I'm going through a case right now, and it seems fairly straight foward, but when I calculate the levered and unlevered IRR, my levered IRR is extremely high. Here are the assumptions:
5 year model
Acquisition cost: $12.4M ($300K clsing)
NOI: $900,000 (2% escalation per annum)
OpEx coverded by tenant
Sale: $14.5M (6.6% cap)
Unlevered IRR: 10.64%
Sr, Loan: $8.1M @ 2.72%; 65% LTC
Mezz Loan: $1.2M @ 9.22%; up the LTV to 75%
Refi after 2 years at 6.5% cap 70% LTV: $14.4M @ 2.62%
Levered IRR: 58.29%
The thing that screws this up for me is the refi. The assumptions provided give you a $5.9M positive cashflow in year 3. With only $3.1M in capital required at purchase the assumptions are pretty wild to me, but I don't think I did anything wrong as this seems pretty straight forward.
Any advice?
you need to provide what was actually given to you if you want someone to be able to actually recreate the model. were the values calculated or did you have to back solve values based on cap rates? what are the terms of the loan (term, amortization, etc.)
The math also doesn't add up. Refi loan amount is $2m over acquisition value, and, assuming that it's a 70% loan, it'd be a roughly $8m (~69%) increase in value
Looks like your issue is that your refi calc is at least off, you’re getting a loan for 100% LTV and also have the Mezz so you’re over 100% levered. You need to cap forward NOI and then take 70%
Well, shoot, that was the total value, so at 70% LTV the loan was $10.1M. Updated that for a leveraged IRR of 32.43%.
Sr. and Mezz loans were 2 year term with 25 year ammort. Refi was 10 year term, 30 year ammort, with 24 months interest only.
Can you post the full case guidelines and assumptions?
Yeah, it would be helpful if you posted the entire case assumptions. I’ve tried to recreate what you described but my results assume one GP partner without any LP equity. I saw in a previous comment that you calculated a roughly ~32% IRR. I got this figure on the IRR immediately after refinancing. Theres no way your IRR should be that low given there will be another equity extraction point in year 5.
I think the reason it was that low was because refi was at a cap rate of 6.5% and exit has a cap rate of 6.6%, so even with escalations it would end up with similar exit minute disposition and the loan, meaning exit is low positive cash flow. I'll post the case below.
Right off the bat I can see why your IRR is so high but I cant tell you whether its right or wrong without more info.
In year 2 you refi at 70% LTV and take out 14.4MM. Which means two things you took out an additional 5 million cash out above your ~9mm acquisition loan, thats returning ~33% of your acquisition price and pretty much 100% of your remaining equity in the deal in just year 2. that also means in year 2 your 70% LTV loan is 100% of your acquisition price meaning the value of the property has increase 42% in value at year two. I assume you sell in year 5 so you have another 3 years of inflation/rent growth to cap on and if you cap out lower than your cap in thats going to further increase your IRR.
So you may not be wrong if all of those assumptions are right, given what you're showing us it should return a very high IRR.
Here's the case:
Please produce a live excel workbook containing the credit model and investment model. The investment cash flows must be annual. The written portion of the investment analysis shall be no longer than two pages, including:
The property is a building with 40,000 rentable square feet located on the southeast corner of Collins Road and Blanding Boulevard in Jacksonville, Florida. It is being acquired at a 7.25% cap rate with 2 years remaining on the lease (see lease abstract). The property has a single tenant and rent escalates 2.0% annually; service lines are OB/GYN and women’s health. Senior debt for the acquisition will be 65% LTC at a fixed rate of 250 basis points above the 2 year US Treasury, with a 2 year term on a 25 year amortization. Mezzanine debt will be borrowed to bring the debt stack up to 75% LTV, at a fixed rate of 900 basis points above the 2 year US Treasury for a 2 year term. Assume closing costs of 3%
At the end of the initial lease, project that the lease will be extended for 10 years (maintaining 2% escalations) in return for a $250,000 tenant improvement allowance. The property will be refinanced at a 6.5% cap rate at this point, with the senior debt for the refinance at 70% LTV, at a fixed rate of 200 basis points above the 10 year US Treasury with a 10 year term on a 30 year amortization, with 24 months interest only. Use the refinance proceeds in priority of tenant improvements, senior debt, mezzanine debt; any remainder goes to cash flow. Hold the property for 3 more years and then sell it for a 6.60% cap rate. Assume disposition costs of 1.5% and no debt prepayment penalties.
Abstract Tenant: Baptist Hospital Landlord: Catalyst Analyst Fund MMXVIII Lease Term Remaining: 24 months Area: 40,000 RSF Lease Rate: $22.50/RSF Lease Structure: NNN Opex Reimbursement: N/A, Tenant pays directly Security Deposit: $35,000 Renewal Options: Two 5-year options
Yeah man this IRR should be in the 50’s. Also, make sure to be thorough with your analysis of the tenant. Might justify a bad debt expense if their financials are shotty. It won’t impact value much but at least it shows them you’re thinking about tenant default risk. Best of luck.
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