Steel Street Case Study

Ruthie Americus & Anil Cheerla

Case Facts

Vincent Colmo (Ex HBS) & cousin Daniel Delconte – partnered to form River Triangle Associates, a profitable RE investment firm specializing in buying apartment bldgs & strip malls below replacement costs, rehab/re-position them and sell them for strong returns.

Average returns to investors – 14% Rents 30% below new construction Vincent was responsible for buying, renovating and maintaining

properties while Daniel managed finances and investor relationships

Project selection based on: Returns, Renovations within 6-9 months to avoid carrying costs,

Bypass city regulations & Target middle-income market

With commercial RE unwinding, RTA focused on office properties in Pittsburgh’s Southside, adjacent to CBD – a hip neighborhood known for vibrant night life, shopping, cafes and business incubation.

Overview of the Space

6 story; 1920 building located in Southside5 floors of office space; 1 floor (ground floor)

of retail space49,000 gross sq. ft.Estimated renovation costs are $69/sq. ft.Hope to increase rents from $8/sq. ft. to

$15/sq. ft.

Pros/Cons

Strategic Advantages of Steel Street

Located in Southside, a hip neighborhood with many startups

Limited space availability for new developmentPotential to attract large new employers –

business office space combined with retail Proximity to a new popular retail complexReplacement cost $69/sq.ft vs. $150 for new

office constructionMarket wise – Pittsburgh had a diversified

economic base, low unemployment, no overcapacity, insulation from RE downturn & growth prospects

Renovation Schedule & Funding Sources

What went wrong?

Causes EffectsFirst, the

cousins chose an architect

that had high fees. Also she thought their

original budget was too small to

work withThe architect and the

contractors have never worked together before and there is some large disconnect between the

architect’s vision for the building and the

contractor’s work style

The architect was getting behind

schedule and her designs were

being repeated reworked and costing much more than the

original estimates

The city building inspector walked through

the site and was not pleased with the safety of

the conditions that the contractor was working

within

The leasing of the space was not going well

because prospective

tenants wanted to see the

finished space before signing a

lease

What is next…

After owning the property for almost 1 and months of construction, in September of 2009 what is next… 1- Find a new construction team

2- Recruit new investors to cover budget shortfalls

3- Ask hedge fund to convert debt into equity4- Contribute from their personal finances5- Give incentives to leasing agents and

tenants6- Lose some green elements to the building

Option 1

Option 1: Find a new construction teamNot an option since hiring a new contractor wouldresult in:Additional costsConstruction delayIncoherence with existing work already doneThreat of losing at least ½ year job with additional

modifications to project scope and schedule Also, being a lump sum contract, Harper & Polowski agreed for a fixed price, so

it is in the best interests of RTA to continue working with the existing contractor.

Option 2

Option 2: Recruit new investors to cover budget shortfalls

Ruled out because of the following factors:Credit markets were in turmoilLiquidity was lackingThe MBS markets were shrinkingSponsors did not have office building

experienceCurrent project situation is not helping anyway

Option 3

Option 3: Ask hedge fund to convert debt into equity

Hedge funds specialize in short-term trading strategies, are open-ended vehicles permitting both periodic subscriptions and redemptions.

So holding a illiquid asset will go against their business strategy.

May even argue that given low yield, low volatile market conditions, Harvard group may find this equity return attractive.

Option 4

Option 4: Contribute from their personal financesAs per the agreement terms, RTA were to extend

financing to the partnership of up to $200,000 as an uncollateralized 10% interest bearing loan.

Personal B/S shows that the cousins can part with capital for additional overruns, but given the risks involved, our opinion was that they would not make any new additional investments.

Initial equity of $563,885 would result in 1,284,886 after 5 years

Option 5

Option 5: Give incentives to leasing agents and tenants To compensate for the leasing agent’s slow movement, the cousins will provide a $20,000 signing bonus to any brokers who sign leases with tenants for over 5,000 sq. ft.

This added bonus will only decrease the IRR from 28% to 26%, and will hopefully drastically improve the leasing situation. Good option, but may have to reduce their returns overall. Will work to mitigate vacancy by having large, clients sign up long-term leases with sound credit

Option 6

Option 6: Lose some green elements to the building

May not be a wise choice as the bldg may not appeal to new tenants or even existing lease renewals.

Cannot justify higher rental rates of $15 psf.Will not bring in the energy efficiencies

expected May not compete with other “green”

properties in the market.

Original Pro Forma

Levered Returns            

  Initial Outlay 2009 2010 2011 2012 2013

Initial Equity $ (563,885)  

Building Renovations $ (794,000)  

   

Annual Cash Flow $ 71,787

$ 197,256

$ 232,108

$ 232,108

$ 232,108

Sales Proceeds - Mortgage Repayment $ 3,175,871

Total Cash Flows $ (1,357,885)

$ 71,787

$ 197,256

$ 232,108

$ 232,108

$ 3,407,979

   

Annual ROE 5.29% 14.53% 17.09% 17.09% 17.09%

IRR 28.16%          

Modified Pro Form with Leasing Bonus

Levered Returns            

  Initial Outlay 2009 2010 2011 2012 2013

Initial Equity $

(563,885)  

Building Renovations

$ (794,000)  

   

Annual Cash Flow $

71,787 $

37,256 $

72,108 $

232,108 $

232,108

Sales Proceeds - Mortgage Repayment

$ 3,175,871

Total Cash Flows $

(1,357,885) $

71,787 $

37,256 $

72,108 $

232,108

$ 3,407,979

   

Annual ROE 5.29% 2.74% 5.31% 17.09% 17.09%

IRR 24.44%          

Looking back: Issues at Stake

• Issues with re-positioning a property• Problems with development teams• Impact of weak credit markets on RE financing• Cost overruns and poor management• Volatile markets – impact on rental/vacancy

rates• Importance of risk assessment, planning and

mitigation• Lack of expertise in RE domain – Office

properties

What-if analysis

To understand the impact on RTA returns, we did sensitivity analysis on the following:

If vacancy rates fluctuate –If rental rates varyIf additional leasing commissions of $20,000 are providedIf costs escalate beyond controlIf existing retail tenant breaks lease and collects $25,000 as

damagesIf one of the Banks/Hedge funds withdraws financing

Vacancy & Rental rates

Vacancy rates vary Rental rates vary

LC & Increasing Equity

Brokers incentivized Cumulative impact (LC+Eq)

Questions???