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• You are evaluating an asset for outright acquisition or mezzanine lending. The asset is a 100 unit student housing apartment project. The apartment is located one stop away on a metro line to a major University. The University caters mostly to Co-Op type students and mature learners who take 6 years to graduate instead of the typical 4 years. This is because 70% of the students work to pay their way through school. 50% of the students who work drive to their work places located between 5-20 kms away from the University.
•  Here are the salient facts:
•  Potential Gross Income = 3M
•  Vacancy = 5%
•  Operating Expenses = 750k/yr. (you ask around and find that normal operating expenses are only 20% of Gross Income for a well maintained facility)
•  Allocation for Major Upgrades/repairs = 100k/yr (You ask around and find that most apartment owners only allocate about 1-2% of Potential Gross Income for a reasonably new property towards the replacement reserve)
•  Make reasonable assumptions, based on any real-estate market you are knowledgeable about, for any information you have not been given.

Questions:

1. What would you pay for this asset as an outright purchase? What assumptions did you have to make?

2. Assume senior debt at 50% LTV @ 5% interest, 5 year term, 25 year amortization, exists on the asset. How much would you be comfortable lending to this asset as a mezzanine lender. What assumptions did you have to make?

3. A market research study told you that rental assets in this market went through a relative cap rate compression of 150bps, since this building was originally financed. You find that this compression was mainly a result of a central bank interest rate drop coupled with significant quantitative easing. Making a few calls you find that rental rates and vacancies for student housing have not materially changed.

   • Would that factor in your calculation of mezzanine loan amount? Is your loan amount higher or lower? Would you reduce or increase your interest rate?

   • How much will this impact your purchase price of the asset?

4. The government increased business taxes by 1000bps. In this environment – do you prefer mezzanine lending to this asset or buying it?

5. Carbon taxes and climate change increased your operating expenses by 10%.  How sensitive is your asset valuation calculation to this increase?

6. The government is forcing a carbon tax, new energy code, environmental requirements and a drywall tariff amounting to a construction cost increase of 10% per door going forward on construction of new assets. Does this change how much you would be willing to pay for this asset / how much you would mezzanine lend to this asset?

7. The alternative opportunity you are evaluating is buying USD denominated Saudi bonds which for a 10 year bond coupons about 170bps higher than US treasuries. A quick google search shows that the bonds were oversubscribed and for the 10Y bond are about 3.44% – about 20bps lower than expected. Should you go for this opportunity?