ONE EMBACADERO PLACE INVESTMENTS BACKGROUND

The Embarcadero Real Estate Investment Partnership LLC owns an apartment building complex, One Embarcadero Place, located near Shoal Creek Road and Anderson lane in suburban Dallas. Embarcadero Partnership wishes to sell the property and is in serious negotiations with a motivated buyer. There is an outstanding mortgage loan balance of $9,045,000 on the property that the buyer of the property may assume since the mortgage is assumable. The contract rate on the existing mortgage is 9%, monthly payments, with a remaining amortization period of 22 years at the time of sale. This existing first mortgage has a term of 10 years, i.e. it is balloon loan as most commercial real estate mortgages are. If the buyer assumes the outstanding mortgage balance the amount of equity investment (or down payment) that will be required is $4,455,000, because asking price (which is firm) is $13,500,000. If the existing first mortgage were assumed by the buyer, the required debt service would be based on the remaining amortization period of 264 months and contract interest rate of 9%. Embarcadero Partnership paid points and fees on the original loan in the amount of $234,741 when it first obtained the mortgage loan to finance the apartment property three years ago.

2 BRIEF PROPERTY AND MARKET CONDITION DESCRIPTIONS

The city skyline is just one of the many highlights you will notice at One Embarcadero Place Apartment Complex located in the historic part of Dallas. At One Embarcadero you will find boutique shops and other services within walking distance as well as affordable dining opportunities. The amenities in the complex include convenient free parking, high tech security, a fitness center and private pool, court yard for hosting guests and community events and friendly, professional on-site staff. Many of the luxury apartments have an array of stylish features including washer and dryer and the kitchens are equipped with modern appliances. The exterior of the building is a combination of brick, wood and textured veneer The Embarcadero Complex is three years old, has 156 units spread over 5 floors with total gross leasable area (GLA) of 178,453 square feet. The property is in good physical condition given that it is relatively new; hence no need for refurbishing after purchase. The units are typically rented to middle class fully employed individuals employed by major companies headquartered in the Dallas Metropolitan Area. The average asking rent in the subject building (i.e. Embarcadero complex) is $11.99/year/square foot of GLA. The typical apartment building in the market area, similar to the subject property, has GLA of 185,466 square feet. The net operating income (NOI) for the typical apartment property in the market area is shown in Table 1 below.

Table 1:

Net Operating Income for Typical Apartment Building in the Market Area. Potential Gross Income (PGI) $2,225,592 Less Vacancy and Bad Debt (V&BD) 137,968 = Effective Gross Income (EGI) $2,087,624 Less Operating Expenses (OE) $689,933 Less Management Expense (ME) $168,433 Less Real Estate Tax (RET) $173,426 Less Replacement Reserve (RR) $103,942 = Net Operating Income (NOI) $951,890 Embarcadero Real Estate Investment Partnership is selling the property for $13,500,000 or $75.65 per square foot GLA which is a firm asking price.

ALCORN PARTNERS LLC: MOTIVATED PROSPECTIVE PURCHASER

Alcorn Partners L.L.C is seriously considering purchasing the property offered by Embarcadero Partnership and your company, Allan Pots Associates has been retained as analyst and consultant to the buyer of the subject property called One Embarcadero Place. The expected holding period for the buyer, Alcorn Partners, is 5 years, over which the partners expect an internal rate of return of 15%. Their expected return on equity (ROE) or equity dividend rate (EDR) is 10%. Of course, EDR does not reflect any return portion associated with appreciation/depreciation of the asset. While the 3 expected holding period of your client, Alcorn is 5 years after buying the property, your client may also consider refinancing the property after two years, with another mortgage that has better terms. As part of your consulting assignment there are several analysis or tasks you need to conduct to assess the feasibility of the sale and purchase of the apartment project. To provide guidance I have described below the series of tasks and analyses you are required to conduct for your clients so as to make for effective and rational decisions associated with the sale by Embarcadero Partnership and purchase by Alcorn Partners respectively of ONE EMBACADERO PLACE.

Question 1

The immediate issues that you need to address in this part of the case is whether the asking price is a fair offer, i.e. is the property overpriced or underpriced at $13,500,000? Here you are explicitly required to use financial solvency model (Front Door and Back Door models) and the income capitalization model as key real estate asset pricing models, to answer this question. Of course you may add other valuation metrics as you deem fit. Next you are asked to assess the (1) Financial Risk, (2) Business Risk and Maximum Loan Amount of the apartment project by calculating quantitative metrics. Lenders in this market typically require a debt coverage ratio of 1.35. In preparation for this assignment you have gathered additional information for typical or average apartment building in the subject property market area as summarized in the Exhibit 1 shown above. This typical apartment building is similar to the subject property that is for sale and it has GLA of 185,466 square feet of space. This property recently sold for $15,000,000.

Alcorn suspects that if it assumes the existing mortgage and invests the required equity amount to complete transaction, financial leverage will be negative. So, you are required to analyze static financial leverage of the project.. The conduct leverage analysis using quantitative metrics to determine whether the leverage situation of the property as currently configured is positive or negative using quantitative static metrics, based on the asking price of $13.5M and assuming the Alcorn assumes the outstanding mortgage balance of $9,045,000 and makes required equity investment to complete the capital structure and the transaction. If leverage is negative what can be done to make it positive. Additionally, Embarcadero Real Estate Partnership, LLP is curious to know the APR and the effective cost of borrowing on the original loan it got to finance the property.