1. Complete the waterfall using the benchmark assumptions outlined in the case. Under these assumptions, calculate the expected return to Wildcat and its limited partners and compare those returns to the property-level return on Financial Commons if it is sold after three years. Returns to Wildcat should be calculated without including its management fee. 2. For each of the following scenarios, re-calculate spreadsheets. With the exception of the changes noted below, keep the benchmark assumptions constant. Each scenario is to be recalculated independently; that is, each scenario is to be treated as a distinct variation from the benchmark. Assume that outside investors will become partners with Wildcat only if they believe they will receive an internal rate of return (IRR) of at least 20 percent, and Wildcat will only close on the property if it believes it can earn a 50 percent IRR. Discuss whether or not the deal will proceed.?
A. North Shore Bank does not renew its lease at the end of Year 3 and its space remains vacant in Year 4. A new tenant begins leasing the space in Year 5 at $18/square foot on a triple-net (NNN) lease requiring $5/square foot expense reimbursement. The new lease does not contain any rent escalation clause. To make the space suitable, capital expenditures of $4/square foot are required in Year 5 for tenant improvements. A leasing broker charges Wildcat 2 percent of the first year's rent as a commission. As a result of this turnover, Wildcat holds the property for five years.
B. All tenants renew according to the benchmark assumptions. However, due to continued weakness in commercial property demand, Wildcat holds the property for five years. During its hold period, Wildcat makes capital expenditures of $500,000 in Year 2 for a new roof and $150,000 in Year 3 for a new parking lot.
C. After more careful underwriting, the life insurance company offers a reduced loan-to-value (LTV) of 60 percent and an interest rate of 7 percent. Assume a three-year holding period.
D. The outside investors are nervous about the economic climate. As a result, they demand the following investor-friendly changes to the waterfall structure. Assume a three-year holding period.
i. Outside investors will provide only 90 percent of the required equity.
ii. Outside investors will receive a 10 percent preferred return.
iii. Outside investors will receive a 12 percent IRR preference. (This means that at reversion, after invested capital has been returned to the outside investors and to Wildcat, the outside investors will receive additional cash until they achieve a 12 percent IRR over the lifetime of the investment. Remaining cash flow will then go through the promote)
iv. Cash flows in the promote structure will be split 80/20 rather than 70/30.
3. Evaluate the benchmark assumptions Zaski made. Would you have made different assumptions? What do you think is the fair market price for Financial Commons? Explain why your answer does or does not differ from $10,400,000.