REAL ESTATE FINANCE AND INVESTMENTS:

Final Exam
Do yourself a big favor – write very legibly or type. Because this exam is due before Friday, December 17th, at 11:59PM,
you may submit your exam electronically earlier than that time. I will not give credit for what I cannot read (so make sure
it is a PDF). You may use your book and notes to complete the exam. Be clear as to your reasoning and give helpful
examples when appropriate. Do not panic. I am available all week should you have questions. I expect answers with
detail commensurate to the question. Do not use your fellow students to help in any way. Use as much space as you like.

This Final Exam is worth 300 total points.
Select from any FIVE (5) of the following for 30 points (10 percent) each:

1. The advantages of increasing the TI allowance rather than offering lower base rent are:
2. React: A building leased to a high–quality tenant is more valuable than the same building leased to a junk credit tenant.
1. Rent or Buy, tell me why. Be sure to cite for both commercial property as a Schedule–C business property as well as
owner occupied residential property.
3. Is it better to refinance a property whose value has risen substantially or is it better to sell the property? Why or why
not?
4. What is a like kind exchange (1031 exchange) and why may it be preferable to an outright sale?

5. React: Mezzanine real estate financings always involve the lender taking a first security collateral position in the
property to which they are lending.
6. What are the costs to be considered when selling a property?

CALCULATIONS (Answer both, at 25% of the total exam in each question):

CASE QUESTION 1 (75 points)
You have received an offer to develop a 150,000 square foot office facility for Sierra Nevada in Chico. The brewery intends
to develop the property as a back office and training facility. You’ve been working with the brewer and they have
countered with 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. Sierra Nevada 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 from 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 Sierra Nevada 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 cost).
Your research indicates that currently market rents are roughly $16 per square foot, triple net, and that development is
occurring at a rate roughly commensurate to employment growth. Vacancy rates are roughly 5% in the market and are
expected to remain stable. Cap rates for “comparable” property sales range from 8%–10%. It is time to decide. What do you?

CASE QUESTION 2 (75 points)
Serrano Clay is a multinational firm that provides consulting services to clients around the world. The company has a 11%
expected return on its invested capital. Recently the firm has enjoyed an expansion in their clientele and is increasing their employee count. With growth in size, management feels that the firm needs to move into newer and bigger offices and is exploring options. Erika Benitez, VP of Development, was recently approached by a local REALTOR, who presented her with prime office space for rent in downtown Modesto, available for immediate occupancy. The space he proposes is a single–user Class A office building with all of the high–end amenities demanded by management. Erika felt that the space is suitable and decided to make the case at senior management’s next meeting.
The details for the rent option are as follows:

Assumptions:
Property Value $8.9 million
Year 1 Rent for LL to achieve $MM in NOI $120,000
Rent Growth Rate 3.265%
Company Retained Capital by not buying Property $8,900,000
Equity Investment in Operations $3,560,000
Capital Borrowed for Investment in Operations $5,340,000
Annual Interest Rate on Borrowed Capital 5.00%
Annual Interest Payment $267,000
Annual Yield on Investment in Operations 11.00%
Income Tax Rate 21.00%
Company Discount 9.00%
Depreciable Value: Avg. Depr. Life: Annual Depr.:
$8.9 million 10 years $890,000

Surprisingly, a few days after receiving the rental proposal, Erika was approached again regarding the same space, this
time with an offer to purchase the space for $8.9 million. Intrigued by the idea, Erika decided to present management
with both options at management’s next meeting.

Assumptions:
Property Value $8.9 million
Year 1 Rent for LL to achieve $MM in NOI $120,000
Rent Growth Rate 3.265%
Company Retained Capital by not buying Property $8,900,000
Equity Investment in Building $3,560,000
Capital Borrowed for Buying Building $5,340,000
Annual Interest Rate on Borrowed Capital 5.00%
Annual Interest Payment $267,000
Annual Building Operating Expense $178,000
Property Year 10 Sale Revenue $11,570,000
Selling Costs $267,000
Selling Costs 2.308%

Repayment of Capital Borrowed for Buying Building $5,340,000
Income Tax Rate 21.00%
Accumulated Depreciation Tax Rate 25.00%
Capital Gains Tax Rate 15.00%
Non–Land Depreciable Value: Avg. Depr. Life: Annual Depr.:
$7.120 million 20 years $356,000
Should Erika recommend the own or rent option?