Underwriting Commercial Real Estate Development With a case study of the Wicker School Redevelopment

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Underwriting Commercial Real Estate
DevelopmentWith a case study of the Wicker
School Redevelopment

• Tucker Bartlett
• Self-Help Ventures Fund
• June 22, 2005

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Agenda

• Self-Help Overview
• Underwriting Points of Concern
• Typical Loan Terms
• Questions

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Self-Help Ventures Fund Overview
Mission To create ownership and
economic opportunity for minorities,
women, rural residents, and low wealth
families and communities.
- 25-year history - 3.9 billion financed -
43,880 families, businesses and non-profits
- Credit union, mortgage lending, commercial
lending, real estate development, advocacy
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The Wicker School Redevelopment in Sanford, NC

• 5.4 million restoration of an African-American
  Rosenwald school built in 1929
• Conversion into a commercial project with
  important community facilities
• Tenants include a dental clinic, mental health
  clinic, daycare center, business incubator, and a
  dental hygienist school

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Underwriting Points of Concern

• Cash Flow (Income less Expenses NOI)
• The Borrower
• Collateral

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Cash Flow Income from Leases

• Pre-Leasing- 50 often required, but this is
  difficult with small tenants
• Credit Quality of Tenants and Lease Expiration
  Schedule
• Mom Pop vs. Credit Tenant
• Will the business work?
• Adequate Parking (Office 4 per 1,000sf Retail
  2.5 per 1,000sf Residential 1 per unit Hotel 1
  per room)
• Traffic counts and Market Demographics- Get a
  market Study
• Possibility of a Master Lease

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Income from Leases
Wicker

• Pre-Leasing and Credit Quality
• Lease Expiration Schedule
• Will the business work?
• Parking
• Market Study

• 94 pre-leased
• 31 government
• 39 related to CDC
• 24 for profit but related work
• All five year leases
• Will the business work?
• Parking- from the county
• Market Study- knowledge of neighborhood
• 210k of projected income (still assumed 8 rent
  loss)

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Cash Flow Operating Expenses

• Are your leases NNN, gross, or some combination?
• Management Leasing
• Janitorial
• Maintenance (elevator, HVAC, general)
• Utilities
• Insurance
• Real Estate Taxes
• Other- security, pest control, legal audit,
  advertising, landscaping
• Possibility of real estate tax abatement for
  nonprofits or historic projects

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Operating Expenses
Wicker

• Lease pass throughs
• Real Estate Tax abatement

• Modified Net Leases
• Net of janitorial, utilities, insurance, taxes
• 36k in projected other operating expenses
  (primarily management and maintenance)
• Working on tax abatement for nonprofit uses

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Cash Flow After NOI

• Operating Reserve (debt service and op ex- amount
  depends on operating risk)
• Capital Reserve- 0.30 per year
• Debt Service- lender requires 1.15-1.25 projected
  coverage
• Subordinate loans?
• Ground lease?
• Preferred returns to equity investors?
• Asset management fees?

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After NOI
Wicker

• Operating Reserve
• Capital Reserve
• Debt Service
• Preferred returns to equity investors?
• Asset management fees?

• 133k (one year of debt service and
  non-reimbursed op ex)
• 0.30/sf/year
• Loan originally underwritten based on 1.25x
• 2 pref to HTC/NMTC investor
• 5,000/year to investor

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The Borrower

• Do you have experience doing commercial real
  estate loans?
• Who is on your team?
• Developer, architect, contractor, leasing agent,
  property management
• Market knowledge
• Do you have helpful connections with tenants,
  government officials, financers?
• Financial strength to provide a guaranty
• Construction loan, permanent loan, tax credit
  investor

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Borrower and Original Team
Wicker

• CDC Experience
• Who is on your team?
• Developer, architect, contractor, leasing agent,
  property management
• Market knowledge
• Financial strength to provide a guaranty

• No experience in commercial development
• Team- no fee developer, primarily residential
  architect, great contractor, no property manager
• Great connections in the area and knowledge of
  market
• 1.2 million in net assets

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The Collateral

• Appraisal
• As is vs As completed
• Income approach is often key
• Environmental
• Get Phase 1 done early preferably before
  acquisition
• Control of property
• Zoning
• Access to Parking

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Commercial Real Estate Loan Terms

• Loan Size- lesser of
• 75-80 LTV
• 80 LTC
• 1.15-1.25 projected 1st year Debt Service
  Coverage
• Amortization- 15 to 25 years
• Term 5 to 10 is typical (7 for NMTC) with a
  balloon

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Commercial Real Estate Loan Terms

• Rate
• Construction- Floating at Prime 1 to 1
• Perm- Fixed at Treasury 200-300 bps
• Origination Fee- 50 to 100 bps
• Other
• Contingency- 5 to 10 (higher for rehab)
• Need for hard cash equity
• Pre-payment penalties on fixed rate loans
  (exclusion on NMTC)
• Environmental Indemnification

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Wicker The Numbers and The Gap

• Cost- 5.4 million
• NOI- 175,000 per year
• Value capped at 10 1.75 million
• 80 LTV 1.4 million
• Other Sources of Equity
• CDBG and County Contribution- 1.15 million
• HTC and NMTC equity- 1.6 million
• CDC equity 130k
• Loan need of 2.5 million creates gap of 1.1
  million

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Wicker The Solution

• EDGE Loan from the Federal Home Loan Bank of
  Atlanta
• 2.5 million loan based on 1.25 debt coverage
  ratio
• 1 rate
• 20 year term
• 30 year amortization
• Still standard lenders worried about operating
  and refinancing risk

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Questions

• Tucker Bartlett
• Director of Commercial Real Estate Development
  and Lending
• Self-Help Ventures Fund
• Durham, North Carolina
• www.self-help.org
• tucker.bartlett_at_self-help.org
• 919.956.4661