A client of yours is considering purchasing a limited partnership interest in a private real estate syndication project that is being formed to purchase the Forest Hill office building. The syndication is to have eight limited partners with the Jim Clements Company acting as the general partner. The partnership is to be organized immediately.Your objective is to determine whether or not acquisition of a limited partnership share of the project is in the best interest of your client, who is totally ignorant of what real estate "syndication" means. Your client has also asked that you prepare an analysis of the expected returns to the general partner. Assume the required after-tax return is 18% for the general partner and 12% for each of the limited partners.

The property will be purchased by the partnership for $2,020,000. A permanent mortgage loan for $1,500,000 has been obtained from Still Open State Bank. The interest rate on the 30-year fixed-rate loan is 6.0%. Payments will be made monthly. There will be no up-front financing costs.

Table 1 shows the financial aspects of the partnership agreement and the equity requirements of the general and limited partners. Ten percent of the total initial equity requirement will be contributed by the general partner. The eight limited partners will contribute 90 percent of the total equity requirement.

Table 1

Partnership Assumptions and Equity Requirements:

Forest Hill Office Building

1. Number of partners: nine, one general and eight limited.

2. Equity capital contribution: general partner - 10 percent, limited partners - 90 percent (11.25 percent each of total required equity).

3. Future cash (equity) assessments: to be funded in the same proportion as equity contributions.

4. Cash distribution from operations: general partner 10%, limited partners 90%.

5. Taxable profits and losses from operations are to be distributed 90 percent to limited partners and 10 percent to the general partner.

6. Sale and liquidation of property: After the payment of selling expenses and the remaining mortgage balance, each partner (general and limited) is to receive all equity invested plus any assessments; any excess net cash flow from sale is to be split 60 percent to limited partners and 40 percent to general partner.

7. Projected holding period: 5 years.

8. Marginal tax rates for general partner and all limited partners: ordinary income, 39%; capital gain income, 25%, and depreciation recapture, 25%.

Taxable income and tax losses from operations are distributed in the same proportions as

equity contributions: 10 percent to the general partner and 90 percent to the limited partners. Future equity contributions (if they are needed) will be funded in the same proportions as equity contributions. Cash disbursements made from cash flow from operations are also to be distributed in the same proportions as equity contributions.

After the real estate has been sold and liquidated, all partners (general and limited) are to first recover their equity and assessments. Any excess cash flow from disposition is to be distributed 60 percent to the limited partners and 40 percent to the general partner. The taxable gain on sale of the property is not allocated per the partnership agreement. Rather, the taxable gain on sale will "fall-out." This means it will depend on capital account balances immediately before sale of the property. The projected holding period for the investment is 5 years. Ignore the possible ramifications of passive activity loss restrictions.

Operation and Tax Assumptions

Table 2 shows the general partner's projections regarding operations and tax deductions. Assumptions are made concerning initial gross income, projected income growth, projected growth in property value, vacancy and collection losses, operating expenses, and the depreciation method.

Table 2 Operating & Tax Assumptions: Forest Hill Office Building

Potential gross income (PGI) $350,000 in year 1

Rental growth rate 2.0% per year

Vacancy and collection expenses (V and CE) 10% per year

Operating expenses (OE) 45% of EGI

Property value growth rate 1.5% per year

Proportional selling costs: 6 percent of future sales price

Depreciable improvements: 80% of the acquisition price

Depreciation method 39-year straight-line

After completing all of the calculations, prepare a letter of transmittal to your client that contains and explains your recommendation. The letter should first summarize your finding and then provide an overview of the steps in your analysis. This overview and discussion may include, in the form of tables, some of calculations performed in the spreadsheet. A hard-copy of the entire calculation should be attached to your report as an appendix. However, your client does not have the patience to sort through numerous pages of detailed output. Therefore, when referring to calculations or results in the spreadsheet that are not replicated in the body of your analysis, you must make reference to specific items that are highlighted in yellow on the spreadsheet in the appendix.