3300 Walnut
by
Thomas G. Thibodeau
Professor of Real Estate
University of Colorado
On June 10, 2006, Matt Godley was contemplating available alternatives for refinancing a property located at 3300 Walnut. The warehouse is owned by the University of Colorado Real Estate Foundation (CUREF) with no debt. The Foundation’s Board of Directors asked Matt to investigate financing alternatives in order to extract some equity from the property. The equity would be used for other market rate real estate investments. The warehouse has 146,565 square feet of space and is currently about 80 percent leased. The University of Colorado leases 52,000 square feet of space with a twenty-year lease. The contract rent is $5.60 per square foot triple net (with CUREF paying the property management fee and $7,667 of the total utility expenses). The terms of the lease are described in Exhibit 1. Rudi’s Organic Bakery, Inc. leases about 66,000 square feet of space with a ten-year triple-net lease (with CUREF paying the property management fee plus $7,667 of the utility expenses). Rudi’s space is divided into 19,719 square feet of freezer space; 33,981 square feet of bakery; 7,580 square feet of office space and 4,430 square feet for storage. Rudi’s lease also provides three sources of additional revenue. Rudi’s is repaying the CUREF $591.43/month (until November 2008) for improvements to the freezer space. Rudi’s is also repaying a $750,000, fixed payment loan at 7% annual interest. The loan proceeds were used for improvements to the bakery. Finally, Rudi’s is repaying CUREF $2.00 per square foot over the term of the lease for improvements to the office area. The current market vacancy rate for warehouse space in Boulder is 10% and Matt is currently negotiating with several potential tenants to lease about 15,000 square feet of the vacant space at the prevailing market rate of $5.75 per square foot triple-net. An MAI appraisal estimates the market value of the property at $ 7.5M.
Expected 2006 operating expenses for the property with the existing tenants consist of $6,029 for landscaping; $1,900 for parking lot maintenance; $6,154 for snow and litter removal; $483,002 for utilities, $16,320 for general maintenance; $70,329 for property taxes and hazard insurance and property management fees at 2% of total revenue. Exhibit 2 provides the details for the 2006 Operating Budget.
The financing alternatives Matt is evaluating are summarized in Exhibit 3. Four lending institutions have responded to Matt’s request for proposals. Three loans are fixed rate loans and one is a variable rate mortgage. American Financial will provide a $6M fixed rate loan for ten years (with a 30 year amortization schedule) at 6.37% annual interest. Bank of Boulder will provide a fixed rate loan at 6.20%, but for only $5.4M. Both American Financial and Bank of Boulder will require CUREF to establish reserve accounts for tenant improvements, reserves for replacements and leasing commissions. State Pension Fund is willing to forego these reserve accounts in exchange for a ten-year fixed rate loan at 6.45%. United Bank and Trust has submitted a proposal suggesting that CUREF refinance the property with a variable rate loan and has proposed a 10-year loan indexed to the 30-day LIBOR. In addition to differences in loan amounts and interest rates, these alternatives have different fees, prepayment penalties and special conditions that influence the ultimate borrowing cost. Exhibit 3 provides the details for these mortgages.
Matt is intrigued by the variable rate alternative. The current yield curve is inverted (Exhibit 4). If interest rates fall, it would be nice to be in a position to take advantage of lower borrowing costs without having to refinance. In addition, the variable rate loan has no prepayment penalty, so Matt could refinance later into a fixed rate loan with minimal cost. Exhibit 5 provides the 15-year history of interest rates for 10-year US Treasuries and for the 30-day LIBOR. Matt expects to close the loan on June 30, 2006.
Questions:
1. What is the expected borrowing cost for each loan? Assume CUREF intends to hold the property for ten years.
2. Comparing American Financial to Bank of Boulder, what is the marginal cost of borrowing the additional $600,000 with American Financial?
3. How would the expected borrowing cost for the Bank of Boulder loan change if the loan term was 15-years instead of 10?
4. Which loan should Matt select? Why?
Exhibit 3
Financing Alternatives
Exhibit 4
Exhibit 5