in the West Loop sub-
market of Chicago.
■ Two Liberty Place – a highly structured debt and equity investment in a 57-story, 1.26 million square
foot Class A tower located in the Central Business District of Philadelphia.
■ 450 Lexington Avenue – a 40-story, 911,000 square foot Class A tower in the Grand Central sub-
market of New York City.
■ US Bank Plaza – a 25-story, 429,000 square foot Class A tower located in Downtown Sacramento.
■ 123 Mission – a partial interest in a 29-story, 330,000 square foot building located in the South
Financial District submarket of San Francisco. Fund Six’s partner in this investment is Shorenstein’s
fourth fund.
■ Hamilton Square – a 9-story, 237,000 square foot Class A building located in the East End submarket
of Washington, D.C.
■ 1440 Broadway and 350 Madison Avenue – a junior mezzanine loan collateralized by equity interests
in a joint venture which owns 1440 Broadway and 350 Madison Avenue, located in New York City’s
Times Square and Grand Central submarkets, respectively.
■ 1111 Pennsylvania Avenue, N.W. – a preferred equity investment in a 14-story, 331,000 square foot
building, also known as the Presidential Building, located in the East End submarket in
Washington, D.C.
A summary of the Shorenstein funds and their performance is attached as Exhibit A. Additional information
about Shorenstein can be found on www.shorenstein.com.
Case Study continued
R e a l E s t a t e C a s e S t u d y 3
Case Study continued
Market Summary
Shorenstein believes that a majority of each fund should be invested in major urban office markets suchas New York City, Washington, DC, Boston, San Francisco, Los Angeles, and Chicago. These markets tend toenjoy greater leasing velocity and capital markets liquidity than secondary ones (Charlotte, New Orleans,Phoenix, etc.) during most points in the economic cycle. While all markets experience the benefits of aneconomic expansion, increases in leasing activity and rental rate growth in major markets often outpace thesecondary markets. In periods of economic recession, the major markets have repeatedly proven moreresilient. They are often the last markets to decline and the first to recover, due to greater depth in theleasing market (by both size of tenants and diversity of industry). Investments in major markets have alsoproven to be more liquid and financible due to greater investor and lender interest.
For this reason, Fund Six was eager to invest again in New York City. In addition, the Park Avenue Buildingand the Lexington Avenue Buildings were near Grand Central Terminal and the largest of Fund Six’s invest-ments, 450 Lexington Avenue. Shorenstein knew the Grand Central submarket very well, having over 15years of experience in the area.
Midtown Manhattan Overview
Midtown Manhattan is the largest Central Business District (“CBD”) office submarket in the United States,comprising 207 million square feet among 434 buildings. Of these, 277 buildings and 168 million squarefeet are considered Class A.1
As of the second quarter of 2004, while 22% lower than the record-setting highs in 2000, rental rates inMidtown had increased by over 44% in the prior 10 years. After negative net leasing absorption of over 5.8million square feet from 2001 to 2003, the market had begun to rebound in mid-2004 -- net leasing absorptionwas nearly 2.7 million square feet in the first two quarters of the year. While the rebound had thus far beenseen in leasing volume and velocity, it had not yet been reflected by a significant increase in rental rates.However, rents had stabilized and concessions (free rent, tenant improvement allowances provided by thelandlords) had decreased. Assuming continued job growth in the service sector, especially in financial andlegal jobs that largely drive the Midtown economy, it was expected that rents would increase over the nextseveral years.
Columbus Circle
Penn Plaza/Garment District
Times Square
Grand Central
Plaza District
Total/Average
Source: Torto Wheaton Research, 2004 Q2
Submarket
19.8
40.7
23.4
41.4
81.4
206.7
6.8%
7.4%
7.3%
10.1%
7.6%
8.0%
Total Inventory(MM, SF)
Total Vacancy(includes
sublease space)
Class A Inventory(MM, SF)
16.8
13.7
20.3
37.4
80.2
168.4
7.1%
4.1%
9.0%
10.0%
7.6%
8.0%
Class A Vacancy(includes
sublease space)
Class A GrossRental Rate
(PSF)
$49.33
$36.47
$51.11
$46.27
$56.92
$51.43
(1) Though Shorenstein classified both target properties as Class B+ buildings, they appear in many databases as Class A buildings. They are included in the Class A statistics shown.
R e a l E s t a t e C a s e S t u d y4
Grand Central SubmarketThe Grand Central submarket consists of all properties south of East 47th Street, north of East 30th Street,east of Fifth Avenue, and west of the East River. Within Midtown, the Grand Central submarket is the secondlargest Class A submarket both in terms of area and the number of buildings, encompassing 83 buildingsand over 41 million square feet. Grand Central has historically enjoyed strong leasing activity because of itsconvenient proximity to major mass transportation hubs.
As of the second quarter of 2004, the Class A vacancy rate in the Grand Central submarket was 10.0% andthe weighted average gross rent was $46.27 per square foot. This was 23% lower than 2000, but was over50% higher than the rental rates recorded a decade before and 5% higher than in the prior year. While totalnet leasing absorption was a negative 1.9 million square feet over the prior three years, in the first twoquarters of 2004, net leasing absorption had been a positive 637,000 square feet.
Manhattan Investment Sales
With such strong real estate fundamentals, especially relative to other markets around the country, mostinvestors remained optimistic that an improving economy would only reinforce Midtown Manhattan’s stability.Because of a confluence of historically low interest rates and an abundance of available capital, Manhattaninvestment sales activity in 2003 and 2004 was very brisk; in the first half of 2004, over $1.5 billion in ClassA office building transactions had been completed with an average price of $400 per square foot.
Recent Sales Comparables
In tandem with gains in leasing activity and rental rate growth, the debt markets increasingly drove invest-ment sales activity. Due to the low-interest rate environment, many investors took advantage of “PositiveLeverage” in pricing assets. Whereas lenders had previously been comfortable with lending 65% to 75% ofthe acquisition cost, some transactions were financed with loan-to-value ratios of up to 85%, and sometimeseven more. Buyers were able to either borrow at tight, competitive pricing on a short-term floating basis, orlock in fixed, low rates for a longer term. Commensurate with the low interest rates, capitalization rates had also fallen to historically low levels.
Case Study continued
Building Size (SF)
717 Fifth Avenue
600 Third Avenue
530 Fifth Avenue
885 Third Avenue
261 Fifth Avenue
1775 Broadway
Source: Real Capital Analytics, July 23, 2004
450,000
525,000
497,000
592,000
426,500
625,000
Sale Price (PSF)
$778
$404
$423
$397
$267
$400
Property Sale Date
Jul-04
Jul-04
May-04
Mar-04
Feb-04
Jan-04
R e a l E s t a t e C a s e S t u d y 5
Case Study continued
Capitalization rates on First Year Net Operating Income (“Initial Cap Rates”) had fallen to levels that typicallyranged from 5.0% to 6.5% depending on location, quality and leasing profile. Capitalization Rates onstabilized Net Operating Income (“Stabilized Cap Rate”) ranged from 6.0% to 8.0% over the holding period.(A property would be stabilized when below-market occupancy or in-place rental rates reflected normalmarket conditions.) These Cap Rates are 100 to 200 basis points below historic averages.
Please see Exhibit E for a glossary of many of the real estate terms used above, as well as other commonlyused terms.
The Park Avenue Building
The Park Avenue Building is a 25-story, 575,000 square foot building. The property presented Shorensteinwith an opportunity to acquire a very well located, Class B+ office building with a high-quality tenant rosterand stable revenue stream. These attributes alone made the property a desirable investment expected todeliver an attractive return throughout the holding period. In addition, several opportunities existed tocreate additional value through the redevelopment of public and retail spaces and to reposition the propertyin the market through an aggressive leasing campaign. This investment presented a challenge and anopportunity to reposition the building to Class A- status. Coupled with its Class A location, the repositionedproperty would be very attractive on exit to “core” investors (e.g. pension funds), a buyer pool which is verydeep and willing to pay a premium in return for acquiring very high quality, stable real estate with reduced risk.
Shorenstein liked the Park Avenue Building for the following reasons:
■ Location: The property was located across the street from Grand Central Terminal. Direct subwayaccess was also available through a station entrance on Park Avenue. Thus, the property’s premierlocation offered tenants convenient and flexible commutes that would be a primary leasing advantageover other competitive properties.
■ Asset Quality: The property was built in 1923; however, over $26 million was spent on renovationsin the last 3 years. These renovations included the overhaul or replacement of several majormechanical systems and the improvement of the façade, building entrances, sidewalks andcommon areas.
■ High Quality Tenant Roster: The property was home to 14 office and 6 retail tenants thatrepresented diverse industries such as publishing, insurance, real estate, advertising and media.Eight of these tenants had investment-grade ratings and in total occupied 48% of the property’s netrentable area.
■ Stable Occupancy: Only 50% of the property’s leases expired between 2004 and 2009, roughlyhalfway through the projected holding period. This expiration schedule produced a steady streamof secure income, but also presented the opportunity for solid income growth as in-place leaseswere marked to market.
■ Below Market Rents: The average office rent was estimated to be 17% below market and theaverage retail rent was estimated to be 24% below market, providing an excellent opportunity toincrease revenues over the holding period.
R e a l E s t a t e C a s e S t u d y6
■ Identity Creation / Lobby Renovation: The Park Avenue Building lacked street presence--theprimary entrance was a narrow, unimpressive vestibule that led to the main lobby and receptiondesk. The property also lacked a strong identity, as the seller was not aggressive in promoting thebuilding in the Grand Central submarket. The potential existed to relocate the building’s entranceand/or redevelop the lobby to provide more of a high-quality “boutique” look and feel. Theseimprovements, in combination with a more aggressive marketing program, could solve theseproblems of perception and aesthetics.
■ Retail Redevelopment: The main retail tenant was a service firm that enjoyed a double-heightceiling with large, arched windows that overlook Park Avenue and 42nd Street. The primarycustomer service provided by this retailer was in decline. Shorenstein believed that this spacecould be re-leased to a higher-quality retail tenant that would pay a premium for the visibility fromPark Avenue and Grand Central Terminal. The addition of a higher-profile, “destination” tenantcould significantly strengthen the property's presence in the market.
With input from its Leasing, Property Management, and Capital Markets groups, Shorenstein developed a“Base Case” proforma. A second proforma was also developed to represent the value-added opportunitywhere money was spent to redevelop the lobby and retail space, resulting in an increase in office and retailrents. The proformas, and the assumptions used to construct them, are attached as Exhibit B.
The Lexington Avenue Buildings
The Lexington Avenue Buildings are a single office complex comprised of two office towers of 34 and 31
stories, totaling 1.66 million square feet. They are interconnected on the ground floor and share some
mechanical systems. Like the Park Avenue Building, the Lexington Avenue Buildings offered Shorenstein the
opportunity to acquire a well-located asset in the Grand Central submarket. It also offered a redevelopment
opportunity, but on a much larger scale. The buildings were built in 1959 and were similar in quality to many
other generic institutional properties built along Third Avenue in its era. However, after a full redevelopment
and re-leasing effort, the property could be repositioned as a Class A/A- asset. While the challenge was
large, the rewards could be larger.
For the last 25 years, the owner of the buildings, a large pension fund, was also the lead tenant using the
property as part of its national headquarters. Due to corporate restructuring, which included moving a
significant number of employees to another state, the pension fund had vacated most of its space in one
building (“Building One”) and had begun to lease space to other tenants (although it planned on keeping a
few floors through 2009). It occupied all of the office space in the second building (“Building Two”), but was
planning on moving out completely by the end of 2005.
As part of the sale transaction, the seller offered to enter into a master lease for the entire project through
December 2005 at a net rent of $20 per square foot ($40 per square foot gross, including expenses),
totaling approximately $33.2 million annually. This guaranteed annual net operating income would give
Shorenstein the ability to start a marketing program ahead of the known vacancy date and defer lease-up
costs. The seller hoped that this strategy would result in higher pricing for the asset.
Case Study continued
R e a l E s t a t e C a s e S t u d y 7
Case Study continued
Shorenstein liked the Lexington Avenue Buildings for the following reasons:
■ Redevelopment Opportunities: Despite a lobby renovation in 1988, the buildings still lookeddated. The opportunity existed to redevelop the property into a premier single- or multi-tenantasset located blocks away from Grand Central Terminal. Few opportunities existed in Manhattan,much less in Midtown, on such a large scale. Strategies included façade renovations, newstreetscape designs, or even the creation of a mixed-use complex with multiple components -- thezoning of the parcel allowed additional uses aside from office use, including hotel, residential, andretail. In its Base Case proforma, Shorenstein underwrote $78 million in new capital for re-tenantingand allocated $25 million for the renovation of the lobby and the entrances (a full renovation,including façade work and system upgrades could cost much more).
■ Market Fundamentals: Market statistics showed that large blocks of space were diminishing inManhattan, especially in the Midtown office market. At the time of the sale, only 9 blocks of spaceover 250,000 square feet were available for lease, totaling 3.4 million square feet. At the sametime, demand for space was increasing -- 2004 net absorption in Midtown Manhattan showedhealthy gains after 3 years of losses. It was estimated that over 20 large companies were in themarket looking at their options for space in excess of 150,000 square feet, potentially totaling over8.0 million square feet.
The large amount of available space at the property was expected to be attractive to manypotential tenants, and would be one of a few locations that could accommodate a large corporateuser, offering such user the ability to name and establish a large headquarters presence inMidtown. Just a few months earlier, a major publishing firm had signed a 15-year, 260,000 squarefoot lease for six floors of Building #1, space that was formerly occupied by the pension fund. Therent was $34.50 per square foot, with $4 per square foot increases every 5 years.
■ Below Replacement Cost: The replacement cost of a Class A building in Midtown was estimated at$550 per square foot. Due to the age and vacancy of the buildings, Shorenstein estimated that thevalue of the asset in its present condition was far below that level, even when adding in the cost ofthe anticipated re-leasing and redevelopment costs. Based on preliminary valuations, the discountto replacement cost was estimated to be as much as 30% to 40%.
■ Location: While not across the street from Grand Central Terminal like the Park Avenue Building, theproperty was only a couple of blocks away, still a distinct leasing advantage over many competitiveproperties in the market.
Like the Park Avenue Building, a “Base Case” proforma was developed for the Lexington Avenue Buildingswith input from the various Shorenstein business groups. A second proforma was also developed torepresent a more aggressive view of the redevelopment opportunity, with higher market rents and anaccelerated lease-up schedule. The proformas, and the assumptions used to construct them, are attachedas Exhibit C.
R e a l E s t a t e C a s e S t u d y8
1. We have given you the reasons why Shorenstein considered buying each property. What reasonsare there for Shorenstein not to buy each property?
2. What are the risks involved for each building? What do you think an appropriate rate of returnshould be for each investment opportunity?
3. What would be your financing strategy for each investment? What is an appropriate Loan-to-Valueratio? What loan terms would you underwrite? Can you explain the effect of Positive Leverage?Please refer to Exhibit D for loan pricing guidance.
4. What would you pay for each property? Which one would you rather buy?
5. How long would you plan to own the property? What would be your exit strategy?
6. Given the information provided on Shorenstein Company’s history, strategy, and investmentperformance, which property do you think is a better fit for Fund Six?
A glossary of common real estate terms is attached as Exhibit E.
Questions for Discussion
Exhibit AInvestment Fund “Scorecard”
R e a l E s t a t e C a s e S t u d y1 0
Exhibit AInvestment Fund “Scorecard”Summary of all Fund Activity as of December 31, 2004
Internal Rate of Return
Fund
OneTwo
ThreeFourFiveSix
Date Formed
1992199419961997199920012004
Gross Projected onProperties Held
N/A12.2%19.7%19.4%12.8%15.2%N/M
Gross Realized onProperties Sold
18.5%13.2%22.4%52.5%14.7%N/MN/M
Net Realized/Projected Fund
Total
16.3%13.1%18.4%20.1%10.3%11.2%N/M
Equity Multiples
Loan-to-Value Average
Annualized Operating Cash Flow Distribution Yield
Committed Capital
MillionMillionMillionMillionMillionMillionMillion
$160.0 $200.0 $151.2$100.0 $281.5$609.4$775.0
Inception to Date
6.7%6.5%9.0%7.2%4.9%8.4%
Current
56.0%
Realized Returnof Capital
1.00x0.99x0.65x0.14x0.38x0.14x
Total RealizedEquity Multiple
2.09x1.58x1.28x0.80x0.60x0.19x
Projected EquityMultiple
N/A1.85x2.70x3.37x1.58x1.60x
Operating CashFlow Distributions
0.45x0.39x0.36x0.40x0.20x0.05x
On Acquisition
63.7%
Methodology■ IRRs and Operating Cash Flow Distribution Yields are compounded monthly over the holding period.
■ Results for assets that have not been sold are based on the operating cash flow distributions anticipated to be realized over the projected holding period and the disposition proceeds anticipated to be realized upon sale at the end of the projected holding period.
■ Total fund results are net of all Sponsor fees and Sponsor distributions Held and Sold Property IRRs are gross of all Sponsor fees andSponsor distributions.
■ N/A = not applicable
■ N/M = not meaningful(a) Fund Seven investment period commenced in July 2004.
RealizedAppreciation
0.64x0.20x0.27x0.26x0.02x0.00x
OneTwo
ThreeFourFiveSix
Seven
Fund
Fund
OneTwo
ThreeFourFiveSix
(a)
Exhibit BThe Park Avenue Building
R e a l E s t a t e C a s e S t u d y1 2
Exhibit B
The Park Avenue Building
Square Feet Vacancy
Office
Retail
Lower Level Retail and Storage
Total
523,458
38,413
13,342
575,213
17,195
0
10,000
27,195
Vacancy as % of Total SF
3.0%
0.0%
2.0%
5.0%
Square Feet % of Total SF
Vacant
Month-to-Month
2004
2005
2006
2007
2008
2009
2011
2013
2014
2018
Messenger Center
Total
5%
1%
3%
1%
8%
12%
12%
12%
30%
2%
14%
1%
0%
100%
Cumulative % of Total SF
5%
6%
9%
10%
18%
30%
42%
54%
84%
85%
99%
100%
100%
Year
Square Feet % of Total SF
Publishing Company
Publishing Company
Financial Company
Business Services Company
Real Estate Company
Financial Services Company
Advertising Company
Service Company (Retail)
143,075
68,878
58,615
56,752
50,571
44,363
29,054
24,057
25%
12%
10%
10%
9%
8%
5%
4%
Lease Expiration Date
12/2011
6/2009
7/2008
8/2014
5/2006
12/2007
2/2011
4/2007
Tenant
Size & Vacancy
Lease Expiration Schedule
Major Tenants
27,195
5,609
19,506
3,416
45,542
69,553
66,595
68,878
172,129
9,028
80,562
5,500
1,700
575,213
Year
1Ye
ar 2
Year
3Ye
ar 4
Year
5Ye
ar 6
Year
7Ye
ar 8
Year
9Ye
ar 1
0Ye
ar 1
1IN
CO
ME
Rent
al In
com
e20
,70
0,0
90
21
,70
4,0
38
23
,544
,659
24,6
46,9
17
26
,252
,371
27,9
25,7
08
28,8
78,0
31
28
,70
1,54
4
33
,811
,745
35,1
71,6
39
36,3
43,4
78
Es
cala
tion
Inco
me
4,34
9,2
32
4,49
4,71
1
4,56
2,26
4
4,56
8,1
47
4,19
9,3
78
4,0
08
,915
4,
235,
398
3,6
74,6
76
3,6
06
,352
3,
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00
3
3,34
1,8
29
Mis
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com
e33
2,6
71
34
2,6
51
35
2,9
30
36
3,51
9
37
4,42
4
38
5,6
57
39
7,22
7
40
9,1
44
42
1,41
7
434,
06
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08
2
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(2
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)
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(332
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(3
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(3
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(36
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67)
(36
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TOTA
L IN
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25,3
81,
99
3
26
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,46
2
28
,229
,60
1
29
,28
2,50
5
30
,523
,20
0
32
,017
,029
33,1
78,4
32
32
,437
,634
37,4
84,
755
39,0
36,8
36
39
,76
8,4
55
EXPE
NS
ES
Ope
ratin
g Ex
pens
es7,
89
0,1
91
8
,09
3,9
64
8,3
20,8
85
8,5
35,8
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8,7
59,4
21
8,9
93,
022
9,2
25,0
65
9,4
24,2
87
9
,744
,618
10
,00
0,5
30
10
,245
,658
Real
Est
ate
Taxe
s4,
133,
584
4,
236
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4,34
2,8
46
4,
451,
417
4,
562,
703
4,
676
,771
4,
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4,
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5,
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5,
162,
280
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TO
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EXPE
NS
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12,0
23,7
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3,73
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7,26
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13,6
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14,3
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810
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874
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139
2,
028
,847
56
1,54
0
2,
99
3,53
7
-
-
1,9
85,
634
Le
asin
g C
omm
issi
ons
493,
444
848
,20
7
1,
102,
325
8
98
,853
1,0
67,
89
5
1,58
8,4
45
491,
483
2,76
2,8
67
6
05,
761
86
,045
1,
798
,335
C
apita
l Res
erve
s 11
7,8
69
121,
910
126
,015
129
,48
7
13
2,9
97
136
,445
141,
146
145,
320
148
,953
153,
051
15
7,0
64
TOTA
L C
API
TAL
EXPE
ND
ITU
RES
1,48
5,8
37
2,42
3,19
2
1,22
8,3
40
2,24
3,24
4
2,38
8,0
31
3,75
3,73
7
1,19
4,16
9
5,9
01,
724
75
4,71
4
239
,09
6
3,
941
,033
NNEETT
CCAA
SSHH FF
LLOOWW
1111
,,887722
,,338811
1111,,55
8888,,33
8833
1144
,,333377
,,553300
1144,,00
5511,,99
9944
1144
,,881133
,,004455
1144,,55
9933,,44
9999
1177
,,996655
,,550088
1122,,11
9988,,00
9911
2211
,,994499
,,005533
2233,,66
3344,,99
3300
2200
,,229900
,,442277
Park
Aven
ue B
uild
ing
Bas
e Ca
se P
roFo
rma
Re
al
Es
ta
te
Ca
se
St
ud
y1
3
R e a l E s t a t e C a s e S t u d y1 4
Park Avenue Building
Base Case ProForma Assumptions
2004
Office
Low-Rise (Floors 3-12)
High-Rise (Floors 13-25)
Retail
Ground Floor
Concourse
Lower Level
$43.00
$45.00
$175.00
$70.00
$20.00
Growth Rates2005 - 2008, 2009+
5%, 7%, 5%, 5%, 3%+
5%, 7%, 5%, 5%, 3%+
5%, 7%, 5%, 5%, 3%+
5%, 7%, 5%, 5%, 3%+
5%, 7%, 5%, 5%, 3%+
2004 - 2006
New Leases
Renewals
8 months
3 months
2007+
6 months
2 months
2004 - 2006
Office
New Leases
Renewals
$45.00
$15.00
2007+
$35.00
$10.00
Growth Rates
2.5%+
2.5%+
Market Rent
Free Rent
Tenant Improvements
Year
1Ye
ar 2
Year
3Ye
ar 4
Year
5Ye
ar 6
Year
7Ye
ar 8
Year
9Ye
ar 1
0Ye
ar 1
1IN
COM
ERe
ntal
Inco
me
20,7
00,0
90
21
,704
,038
22,9
66,2
85
23
,405
,630
28,0
66,4
82
30
,184
,971
31,4
75,5
71
31
,652
,840
37,8
44,8
23
38
,642
,643
38,9
33,5
67
Es
cala
tion
Inco
me
4,34
9,23
2
4,49
4,73
6
4,
513,
768
4,
471,
451
4,
126,
418
3,
943,
778
4,
180,
458
3,
609,
067
3,
583,
970
3,
954,
020
3,
390,
296
M
isce
llane
ous
Inco
me
332,
671
342,
651
352,
930
363,
519
374,
424
385,
657
397,
227
409,
144
421,
417
43
4,06
1
44
7,08
2
Co
llect
ion
Loss
(1
98,9
38)
(2
22,8
17)
(288
,524
)
(380
,949
)
(384
,936
)
(420
,195
)
(4
38,7
31)
(448
,700
)
(4
58,8
04)
(4
63,9
94)
TOTA
L IN
COM
E25
,38
1,99
3
26
,342
,487
27,6
10,1
66
27
,952
,076
32,1
86,3
75
34
,129
,470
35,6
33,0
61
35
,232
,320
41,4
01,5
10
42,5
71,9
20
42
,306
,951
EXPE
NSE
S
Ope
rati
ng E
xpen
ses
7,89
0,19
1
8,09
3,96
5
8,
308,
496
8,50
9,24
2
8,
792,
685
9,
035,
270
9,
274,
157
9,
480,
180
9,
822,
953
10
,071
,231
10,2
96,4
28
Re
al E
stat
e Ta
xes
4,13
3,58
4
4,23
6,92
3
4,
342,
846
4,
451,
417
4,
562,
703
4,
676,
771
4,
793,
690
4,
913,
532
5,
036,
370
5,
162,
280
5,
291,
337
TO
TAL
EXPE
NSE
S
12,0
23,7
75
12
,330
,888
12,6
51,3
42
12
,960
,659
13,3
55,3
88
13
,712
,041
14,0
67,8
47
14
,393
,712
14,8
59,3
23
15
,233
,511
15
,587
,765
NNEETT
OOPPEE
RRAATTII
NNGG
IINNCCOO
MMEE
1133,,33
5588,,22
1188
1144
,,001111
,,559999
1144,,99
5588,,88
2244
1144
,,999911
,,441177
1188,,88
3300,,99
8877
2200
,,441177
,,442299
2211,,55
6655,,22
1144
2200
,,883388
,,660088
2266,,55
4422,,11
8877
2277
,,333388
,,440099
2266,,77
1199,,11
8866
CAPI
TAL
EXPE
ND
ITU
RES
Tena
nt Im
prov
emen
ts87
4,52
4
1,
453,
075
-
1,
214,
904
1,
187,
139
2,
028,
847
56
1,54
0
2,
993,
537
-
-
1,
998,
219
Le
asin
g Co
mm
issi
ons
493,
444
848,
207
-
943,
241
1,12
1,65
4
1,73
6,59
6
515,
754
3,
022,
902
-
86
,045
1,
934,
597
Re
deve
lopm
ent C
osts
-
-
10,0
00,0
00
-
-
-
-
-
-
-
-
Ca
pita
l Res
erve
s 11
7,86
9
12
1,91
0
12
6,01
5
12
9,48
7
13
2,99
7
13
6,44
5
14
1,14
6
145,
320
14
8,95
3
153,
051
15
7,06
4
TOTA
L CA
PITA
L EX
PEN
DIT
URE
S1,
485,
837
2,
423,
192
10
,126
,015
2,28
7,63
2
2,
441,
790
3,
901,
888
1,
218,
440
6,
161,
759
14
8,95
3
239,
096
4,08
9,88
0
NN
EETT CC
AASSHH
FFLLOO
WW
1111,,88
7722,,33
8811
1111
,,558888
,,440077
44,,8833
22,,8800
99
1122
,,770033
,,778855
1166,,33
8899,,11
9977
1166
,,551155
,,554411
2200,,33
4466,,77
7744
1144
,,667766
,,884499
2266,,33
9933,,22
3344
2277
,,009999
,,331133
2222,,66
2299,,33
0066
Park
Aven
ue B
uild
ing
ProF
orm
a 2:
Val
ue-A
dded
Opp
ortu
nity
Re
al
Es
ta
te
Ca
se
St
ud
y1
5
R e a l E s t a t e C a s e S t u d y1 6
Park Avenue BuildingProForma 2: Value-Added OpportunityAssumptions
All assumptions remained the same as in the Base Case Proforma with the following exceptions:
Lobby and Retail Redevelopment
It was assumed that the Lobby and Retail Redevelopment commenced and was completed in 2007, at atotal cost of $10 million.
Market Rent
Office Market Rent assumptions were the same as in the Base Case Proforma until 2008, at which timethey were increased, reflecting its upgrade in status to a Class A- building:
Office
Low-Rise (Floors 3-12)
High-Rise (Floors 14-26)
Retail
Ground Floor
Concourse
Lower Level
2008 Rent Increase
+ $2.00
+ $4.00
+ $25.00
+ $55.00
+ $20.00
Exhibit CThe Lexington Avenue Buildings
R e a l E s t a t e C a s e S t u d y1 8
Exhibit C
The Lexington Avenue Buildings
Square Feet Vacant SF
Office
Retail
Other
Total
712,468
33,077
21,361
766,906
184,072
8,972
11,592
204,636
Vacant(% of SF)
26%
27%
54%
27%
Square Feet % of Total SF
Vacant
2005
2008
2009
2012
2013
2014
2017
2019
2021
Total
215,216
846,304
1,380
93,310
26,968
67,653
17,220
123,867
8,736
261,495
1,662,146
13%
51%
0%
6%
2%
4%
1%
8%
1%
16%
100%
Cumulative % of Total SF
13%
64%
64%
70%
72%
76%
75%
83%
84%
100%
Year
Square Feet Vacant SF
834,230
43,955
17,055
895,240
0
8,028
2,552
10,580
Vacant(% of SF)
0%
18%
15%
1%
Square Feet Vacant SF
1,546,698
77,032
38,416
1,662,146
184,072
17,000
14,144
215,216
Vacant(% of SF)
12%
22%
37%
13%
Building One Building Two Total Property
Square Feet % of Total SF
Building One
Publishing Company
Pension Fund (Seller)
Accounting Company
Financial Company
Building Two
Pension Fund (Seller)
Parking Company
Retail 2
261,495
93,310
85,682
49,989
834,230
22,425
17,220
34%
12%
11%
7%
93%
3%
2%
Lease Expiration Date
2/2021
6/2009
7/2017
4/2013
12/2005
11/2012
11/2014
Tenant
Size & Vacancy
Lease Expiration Schedule
Major Tenants
YYeeaarr
11YYee
aarr 22
YYeeaarr
33YYee
aarr 44
YYeeaarr
55YYee
aarr 66
YYeeaarr
77YYee
aarr 88
YYeeaarr
99YYee
aarr 11
00YYee
aarr 11
11IN
COM
E
Rent
al In
com
e33
,242
,920
28,3
05,6
66
69
,320
,638
78,6
88,4
91
79
,535
,660
80,4
40,6
67
83
,656
,437
87,3
37,9
28
86
,637
,633
88,6
36,1
14
89
,216
,919
Esca
latio
n In
com
e-
3,
058,
031
8,56
3,35
6
9,64
0,76
9
10,5
96,8
61
11
,689
,768
12,9
20,4
88
14
,179
,179
14,9
94,7
26
16
,285
,910
17,5
61,2
86
Va
canc
y /
Cred
it Lo
ss-
(3
,894
,200
)
(4
,416
,463
)
(4
,506
,626
)
(4
,606
,522
)
(4
,828
,846
)
(5
,049
,794
)
(4
,460
,422
)
(5
,246
,101
)
(5
,338
,910
)
TO
TAL
INCO
ME
33,2
42,9
20
31
,363
,697
73,9
89,7
94
83
,912
,797
85,6
25,8
95
87
,523
,913
91,7
48,0
79
96
,467
,313
97,1
71,9
37
99,6
75,9
23
10
1,43
9,29
5
EXPE
NSE
S
Ope
ratin
g Ex
pens
es-
9,
256,
885
24
,014
,822
24,7
64,6
71
25
,484
,040
26,3
32,3
33
27
,208
,167
28,1
10,0
49
28
,979
,866
30,0
12,5
35
31
,007
,688
Real
Est
ate
Taxe
s-
15
,444
,687
15
,972
,018
16,3
45,2
65
16
,753
,897
17,1
72,7
44
17,6
02,0
63
18
,042
,114
18,4
93,1
67
18
,955
,496
19,4
29,3
84
TO
TAL
OPE
RATI
NG
EXP
ENSE
S-
24
,701
,572
39
,986
,840
41,1
09,9
36
42
,237
,937
43,5
05,0
77
44
,810
,230
46,1
52,1
63
47
,473
,033
48,9
68,0
31
50
,437
,072
NNEETT
OOPPEE
RRAATTII
NNGG
IINNCCOO
MMEE
3333,,22
4422,,99
2200
66,,
666622,,
112255
3344
,,000022
,,995544
4422,,88
0022,,88
6611
4433
,,338877
,,995588
4444,,00
1188,,88
3366
4466
,,993377
,,884499
5500,,33
1155,,11
5500
4499
,,669988
,,990044
5500,,77
0077,,88
9922
5511,,00
0022,,22
2233
CAPI
TAL
EXPE
ND
ITU
RES
Te
nant
Impr
ovem
ents
-
36,1
35,6
98
10
,266
,943
-
-
-
-
-
1,79
5,48
1
-
-
Leas
ing
Com
mis
sion
s-
24
,804
,215
6,72
2,51
4
45,6
37
-
-
-
-
1,40
6,45
4
-
175,
989
Reno
vatio
n Co
sts
-
20,9
72,0
11
4,46
6,81
1
-
-
-
-
-
-
-
-
Capi
tal R
eser
ves
-
176,
337
18
1,62
7
187,
076
192,
688
198,
469
204,
423
210,
555
217,
199
22
3,71
4
23
0,42
5
TO
TAL
CAPI
TAL
EXPE
ND
ITU
RES
-
82,0
88,2
61
21
,637
,895
232,
713
19
2,68
8
19
8,46
9
20
4,42
3
21
0,55
5
3,
419,
134
22
3,71
4
40
6,41
4
NNEETT
CCAASS
HH FF
LLOOWW
3333,,22
4422,,99
2200
((77
55,,4422
66,,1133
66))
1122
,,336655
,,005599
4422,,55
7700,,11
4488
4433
,,119955
,,227700
4433,,88
2200,,33
6677
4466
,,773333
,,442266
5500,,11
0044,,55
9955
4466
,,227799
,,777700
5500,,44
8844,,11
7788
5500
,,559955
,,880099
Lexi
ngto
n Av
enue
Bui
ldin
gs
Bas
e Ca
se P
roFo
rma
Re
al
Es
ta
te
Ca
se
St
ud
y1
9
R e a l E s t a t e C a s e S t u d y2 0
Lexington Avenue Buildings
Base Case ProForma Assumptions
2004
Office
Low-Rise (Floors 2-16)
High-Rise (Floors 17-34)
Retail
Side Street Retail
Avenue Retail
Other
Storage
$43.00
$45.00
$85.00
$100.00
$20.00
Growth Rates2005 - 2008, 2009+
5%, 7%, 5%, 5%, 3%+
5%, 7%, 5%, 5%, 3%+
5%, 7%, 5%, 5%, 3%+
5%, 7%, 5%, 5%, 3%+
5%, 7%, 5%, 5%, 3%+
2004 - 2006 2007+
New Leases
Renewals
8 months
3 months
6 months
2 months
2004 Growth Rates
Office
New Leases
Renewals
$45.00
$15.00
2.5%+
2.5%+
Market Rent
Lease-Up AssumptionsThe existing vacant space and the space to be vacated by the Pension Fund/Seller was leased up as follows:
Square Feet Lease-Up
Building 1
Building 2
Building 1
Building 2
Building 2
Building 1
Building 2
94,198
171,211
265,409
41,291
204,241
245,532
293,139
293,139
69,147
176,219
245,366
4/2006
4/2006
7/2006
7/2006
10/2006
1/2007
1/2007
% of Total Vacancy
25%
24%
28%
23%
Building Space
Free Rent Tenant Improvements
Year
1Ye
ar 2
Year
3Ye
ar 4
Year
5Ye
ar 6
Year
7Ye
ar 8
Year
9Ye
ar 1
0Ye
ar 1
1IN
CO
ME
Re
ntal
Inco
me
33,2
42,9
20
41
,951
,324
8
1,16
5,13
2
8
1,8
28,7
59
8
2,6
22,2
41
8
3,52
7,24
8
8
8,9
66
,98
6
90
,477
,626
89
,88
0,7
10
9
2,12
7,9
24
9
2,70
8,7
29
Es
cala
tion
Inco
me
-
5,0
68
,09
9
8,2
03,
033
9
,229
,030
10
,19
3,6
26
11
,29
5,13
1
12,5
26,5
16
13
,78
5,8
78
14
,60
2,0
37
15
,89
3,9
41
17
,170
,059
Vac
ancy
/ C
red
it L
oss
-
(4
,46
8,4
09
)
(4
,552
,88
9)
(4,6
40,7
93)
(4,7
41,1
19)
(5
,074
,675
)
(5
,18
5,14
6)
(4
,56
1,6
33)
(5,4
01,
09
3)
(5
,49
3,9
39)
TOTA
L IN
CO
ME
33,2
42,9
20
47
,019
,423
8
4,8
99
,756
86
,50
4,9
00
88
,175
,074
90
,08
1,26
0
9
6,4
18,8
27
9
9,0
78,3
58
9
9,9
21,1
14
10
2,6
20,7
72
104,
384,
849
EXPE
NS
ES
Ope
rati
ng E
xpen
ses
-
21,2
34,8
75
23,0
69
,654
23,7
61,
744
24,4
51,0
24
25
,26
8,3
27
26
,112
,241
26,9
81,
245
27,8
14,5
92
28,8
12,3
03
29,7
71,4
50
Re
al E
stat
e Ta
xes
-
15,4
44,6
87
15
,972
,018
16,3
45,2
65
16,7
53,8
97
17,1
72,7
44
17
,60
2,0
63
18,0
42,1
14
18
,49
3,16
7
18
,955
,49
6
19
,429
,38
4
TO
TAL
OPE
RATI
NG
EXP
ENS
ES
-
36
,679
,56
2
39
,041
,672
40,1
07,
00
9
41
,20
4,9
21
42
,441
,071
43,7
14,3
04
45,0
23,3
59
46
,30
7,75
9
47
,76
7,79
9
49
,20
0,8
34
NET
OPE
RATI
NG
INCO
ME
33,2
42,9
20
10
,339
,861
45,8
58,0
84
46
,397
,891
46,9
70,1
53
47
,640
,189
52,7
04,5
23
54
,054
,999
53,6
13,3
55
54
,852
,973
55,1
84,0
15
CA
PITA
L EX
PEN
DIT
URE
S
Tena
nt Im
prov
emen
ts
-
35
,86
6,6
15
-
-
-
-
-
-
1,59
5,9
83
-
-
Le
asin
g C
omm
issi
ons
-
27,7
20,8
40
-
30
,425
-
-
-
-
1,
228
,925
-
11
7,32
6
C
apit
al R
eser
ves
-
25,6
38,8
07
181,
627
187,
076
192,
68
8
19
8,4
69
204,
423
210
,555
217,
199
223,
714
230
,425
TOTA
L C
API
TAL
EXPE
ND
ITU
RES
-
89
,226
,26
2
18
1,6
27
21
7,50
1
19
2,6
88
198
,46
9
20
4,42
3
21
0,5
55
3,
042
,10
7
223,
714
347,
751
NET
CAS
H F
LOW
33,2
42,9
20
(7
8,88
6,40
1)
45
,676
,457
46,1
80,3
90
46
,777
,465
47,4
41,7
20
52
,500
,100
53,8
44,4
44
50
,571
,248
54,6
29,2
59
54
,836
,264
Lexi
ngto
n Av
enue
Bui
ldin
gs
ProF
orm
a 2:
Agg
ress
ive
Case
Re
al
Es
ta
te
Ca
se
St
ud
y2
1
R e a l E s t a t e C a s e S t u d y2 2
Lexington Avenue BuildingsProForma 2: Aggressive CaseAssumptions
2004
Office
Low-Rise (Floors 2-16)
High-Rise (Floors 17-34)
$48.00
$55.00
Growth Rates2005 - 2008, 2009+
5%, 7%, 5%, 5%, 3%+
5%, 7%, 5%, 5%, 3%+
2004 Growth Rates
Office
New Leases
Renewals
$35.00
$15.00
2.5%+
2.5%+
All assumptions remained the same as in the Base Case ProForma with the following exceptions:
Lease-Up Assumptions
Square Feet Lease-Up
Building 1
Building 2
Building 1
Building 2
Building 2
Building 1
Building 2
128,844
469,358
265,409
23,342
204,241
245,532
37,187
171,211
208,398
12,298
245,366
1/2006
1/2006
4/2006
4/2006
7/2006
7/2006
10/2006
% of Total Vacancy
57%
22%
20%
1%
Building Space
Tenant Improvements
Exhibit DDebt Assumptions
R e a l E s t a t e C a s e S t u d y2 4
Exhibit D
Debt Assumptions
The cost of debt is often predicated on the amount of debt relative to the total asset value ("Loan-to-Valueratio" or "LTV"). In addition, other property specific factors, such as Debt Service Coverage ratios (a property'sNet Operating Income relative to debt service - see below) will affect risk and loan pricing and terms.
Generally, the higher the Loan-to-Value ratio, the more expensive the debt, since the risk profile (thepossibility of default) increases. However, with Positive Leverage (see Exhibit E for a definition), the totalreturn (IRR) increases on the levered amount of equity. Lenders will often quote prices with fixed rates,based on Treasury rates, or floating rates, based on LIBOR (London InterBank Offered Rates). Borrowers willusually decide on the term and the type of loan based on their holding strategy and appetite for risk.
The chart below outlines estimated pricing for fixed 5- and 10-year loans on a Class A/B+ building inManhattan. The "Spread" is the risk premium that lenders will charge over the 5- or 10-year Treasury rate,and is added to the Treasury rate for the overall interest rate.
For this exercise, assume that the 5-year Treasury rate is 3.75% and the 10-year Treasury rate is 4.50%. Alsoassume that the loan is interest-only (there are no amortization payments.) What loan-to-value ratio wouldyou apply? What loan term?
Things to Consider:
■ If you choose to hold the property longer than your loan term, you must refinance the property. Inthat case, assume that Treasury rates have been increasing 0.35% per year, starting in Year 2.
■ In evaluating the appropriate level of leverage for a property, lenders will calculate a property'sDebt Service Coverage Ratio ("DSCR"). The DSCR is most often calculated as the ratio of aProperty's Net Operating Income ("NOI") to Debt Service Payments. While the DSCR calculated onactual Debt Service Payments are important, lenders will usually impose a DSCR "test", whichuses a hypothetical Debt Service payment using a historically stabilized interest rate (currently7.50% - 8.0%), which in today's low interest rate environment, can be significant. Lenders typicallyrequire that the DSCR test result in a DSCR of 1.10x to 1.25x.
For instance, assuming a 75% LTV, $100,000,000, interest-only 10-year loan, annual debt service is$6.25 million [= $100,000,000 x (4.50% + 1.75%)]. An NOI of $10 million would result in an actualDSCR of 1.60x [= $10,000,000 / $6,250,000].
However, a lender may require that a borrower apply a test, using hypothetical debt service, basedon a loan with a 7.5% interest rate and a 25-year amortization schedule. For such a loan, annualdebt service would be $8.87 million, and the test DSCR would only be 1.13x.
For this exercise, assume that the lender will require a DSCR test using an 7.5% interest rate and a30-year amortization schedule. The DSCR test cannot result in a ratio lower than 1.10x.
■ How would you fund large cash deficits? Would you borrow more money or would you put inadditional equity?
Loan-to-Value Ratio60% 65% 70% 75% 80% 85%
5-Year Loan Spread 1.65% 1.75% 2.00% 2.25% 2.75% 3.25%10-Year Loan Spread 1.15% 1.25% 1.50% 1.75% 2.50% 3.00%
Exhibit EGlossary of Terms
R e a l E s t a t e C a s e S t u d y2 6
Exhibit E
Glossary of Terms
1. Capitalization Rate ("Cap Rate"): The rate of return generated by income as it relates to propertyvalue. It often refers to the ratio of the first year's Net Operating Income divided by the Purchase Price:
Capitalization Rate = Net Operating IncomePurchase Price
"Cap Rate" is sometimes used to refer to the "Initial Cap Rate", which is calculated using the NetOperating Income in the first year. It can also refer to the "Stabilized Cap Rate", which uses the NetOperating Income in a year that is considered "stabilized" (e.g. after a building leases an abnormallylarge block of space, or a below-market lease is renewed at market levels).
2. Cash-on-Cash Return: The rate of return generated by cash flow (before debt service) as it relatesto property value. The ratio used here is:
Cash-on-Cash Return = Cash Flow (before Debt Service)Property Value
3. Internal Rate of Return ("IRR"): A discount rate where future Net Cash Flows equal the initialinvestment. In other words, a discount rate where the net present value (NPV) is equal to zero.
NPV = Initial investment + CF1 + CF2 + CFY
(1 + IRR)1 (1+IRR)2 (1+IRR)Y
4. Leveraged Return: The rate of return generated by net cash flow (after debt service) as it relatesto invested equity. The ratio used here is:
Leveraged Return = Net Cash Flow (after Debt Service)Invested Equity
5. Loan-to-Value Ratio ("LTV"): The ratio of a mortgage loan principal (value of loan) to the property'svalue/sale price. For example:
If a property is purchased for $300m and our target LTV is 65%, our loan would be$300,000,000 x 65% = $195,000,000. Accordingly, our equity contribution would be35% or $105,000,000.
6. Net Cash Flow ("NCF"): Net Operating Income less Capital Expenditures and Debt Service.
NOI - Capital Expenditures - Debt Service = Net Cash Flow
7. Net Operating Income ("NOI"): The balance remaining after deducting Total Expenses (fixedproperty expenses and operating expenses) from Total Revenues (Gross Receipts less a vacancyand/or credit loss allowance), but before Capital Expenditures and Debt Service.
Total Revenues - Total Expenses = Net Operating Income
R e a l E s t a t e C a s e S t u d y 2 7
8. Positive Leverage: Positive Leverage occurs when leverage increases the return on the investedequity. When cash-on-cash return is greater with financing than without, positive leverage exists.That is, the rate of return on the investor's equity is greater if the investor borrows part of theproperty cost than if the investor pays all cash for it. This usually occurs when the property isearning a return at a greater rate than the cost of borrowing money. (Conversely, Negative Leverageoccurs when cash-on-cash return is less with financing than without. Such a situation occurswhen the cost of borrowing money is greater than the rate at which the property is earning a return.)
9. Replacement Cost: The cost of constructing a building with current materials and techniques thatis identical in functional utility to the structure being evaluated. The costs include Hard Costs(e.g. building materials, furniture, fixtures, and equipment), Soft Costs (e.g. architectural, legaland other professional fees, permits and licenses, and insurance), Leasing Costs, Financing Costs,and Land Costs.
10. Tenant Improvement ("TI's"): Tenant Improvements are any physical improvements made to atenant's space. Tenant Improvements are typically offered by the Landlord as a means of attractingnew tenants and are modeled for new and renewing leases.
Glossary of terms continued