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REAL ESTATE FINANCE AND INVESTMENTS: Case: Westwood Publix Plaza The Property: : The property in question is a 100,000 square foot strip mall "Westwood Plaza" located in a suburb in Central Florida (Tampa). The 31 year old center is decently located within the town. You purchased the property 8 years ago for $7,000,000 (current time/year is 2003). Based on IRS filings, 30% of the purchase price was attributable to land costs. There are two primary retail anchors and 11 smaller local tenants. Tenants: Publix Supermarket: The first anchor tenant is a 35,000 square foot Publix supermarket which has been a tenant in the center since 1980. The Publix chain as a whole is financially solvent and has good quality credit. The terms of the Publix lease dictate that it pay $10 per square foot annually with no provisions for increase. Moreover, they are responsible for paying 29% of the property's total common area maintenance costs. They have an option to renew their lease for an additional 10 year period upon expiration of their current lease at a rental rate of $13 per square foot. Publix has the absolute right to go dark at any time. The current lease expires in December of 2009. Eckerd Drugstore: The second anchor tenant is a 25,000 square foot Eckerd drugstore. Eckerd has been in the center since 1980 and is paying $8 per square foot annually, with no rental increases over the life of the lease. Under Eckerd's lease, they must pay 23% of the property's total common area maintenance costs. The expiration date on the Eckerd lease is December 2012. They have the right to void the lease if Publix either goes dark or leaves the center. The Eckerd chain has experienced a decline in the quality of their credit, which now stands at BB. Other Tenants: The remaining 40,000 square feet is presently fully leased and occupied by 11 smaller local tenants. Although there are no credit ratings available for these tenants, it can be assumed that they are generally a significant credit risk. Your rental revenues from these tenants are based not only upon a base rent amount, but also include a percentage rent component of 1.5% of each tenant's gross sales figures (excluding the good doctor). The basic terms of the 11 local tenant's leases are as follows. WESTWOOD PLAZA IN-LINE TENANT LIST - Tenants Description Term of Lease Square Feet 2,500 2,500 4,000 CAM Allocation 2.5% Base Rent Per SF $11.49 Ross Travel Rob's Pizza 2.5% Gross Sales 2002 $502,000 $354,000 $626,000 $480,000 $304,000 Jan-01-Dec-07 Jan-03-Dec-07 Jan-02-Dec-09 Jan-99-Dec-04 2,500 Travel Agency Food Liquor Store Hair Salon Nail Salon Ophthalmologist Video Rental Dry Cleaners Food Trew's Brews Supercuts Nails by Dykstra Dr. P Linneman DB's Video Stain B Gone Ma's Diner 4.0% 2.5% 2.5% 2,500 5,000 4,000 $11.88 $12.65 $14.00 $13.68 $16.00 $14.25 $10.74 $11.33 5.0% 4.0% Jan-97-Dec-04 Jan-00-Dec-os Jan-99-Dec-06 Jan-01-Dec-09 Jan-00-Dec-03 2,500 $585,000 $377,000 $543,000 2.5% 6,000 6.0% 1 REAL ESTATE FINANCE AND INVESTMENTS: Powerhouse Gym 7,000 Bundy's Shoes Women's Shoes 1,500 7.0% 1.5% $15.36 $16.67 $669,000 $298,000 Jan-02-Dec-08 Jan-03-Dec-06 In addition to rental payments, all leases include terms requiring tenants to pay their designated share of common area costs, which includes operating costs and all applicable insurance premiums. The landlord pays for all of these expenses directly and then is reimbursed by the tenants. Total CAM and insurance costs to the tenants totaled $540,650 in 2002. The property also generates revenue from two additional sources: a cell tower and a billboard. Each earns $2500/month and incurs no additional costs to your mother. Below is an excerpt from the financials of Westwood Plaza over the last 3 years of operation. WESTWOOD PLAZA FINANCIALS 2000 2001 2002 Gross Rents $1,264,698 $58.970 $1,220,811 $121,870 $1,098,941 $1,223,645 $45,136 $1,178,509 Vacancy Net Rents CAM/RE Tax Recoveries Total Revenue CAM Costs/Insurance Costs $1,205,728 $429,087 $1,634 815 $460,840 $508,648 $1,559,780 $1,687,157 $540,650 $490 385 $514,905 Real Estate Taxes $125,000 $639.905 $137,500 $678,150 Total Operating costs NOI $1,009,007 $125,000 $615,385 $1,019,429 $55,000 $17,100 $50,588 $896,742 Tenant Improvements Leasing Commissions $55,000 $919,876 $25,000 $11,068 $48.832 $28,933 $48.946 Cap Ex NOI after Tis/Comm/CapEx $834,975 $876,129 The landlord is responsible for paying property taxes for Westwood Plaza. However, each lease requires the tenants to pay their CAM share of property taxes above the level that existed when they signed the lease. Last year the property tax rate was reassessed at $1.375 per square foot. This was an increase of 10%. Additionally, in light of frequent tenant turnover and wear resulting from high customer traffic, the landlord typically holds 4% of gross rent in a replacement reserve to be used for capital expenditures. Market: The Central Florida market where Westwood Plaza is located has experienced tremendous growth over the last 10 years. The population of the surrounding region is rapidly growing and the city has made substantial improvements to the local infrastructure. With the burgeoning market for residential space, retail rents have enjoyed an upward trend, which your mom currently estimates at 3% -4% per year. Typical cap rates for retail space in the surrounding areas have generally been 9% to 11% (based on a few recent sales). The surrounding area is typically composed of upper-middle class residents, who 2 REAL ESTATE FINANCE AND INVESTMENTS: have an annual median household income of $55,000. Approximately 75,000 residents occupy the area within a 5-mile radius of the strip center. Also, as is typical of Central Florida the area surrounding the local region has a disproportionate number of retirees. As a result the majority of the employment for working area residents is in the service sector. Issues: Over the past few years, things have gotten a bit complicated for Westwood Plaza. Two years ago, a new 220,000 square foot Wal-Mart super-center, complete with supermarket, opened just a little over 2 miles away. In addition, roughly 300,000 square feet of new retail space was constructed in the area surrounding Wal-Mart. Since that time, the Publix and Eckerd stores in the strip-center have each experienced nearly 25% drops in sales. Current sales at these stores appear to have stabilized after this initial decline. However, current sales levels are generating little profit if any to either Publix or Eckerd at the Westwood locations. Moreover, Publix has recently increased their preferred store size to a minimum of 50,000 square feet and are seeking to convert all of their locations to this model. Current market rents for retail tenants in the area are estimated to be roughly $12 per square foot. Furthermore, in the current retail market, it typically takes 3 - 9 months of aggressive leasing to fill vacant space in well located strip centers. However finding larger tenants to assume "anchor" positions can take upwards of one year, and can involve substantial effort without guaranteed results. Financing Alternatives: When she purchased the center, your mother took out a full recourse, interest only loan for $5 million. This loan is now maturing and she is deciding what to do. As such, she has the option of either selling the plaza or refinancing the loan. Her alternatives are outlined below. Based upon an appraised value of $10 million, a local bank has offered your mother a 5 year, non- recourse note of $6 million. The loan is at a 6% interest rate, amortized over 30 years, and contains a payment at time of closing of 1.5 points. With these proceeds she could repay (without penalty) her maturing $5 million loan including fees and points, and pocket close to $1 million. Alternatively, she has received a $7 million all cash offer to sell to an opportunity fund. If she sells she will have to pay the applicable local fees and taxes of 3% of the sale price, as well as repay the $5 million loan. She can alternatively refinance with a 10-year, $7.5 Million, participating non-recourse loan. The lender would receive 10% of the annual pre-tax profits, as well as receive 4% interest payments on the loan. The loan is amortized over thirty years. Finally, she could redevelop the center and expand the Publix space in 2008 (the redevelopment must be completed before their current lease expires). This can only be accomplished by warehousing the local tenant space that expires over the next 5 years and expanding Publix into this space in 2008. If this alternative is chosen, Publix has agreed to sign a lease that pays $9 per square foot from now through 2008, and $11 per square foot through 2020. The new lease would prohibit them from going dark prior to 2008. If she pursues this path she can refinance her currently maturing $5 million loan with a 5-year, $5 million non-recourse floating rate loan (interest rate reset annually), at an initial interest rate of 4.0%, with no amortization and no prepayment penalty after 1 year (Note: this reduced loan amount takes 3 REAL ESTATE FINANCE AND INVESTMENTS: into account the lost income on the expiring local tenant space required for the expansion). Your mother estimates that the interest rate on the loan will increase by 50 basis points per year through 2007 and stabilize thereafter. The re-development will necessitate an additional construction loan. Your mother believes that in 2005 she should be able to get a 3-year construction loan for $1.5 million at a 9% interest rate. This loan would be interest only and take effect in 2005. Given the nature of the site, space for the redevelopment must be made available through the warehousing of existing retail space. Once space has been warehoused it can no longer generate income to your mother. The cost of preparing existing retail space for the grocery store space is projected to be $100 per square foot. The actual redevelopment process will take approximately one year to finish and must be completed by 2008. All of the space for the expansion must be completely warehoused by the time construction commences. Profile of Mother: Your mother has experience in strip retail development and possesses the expertise necessary for undertaking the redevelopment option. Moreover, she has adequate income streams from other assets so she has no immediate need to liquidate her equity position in Westwood Plaza. Her other assets include another strip center in a nearby town that is both stable and profitable, as well as a substantial portfolio of moderate risk stocks and bonds. If she elects not to sell the center immediately, it can be assumed that she has an 8-year holding period after which time she will sell the center. General Information: The prevailing ordinary income tax rate is 35%. The capital gains tax is 15%. The tax rate on accumulated depreciation is 25% Moreover, in the current market one could reasonably expect to obtain a 10 year interest only loan at an interest rate of 6.5%. These terms could be expected for financing a project with high quality credit tenants, a maximum loan to value ratio of 70%, and a debt service coverage ratio of at least 1.3. Your Task: For the first time in your life, your Mom has asked for your opinion. Thus, the purpose of the case is twofold. First, this is a numbers-crunching exercise designed to push up the learning curve in the use of real estate finance tools. Once you have completed the numbers, the second task is to grapple with what they tell you (or don't tell you) about risk and return for the property. After running all applicable numbers for the case and generating projected return figures, analyze key assumptions of the case and consider various "what-if" scenarios, testing the risk/return sensitivity of alternatives. Pool these analyses into an articulate recommendation to your mother, taking a specific position and explaining your rationale. Your recommendation should be no longer than 3 pages, single-spaced with 1" margins and font of at least 11 point. Spreadsheets for each alternative must be attached with thumbnails of your assumptions. In addition, you have a cover page ovides names of all group members and includes an introductory set of bullet points summarizing your findings. The cover page should be no longer than one-half a page and will be graded. The next 3 pages should describe the important 4 REAL ESTATE FINANCE AND INVESTMENTS: features of your decision. You should conclude with your recommendations for your mother along with your reasoning. In addition, you may include up to 3 additional pages of exhibits, charts, figures, etc. Note that these are supplementary to the mandatory spreadsheets. This is a long assignment and ample time must be allowed. For this case, you are encouraged, but not required to work in groups of 2 or 3 that you will create. Decisiveness and rational thinking will be rewarded. There is no correct answer to this case. There are some answers that are better than others, but a well articulated and supported conclusion that is less optimal better than an uncertain answer that is most profitable. Current photo 5 REAL ESTATE FINANCE AND INVESTMENTS: Case: Westwood Publix Plaza The Property: : The property in question is a 100,000 square foot strip mall "Westwood Plaza" located in a suburb in Central Florida (Tampa). The 31 year old center is decently located within the town. You purchased the property 8 years ago for $7,000,000 (current time/year is 2003). Based on IRS filings, 30% of the purchase price was attributable to land costs. There are two primary retail anchors and 11 smaller local tenants. Tenants: Publix Supermarket: The first anchor tenant is a 35,000 square foot Publix supermarket which has been a tenant in the center since 1980. The Publix chain as a whole is financially solvent and has good quality credit. The terms of the Publix lease dictate that it pay $10 per square foot annually with no provisions for increase. Moreover, they are responsible for paying 29% of the property's total common area maintenance costs. They have an option to renew their lease for an additional 10 year period upon expiration of their current lease at a rental rate of $13 per square foot. Publix has the absolute right to go dark at any time. The current lease expires in December of 2009. Eckerd Drugstore: The second anchor tenant is a 25,000 square foot Eckerd drugstore. Eckerd has been in the center since 1980 and is paying $8 per square foot annually, with no rental increases over the life of the lease. Under Eckerd's lease, they must pay 23% of the property's total common area maintenance costs. The expiration date on the Eckerd lease is December 2012. They have the right to void the lease if Publix either goes dark or leaves the center. The Eckerd chain has experienced a decline in the quality of their credit, which now stands at BB. Other Tenants: The remaining 40,000 square feet is presently fully leased and occupied by 11 smaller local tenants. Although there are no credit ratings available for these tenants, it can be assumed that they are generally a significant credit risk. Your rental revenues from these tenants are based not only upon a base rent amount, but also include a percentage rent component of 1.5% of each tenant's gross sales figures (excluding the good doctor). The basic terms of the 11 local tenant's leases are as follows. WESTWOOD PLAZA IN-LINE TENANT LIST - Tenants Description Term of Lease Square Feet 2,500 2,500 4,000 CAM Allocation 2.5% Base Rent Per SF $11.49 Ross Travel Rob's Pizza 2.5% Gross Sales 2002 $502,000 $354,000 $626,000 $480,000 $304,000 Jan-01-Dec-07 Jan-03-Dec-07 Jan-02-Dec-09 Jan-99-Dec-04 2,500 Travel Agency Food Liquor Store Hair Salon Nail Salon Ophthalmologist Video Rental Dry Cleaners Food Trew's Brews Supercuts Nails by Dykstra Dr. P Linneman DB's Video Stain B Gone Ma's Diner 4.0% 2.5% 2.5% 2,500 5,000 4,000 $11.88 $12.65 $14.00 $13.68 $16.00 $14.25 $10.74 $11.33 5.0% 4.0% Jan-97-Dec-04 Jan-00-Dec-os Jan-99-Dec-06 Jan-01-Dec-09 Jan-00-Dec-03 2,500 $585,000 $377,000 $543,000 2.5% 6,000 6.0% 1 REAL ESTATE FINANCE AND INVESTMENTS: Powerhouse Gym 7,000 Bundy's Shoes Women's Shoes 1,500 7.0% 1.5% $15.36 $16.67 $669,000 $298,000 Jan-02-Dec-08 Jan-03-Dec-06 In addition to rental payments, all leases include terms requiring tenants to pay their designated share of common area costs, which includes operating costs and all applicable insurance premiums. The landlord pays for all of these expenses directly and then is reimbursed by the tenants. Total CAM and insurance costs to the tenants totaled $540,650 in 2002. The property also generates revenue from two additional sources: a cell tower and a billboard. Each earns $2500/month and incurs no additional costs to your mother. Below is an excerpt from the financials of Westwood Plaza over the last 3 years of operation. WESTWOOD PLAZA FINANCIALS 2000 2001 2002 Gross Rents $1,264,698 $58.970 $1,220,811 $121,870 $1,098,941 $1,223,645 $45,136 $1,178,509 Vacancy Net Rents CAM/RE Tax Recoveries Total Revenue CAM Costs/Insurance Costs $1,205,728 $429,087 $1,634 815 $460,840 $508,648 $1,559,780 $1,687,157 $540,650 $490 385 $514,905 Real Estate Taxes $125,000 $639.905 $137,500 $678,150 Total Operating costs NOI $1,009,007 $125,000 $615,385 $1,019,429 $55,000 $17,100 $50,588 $896,742 Tenant Improvements Leasing Commissions $55,000 $919,876 $25,000 $11,068 $48.832 $28,933 $48.946 Cap Ex NOI after Tis/Comm/CapEx $834,975 $876,129 The landlord is responsible for paying property taxes for Westwood Plaza. However, each lease requires the tenants to pay their CAM share of property taxes above the level that existed when they signed the lease. Last year the property tax rate was reassessed at $1.375 per square foot. This was an increase of 10%. Additionally, in light of frequent tenant turnover and wear resulting from high customer traffic, the landlord typically holds 4% of gross rent in a replacement reserve to be used for capital expenditures. Market: The Central Florida market where Westwood Plaza is located has experienced tremendous growth over the last 10 years. The population of the surrounding region is rapidly growing and the city has made substantial improvements to the local infrastructure. With the burgeoning market for residential space, retail rents have enjoyed an upward trend, which your mom currently estimates at 3% -4% per year. Typical cap rates for retail space in the surrounding areas have generally been 9% to 11% (based on a few recent sales). The surrounding area is typically composed of upper-middle class residents, who 2 REAL ESTATE FINANCE AND INVESTMENTS: have an annual median household income of $55,000. Approximately 75,000 residents occupy the area within a 5-mile radius of the strip center. Also, as is typical of Central Florida the area surrounding the local region has a disproportionate number of retirees. As a result the majority of the employment for working area residents is in the service sector. Issues: Over the past few years, things have gotten a bit complicated for Westwood Plaza. Two years ago, a new 220,000 square foot Wal-Mart super-center, complete with supermarket, opened just a little over 2 miles away. In addition, roughly 300,000 square feet of new retail space was constructed in the area surrounding Wal-Mart. Since that time, the Publix and Eckerd stores in the strip-center have each experienced nearly 25% drops in sales. Current sales at these stores appear to have stabilized after this initial decline. However, current sales levels are generating little profit if any to either Publix or Eckerd at the Westwood locations. Moreover, Publix has recently increased their preferred store size to a minimum of 50,000 square feet and are seeking to convert all of their locations to this model. Current market rents for retail tenants in the area are estimated to be roughly $12 per square foot. Furthermore, in the current retail market, it typically takes 3 - 9 months of aggressive leasing to fill vacant space in well located strip centers. However finding larger tenants to assume "anchor" positions can take upwards of one year, and can involve substantial effort without guaranteed results. Financing Alternatives: When she purchased the center, your mother took out a full recourse, interest only loan for $5 million. This loan is now maturing and she is deciding what to do. As such, she has the option of either selling the plaza or refinancing the loan. Her alternatives are outlined below. Based upon an appraised value of $10 million, a local bank has offered your mother a 5 year, non- recourse note of $6 million. The loan is at a 6% interest rate, amortized over 30 years, and contains a payment at time of closing of 1.5 points. With these proceeds she could repay (without penalty) her maturing $5 million loan including fees and points, and pocket close to $1 million. Alternatively, she has received a $7 million all cash offer to sell to an opportunity fund. If she sells she will have to pay the applicable local fees and taxes of 3% of the sale price, as well as repay the $5 million loan. She can alternatively refinance with a 10-year, $7.5 Million, participating non-recourse loan. The lender would receive 10% of the annual pre-tax profits, as well as receive 4% interest payments on the loan. The loan is amortized over thirty years. Finally, she could redevelop the center and expand the Publix space in 2008 (the redevelopment must be completed before their current lease expires). This can only be accomplished by warehousing the local tenant space that expires over the next 5 years and expanding Publix into this space in 2008. If this alternative is chosen, Publix has agreed to sign a lease that pays $9 per square foot from now through 2008, and $11 per square foot through 2020. The new lease would prohibit them from going dark prior to 2008. If she pursues this path she can refinance her currently maturing $5 million loan with a 5-year, $5 million non-recourse floating rate loan (interest rate reset annually), at an initial interest rate of 4.0%, with no amortization and no prepayment penalty after 1 year (Note: this reduced loan amount takes 3 REAL ESTATE FINANCE AND INVESTMENTS: into account the lost income on the expiring local tenant space required for the expansion). Your mother estimates that the interest rate on the loan will increase by 50 basis points per year through 2007 and stabilize thereafter. The re-development will necessitate an additional construction loan. Your mother believes that in 2005 she should be able to get a 3-year construction loan for $1.5 million at a 9% interest rate. This loan would be interest only and take effect in 2005. Given the nature of the site, space for the redevelopment must be made available through the warehousing of existing retail space. Once space has been warehoused it can no longer generate income to your mother. The cost of preparing existing retail space for the grocery store space is projected to be $100 per square foot. The actual redevelopment process will take approximately one year to finish and must be completed by 2008. All of the space for the expansion must be completely warehoused by the time construction commences. Profile of Mother: Your mother has experience in strip retail development and possesses the expertise necessary for undertaking the redevelopment option. Moreover, she has adequate income streams from other assets so she has no immediate need to liquidate her equity position in Westwood Plaza. Her other assets include another strip center in a nearby town that is both stable and profitable, as well as a substantial portfolio of moderate risk stocks and bonds. If she elects not to sell the center immediately, it can be assumed that she has an 8-year holding period after which time she will sell the center. General Information: The prevailing ordinary income tax rate is 35%. The capital gains tax is 15%. The tax rate on accumulated depreciation is 25% Moreover, in the current market one could reasonably expect to obtain a 10 year interest only loan at an interest rate of 6.5%. These terms could be expected for financing a project with high quality credit tenants, a maximum loan to value ratio of 70%, and a debt service coverage ratio of at least 1.3. Your Task: For the first time in your life, your Mom has asked for your opinion. Thus, the purpose of the case is twofold. First, this is a numbers-crunching exercise designed to push up the learning curve in the use of real estate finance tools. Once you have completed the numbers, the second task is to grapple with what they tell you (or don't tell you) about risk and return for the property. After running all applicable numbers for the case and generating projected return figures, analyze key assumptions of the case and consider various "what-if" scenarios, testing the risk/return sensitivity of alternatives. Pool these analyses into an articulate recommendation to your mother, taking a specific position and explaining your rationale. Your recommendation should be no longer than 3 pages, single-spaced with 1" margins and font of at least 11 point. Spreadsheets for each alternative must be attached with thumbnails of your assumptions. In addition, you have a cover page ovides names of all group members and includes an introductory set of bullet points summarizing your findings. The cover page should be no longer than one-half a page and will be graded. The next 3 pages should describe the important 4 REAL ESTATE FINANCE AND INVESTMENTS: features of your decision. You should conclude with your recommendations for your mother along with your reasoning. In addition, you may include up to 3 additional pages of exhibits, charts, figures, etc. Note that these are supplementary to the mandatory spreadsheets. This is a long assignment and ample time must be allowed. For this case, you are encouraged, but not required to work in groups of 2 or 3 that you will create. Decisiveness and rational thinking will be rewarded. There is no correct answer to this case. There are some answers that are better than others, but a well articulated and supported conclusion that is less optimal better than an uncertain answer that is most profitable. Current photo 5