As a financial advisor for the TPB Development Co. (TPB), you have been given the construction and marketing studies for the proposed Timber Creek office project. Several potential sites have been selected, but a final decision has not been made. Your manager needs to know how much he/she can afford to pay for the land and still manage to return 16 % on the firm’s equity investment in the project over its lifetime.
The strategic plan calls for a construction phase of one year and an operation phase of five years, after which time the property will be sold. The marketing staff says that a 1.3-acre site will be adequate because the initial studies indicate that this site will support an office building with a gross leasable area (GLA) of 26,520 square feet. The gross building area (GBA) will be 31,200 square feet, giving a leasable ratio of 85 percent. Several properties that are appropriately zoned and approximately this size are available in the local market at a price of about $170,000. The marketing staff further assures you that the space can be rented for $19 per square foot. The head of the construction division maintains that all direct costs of development (excluding interest carry and all loan fees) will be $2.4 million.
The First Street Bank will provide the construction loan for the project. The bank will finance all of the construction costs, site improvements, and interest carry at an annual rate of 13 percent plus a loan origination fee of 1.5 points. The construction division estimates that the direct cost draws will be taken down in six equal amounts, commencing with the first month after close. The permanent financing for the project will come at the end of the first year from the Travelers Insurance Co. at an interest rate of 11.5 percent with a 4 percent prepaid loan fee. The loan has an eight-year term and is to be paid back monthly over a 25-year amortization schedule. No financing fees will be included in either loan amount. TPB will fund the acquisition of the land with its own equity.
TPB expects tenant reimbursements for the project to be $3.25 per square foot and the office building to be 75 percent leased during the first year of operation. After that, vacancies should average about 5 percent of potential gross income per year. Rents, tenant reimbursement, and operating expenses are expected to increase by 3 percent per year during the lease period. Initially, operating expenses are expected to be $9.50 per square foot. The final sales price is based on the net operating income (NOI) in the sixth year of the project. The project will incur sales expenses of 4 percent. TPB’s marginal tax rate is 28 %. Currently, the capitalization rate for property of this type in this market is 9 percent. As income comes in to your company from property you own. It can be reinvested at a rate of 12 percent.
TPB is concerned that it may not be able to afford to pay for the land and still earn 15 percent (before taxes) on its equity (remember that the land acquisition cost represents TPB’s equity). You are going to construct an Excel workbook that will do the financial feasibility analysis needed to answer this question. You will do it in stages on individual worksheets within the workbook. Ultimately, the analysis done at each stage (individual sheets) will be linked together to do the full financial analysis. You will submit the individual assignments to me as email attachments. I will notify you when to start the assignments and when each assignment is due.
Individual Assignments
Assignment I: Estimate construction draw schedule, interest carry, and total cost of the construction financing obtained for the improvements. Set up the worksheet so that the interest rate on the loan, the loan amount, the prepaid loan fees, and the schedule of disbursements on the loan can easily be changed so that different financing terms and conditions could be analyzed quickly and easily. Submit the Excel workbook as evidence of completion of the assignment.