This assignment is a case study of renovating an existing building and valuing it based on cash flows, operating expenses, etc.
PENN AVENUE CASE STUDY Penn Ave, LLC (PENN) is a developer that acquires and renovates existing buildings in the urban area of Washington, DC. They are acquiring an existing building that has a total of 200,000 square feet comprised of 8000 square feet of retail and 192,000 square feet of office space. The current market value is $369 per square foot, but given the need for renovation, PENN is acquiring the building at 85% of fair market value. The intent is to improve the building to Class A status with multi-tenant lobbies on all floors according to the attached budget. Once renovated the Class A office space will command rent of $42 per square foot and the retail space will command $65 per square foot. The current market conditions indicate that office rent will grow at 2% annually and retail rent will grow at 4% annually. The current vacancy factor for comparable properties is 3% of gross revenue, and operating expenses for the building will be 3% of effective rental revenue, plus property taxes. Property taxes in this municipality are calculated on an assessment rate of 40% of fair market value, and the current millage rate is $30 per $1000 of assessed value with no increases anticipated for the next 8 years. The acquisition of the building will occur in Year 0. The renovation will occur during the first 3 months of Year 1. The building will be ready for occupancy on the first day of Month 4 in Year 1, and PENN has a retail client that will lease the 8000 square feet beginning on the first day of Month 4. Further, PENN has commitments for 72,000 square feet of office space beginning on the first day of Month 4 in Year 1, an additional 80,000 square feet of office space beginning on the first day of Month 1 in Year 2, and for the remainder of the office space to be fully leased beginning on the first day of Month 1 in Year 3. The leases beginning in Year 1 are at market rents, and those beginning in Year 2 and Year 3 will be at market rents for those years anticipating the above mentioned annual growth. PENN has committed to providing $20 per square foot to all tenants for tenant improvements in the year of occupancy, and will pay leasing commissions of 5% of gross rents on an annual basis. PENN will review this deal with an unlevered and levered cash flow pro forma. For the levered analysis, PENN has a three tiered capital stack negotiated consisting of a primary loan at 80% of fair market value with an annual interest rate of 6% amortized over 30 years with a 5 year call, a mezzanine loan at 100% of the cost of renovation plus all tenant improvements at an annual interest rate of 12% with interest only terms for 5 years, and a third position equity loan at 50% of equity to close at an annual interest rate of 18% with interest only terms for 5 years. Primary loan financing fees and closing costs are ½ of 1% of the primary loan amount, are not financed by the primary loan, and will be paid in Year 0 as part of the equity required to close. Mezzanine loan financing fees are ½ of 1% of the mezzanine loan and paid from cash flow during the year the money is funded. The intent is that PENN will hold the building for 5 years at which time it will be sold. The current cap rate for mixed use buildings in this area is 6%, and all studies indicate that the cap rate will increase to 6.5% over the next five years. The typical selling costs in this market is 6% of the sales price of the building. Produce a spreadsheet with all the necessary information flowing to an unlevered and levered cash flow pro forma to provide an internal rate of return unlevered and levered, and to provide the net present value in the unlevered analysis if the required investment return is 12%. The debt service can be calculated off the amortization schedule.