Overview and Instructions

Below is sketch of a potential deal that you have been tasked to analyze, please write a short $$memo$$ answering the questions below and giving thoughts and detail you may wish to add. Assume you are an analyst working for a private equity investment firm, thus you are writing to your boss $($a Chief Investment Officer type$)$ with recommendations on doing this deal. Use everything you have learned including your spreadsheet from the prior homework. Grading will be on thought process, means of analysis, and less on getting a $$right$$ answer. Thus, completeness of thought is very important, a right set of answers without corresponding thought and explanation of process will not get much credit $($just like in the real world$).$ As a $$hint$,$ there can actually be multiple right answers as you must make some judgement calls, just like in the real world! As an additional note, this is an individualized project, but discussion and collaboration in thought is allowed and even encouraged, just do not turn in the same project as that will be a violation of SJU rule $($and subject to not fun stuff$).$

The Property

You have the opportunity to buy a $100$ unit apartment building in suburban New Jersey. It is currently $92\%$ leased but the market occupancy is presently $95\%,$ but has averaged only $89\%$ over the past $10$ years. The building has an average unit rent of $$1,400$ per month per unit, but other units in the market only get $$1,350.$ The building has run operating expenses of $40\%$ of EGI, but your property management department thinks that it may be a little low and under expenditure may lead to expensive repairs in the future. The owner has successfully raised rents $3\mathrm{.}5\%$ per year the last five years and has resulted in low rates of tenant turnover; but market rents have only risen about $2\mathrm{.}5\%$ over the same period, and future inflation is only forecast at $2\%.$

The Financing

The firm has sufficient equity to invest any reasonable amount of down payment to make this acquisition, however, it must earn at least a $10\%$ annualized total return on equity for the CEO to approve. If the deal is $$risky$$ in the CEO$$s view, they may require even higher rates, but you can$$t know what that is ahead of time. While figuring out the CEO is tricky, they have generally said $$yes$$ to deals that preference income return over appreciation return in the past. The firm$$s preferred lender has prepared the following quotes for apartment building loans:

Option $1$

LTV $75\%$

Minimum DSCR $1\mathrm{.}4$

Term $10$ Years

Amortization $20$ Years

Rate $5\mathrm{.}0\%$

Option $2$

LTV $70\%$

Minimum DSCR $1\mathrm{.}5$

Term $10$ Years

Amortization $30$ Years

Rate $4\mathrm{.}5\%$

Option $3$

LTV $65\%$

Minimum DSCR $1\mathrm{.}3$

Term $10$ Years

Interest Only

Rate $4\mathrm{.}75\%$

Valuation Information

There have not been a lot of market sales for which you can use in basing a price, as such, the seller has not indicated a listing price and has instead said all reasonable offers will be considered. A national brokerage has released a report that apartment buildings in suburban NJ markets should trade for cap rates of $6\%$ to $8\%$ in today$$s market.

Questions to Address

Develop a proforma based on the above information on the property and financing options. Your goal is to recommend to your boss, a price to offer on the property to the seller. There is no listing price, but if your offer is too low, you will not buy it$,$ and probably lose your job. If it is too high, the CEO will probably reject the deal $($clue$,$ use guidance on return on equity requirements and DSCR guidelines to work into feasible prices$),$ and you may lose your job!

In the written part of the memo, explain what assumptions you made and how you approached the analysis to come up with the recommended offer. Also, you must address your choice of financing and the option selected is better than the others. While you are not required to $$analyze the market$($as I really have not identified one$),$ you are encourage to give an analysis of what should be researched$/$analyzed during due diligence to decide if a good deal and how risky it is$.$

Can you provide an Excel sheet to go along with this? Thanks