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Posted: February 28th, 2022

DEPAUL UNIVERSITYPRIVATE

RE 352

Real Estate Finance

Assignment 2

Instructions:

Set up an excel spreadsheet to analyze each part of the assignment below. You may base your “excel spreadsheet” on those we have used in class. Turn your results in to the dropbox.

This assignment has three parts:

Part 1.

A property has a $400 million convertible mortgage at a fixed interest rate of 4% for 25 years (payable monthly). The loan gives the lender the option to convert the mortgage balance into a 40% equity position at the end of year 5. That is, instead of receiving the payoff on the mortgage, the lender would own 40% of the property. The loan is secured by mortgages on a large office building that is currently valued at $750 million. The property is projected to increase 4% per year over a five-year holding period.

a. Calculate the effective cost (to the borrower) of this loan.

b. By how much (in annualized percentage rates) does the property have to rise over the five-year holding period to justify conversion?

c. Suppose that the lender has inside information indicating that real estate prices today are too low. Other things being equal, would the convertible mortgage be worth more or less than a standard fixed-rate mortgage (written without a conversion option) to the lender?

Part 2.

Hudson Property has agreed to acquire an office building for $500 million. The property is expected to have an NOI of $50 million during year 1 and the NOI is expected to increase at a rate of 5% per year for the next five years. The property is expected to be worth $650 million at the end of five years. A lender is willing to make an income-equity participation (mezzanine) loan for $150 million on the property at a 6% interest rate. The loan will be amortized with monthly payments over a 25-year term. In addition to the regular monthly payments, the lender will receive 30% of any NOI in excess of $50 million each year until the loan is repaid. The lender will also receive 30% of any increase in the value of the property. In connection with the deal, Hudson Property is able to obtain a first mortgage loan in the amount of $300 million at a fixed interest rate of 5% for 25 years.

a. Determine the (before-tax) effective cost (to the borrower) of the income-equity participation (mezzanine) loan assuming the loan is held for 5 years, taking into account the income-equity participation.

b. Compute the effective cost of the combined first and second mortgage.

Part 3.

Consider the following construction loan. Disbursements under the loan are expected to proceed as follows: months 1-6, $2,000,000 each month. Each disbursement occurs at the end of the month. The budgeted annual interest rate on the loan is expected to remain fixed at 5%.

Assume that the loan will be repaid in full at the end of month 6.

a. What will be the interest carry for this project?

b. What will be the total loan amount that the developer must borrow (including interest carry)?

c. Calculate the lender’s IRR (effective cost to the borrower) if the loan is made with a 2 percent loan origination fee.

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