Question

You have been approached by General Electric (GE) to develop a 150,000 SF office facility for them in suburban Dallas. They will use the property for “back office” operations and corporate training. After considerable negotiation, you have received their final non-negotiable offer. They would lease the facility for 6 years, at a triple net annual rent of $2,250,000. The rent would remain constant over the term of the lease. GE would also have the option to renew their lease for an additional 6 years for $3,000,000 (triple net). In addition, they would have the option to purchase the property at any time during their lease (including the renewal period if exercised) for the price of $29 million. They insist that the property be completed by 11 months from today. Failure to achieve this completion date would relieve them of the agreement.  

You estimate that the project will cost $25 million (all costs included), and will take 9.5 months from today to complete. You feel that due to the presence of GE as a tenant, you will be able to secure a $20 million loan during the next 3 months, at a 6% interest rate for 3 years with no amortization. You have $2 million in cash available to start the project immediately, and believe that during the next 2 months you will be able to access the remaining $3 million of required equity either by refinancing equity out of other projects you own, selling other properties you own or bringing in a 3rd party as an equity partner. If you provide the entire $5 million of anticipated equity requirements, it will represent 75% of your net worth. You anticipate that you would receive a $1 million development fee upon successful completion (included in the $25 million total costs).  

Your research indicates that currently, market rents are roughly $16 per SF triple net and that development is occurring at a rate roughly commensurate to employment growth. Vacancy rates are roughly 5% in the market and expected to remain stable. Cap rates for “comparable” property sales range from 8%-10%.  

It is decision time. Would you accept their offer? Explain your reasoning.

Answer 1

Cost of Project = $ 25 million

Bank loan that will be sanctioned = $ 20 million

Hence equity to be infused = $ 5 million (i.e. 75% of our net worth)

Loan to be sanctioned is for 3 years

Following is Income / Cost table for first 3 years

Year	1	2	3
Cost of Project	- $ 25million
Self Equity	$ 5 million
Development fee on completion	$ 1 million
Interest on bank loan	-$ 1.14 million	-$ 1.14 million	-$ 1.14 million
Rent received from GE	$ 2.25 million	$ 2.25 million	$ 2.25 million
Total	- $ 17.80 million	$ 1.11 million	$ 1.11 million

After 3 years we will short fall of by -17.8 +1.11+1.11 = $ -15.67 million

As we will fall short of cash after 3 years property needs to be sold

If the property is to be sold after 3 years

Rent = $16 * 150000 = $2.4 million

Comparable property sale rate = 2.4 / 0.10 = 24 million

As $ 24 million < 20 million (debt ) + 5 million (equity)

Offer should not be accepted .