The purpose of this project is to provide the student with the experience of preparing a comprehensive financial and tax package, detailing a potential real estate development.
You have purchased land and a building shell (fire gutted). The property is located at 850 East 55th Street, New York, New York, and you plan to demolish the existing building and construct a new apartment building. Assume you may build a maximum of 500,000 rentable square feet.
The development will consist of 400 rental apartments, 212 one-bedroom, 238 two-bedroom, and 3 retail stores.
Retail space comprises no more than 20% of gross rentable square feet.
The cost of the land and shell is $50,000,000, and upon signing the contract you most provide a 10% deposit. The Construction Loan will be equal to 50% of the total construction costs and investors will provide the balance in the form of equity. The permanent loan amount will be calculated at 60% of the property’s value at the end of construction. The method for valuing the property will be the 2023 NOI capped at 10.5%.
The development project has qualified under a local law granting partial real estate tax exemption for newly constructed multiple dwellings. In order to qualify you will need to agree to reserve 50% of the one-bedroom apartments for low income qualifying tenants who will pay 35% of the market rent. If you decide to so this you will receive a property tax exemption as described on Page 6. This will be referred to as the “Qualified Tenant Option”. If you decide not to pursue this option, then you will be employing the “Market Rate” option.
The timetable is as follows:
You have located the property in September 2020.
You reported to your equity investors in early October 2020. Soon thereafter you entered into a contract to purchase the land. You purchased the land by November 15, 2020. You arranged for construction financing and permanent loan commitments over the next 45 days and closed with the construction lender on December 31, 2020, and plan to close on the permanent loan on December 31, 2021.
The critical dates are as follows:
2021 is construction year
2022 is lease-up year
2023 is stabilization year
2024-2026 are operational years
The property is expected to be sold on December 31, 2026 at a 5.75% cap rate , with costs of sales at 3.0% of gross sales price.
You have met with a few potential investors and creditors who are interested in this development opportunity. They have requested that you provide them with a Written Project Summary and Excel Spreadsheet with the following information:
A. A brief description of the project and the proposed deal terms offered to both investors and creditors. Be specific as to how much initial equity and financing is required and be sure equity is available to fund the acquisition of land, securing permanent loan commitment, construction financing and predevelopment costs. Include a schedule of investor returns and rates of return.
B. A detailed project budget. In summary form, please detail all costs including land acquisition price and costs, pre-development costs, construction costs (hard & soft), construction period interest (carry), construction period taxes, construction loan fees, permanent loan fees, rent up costs, and shortfall reserve. Please provide a time frame for the development. Show all costs in total and per square foot amounts.
C. A pro-forma income and expense analysis for all years during the holding period (after substantial completion). Your analysis should be both pre-tax and after-tax.
D. A discussion of your choice of entity and the tax advantages to investors.
E. The returns (pre-tax and after-tax) that the developer and investors can expect through the end of the deal. Specifically, Cash-on-Cash, quarterly IRR (pre and post-tax) and NPV. Use a discount rate of 10% to calculate NPV. For this analysis, assume that you will offer a 9% IRR to equity investors and that the developer will earn a 20% carry after the 9% IRR hurdle has been met.
F. A section that demonstrates critical thinking and compares and contrasts the reasons as to why you chose either the Qualified Tenant option or the Market Rate option. You can offer sensitivity analysis to support your conclusions.
Your work must be done on the Excel spreadsheet answer key that I have posted on Classes. Your spreadsheet must be able to toggle between the Qualified Tenant and the Market Rate options. The use of any other spreadsheet will not be accepted.
The following assumptions should be incorporated into your analysis:
1) Closing costs connected with the land purchase will be 2.0% of the purchase price. Land closing will be prior to the closing of the construction loan. Remember that the total cost of land & capitalized costs represents your equity contributions and should be included in your budget.
2) Total hard construction costs will be $400 per buildable foot (120% of rentable residential square feet), excluding tenant improvements, -retail- that will be done by commercial tenants. Additional demolition costs are $450,000. Soft costs (not including construction interest) are calculated at 6.5% of hard costs.
The pre-development costs which are in addition to all other square foot costs will include:
Engineering, design, architects, fees & costs $45,000
NYC plumbing, water, steam connection permits 3,500
Land, soil tests, environmental testing 13,000
3) Construction period interest must be calculated on a separate draw schedule and shown as part of the budget. Please use an annual rate of 8.0%. Allow 12 months total for closing through substantial completion of the project. Assume construction costs will be paid, 50% over the first 4 months and 50% ratably over the next 7 months, and 10% of construction mortgage retained and paid on final draw.
4) You may assume that the permanent loan will take out the construction loan at the end of the 12-month period. For the permanent loan, please use the following information: rate 6.0%, term 25 years, amortized over 25 years.
5) You may assume a strong rental market, with pre-leasing activity of residential and retail space. Use the market reports provided to develop your lease-up assumptions. Please present a separate schedule for year one, detailing by month, phase-in of units, show # of units occupied and prorate rents accordingly. By the end of the first year all units should be occupied. Incorporate year one into your pro-forma income and expense analysis for the entire holding period.
6) Rent-up charges consist primarily of leasing commissions and are estimated at 5% of gross income in 2022 the lease-up year. Stabilization will be in year 2023. Please note that leasing commissions are paid out when due. You may assume that all residential leases are for a 3-year period, and retail leases will be for a 5-year period. Residential and retail leases will remain in place during the holding period and that no further lease commissions will be paid for purposes of your calculations.
7) Fees connected with the permanent mortgage commitment letter will include a charge for issuing the commitment letter of 0.15% of total permanent mortgage; a legal fee of $30,000 and other costs (credit search, title exam, etc.) of $15,000. Borrower’s costs including legal fees are $40,000.
8) Fees connected with the construction loan to be paid by the investors will be $30,000 for points, $15,000 for lender legal fee, $5,000 for an engineering review and $10,000 for borrower’s legal fees.
9) Permanent loan closing fees will include: loan points at .001 of permanent loan; borrower’s legal fees of $25,000; lender’s legal fees of $15,000; and other fees to lender (such as inspecting architect, appraisal, engineering, audit, lender’s package fee, etc.) of $28,000.
10) Current market rates for rentals are:
One-bedroom $3,500 per month *See note on Real Estate Property
Two-bedroom $6,000 per month Tax – Page 6*
Commercial/retail space for this location will rent at $25,000 per month, per unit, plus escalations and expenses.
Residential rents escalate at 3% annually.
Commercial base rent escalates at 5% annually.
11) Operating expenses, excluding property taxes, will be 15% of gross income during the lease-up year and 10% in the stabilized year. All expenses, excluding real estate taxes, escalate at 3% per annum, after stabilized year.
12) Real estate taxes on land and building are $27,500 per year. They will remain the same during construction, and the lease-up year. You should calculate yearly real estate taxes based upon available NYC formulas, see page 6 attached.
13) Lenders require a 4% vacancy and credit loss on retail space, and 3% on residential. These costs escalate 2% and 3.5% respectively after stabilization year.
14) If your chosen entity will involve taxation of individuals, then the marginal federal tax rate will be 39.6%. If it is a corporation then the marginal tax rate will be 28%. Capital gains rates for individuals will be 25% on gain attributable to tax depreciation deductions and 20% on all other capital gain.
15) Assume that a cost segregation study is done, and it is determined that 8% of the depreciable property is considered to be personal property. Upon sale, the value of the personal property is considered to be equal to its adjusted tax basis.
This optional project
REAL ESTATE PROPERTY TAX
Calculation for STABILIZED YEAR real estate taxes on the land and building based on NYC formulas:
ASSESSED VALUATION = Land & (Total Construction Cost x 50%)
REAL PROPERTY TAX = (ASSESSED VALUE) x 5.911% (Tax Rate)
The development project has qualified under a local law granting partial real estate tax exemption for newly constructed multiple dwellings. In order to qualify the Developer agreed to reserve 50% of the one-bedroom apartments for low income qualifying tenants who will pay 35% of the market rent.
The Real Estate Tax Exemption is as follows:
The exemption will continue to decrease by 5% each year until year 9 in which there will be no further exemptions and the landlord will need to continue to lease to low income qualifying tenants who will pay 35% of the market rent. To the extent a low-income qualifying tenant moves out after year 9, the landlord can rent the unit at market rent.