SANCHEZ, RENALYN C.

2 BSA 2

SPANISH TRAILS BUSINESS PARK: REAL ESTATE DEVELOPMENT CASE

a) At the early stages of the deal (2004), what were the projected income and expenses?

- At the early stages of the deal, the projected rent income was $2.25 per square foot, which amounted
to $22,500 monthly income, or $270K annually. Estimated expenses included tenant improvements,
which were to be paid by the landlord at $30 per square foot, amounting to $300K total, and also
included other soft costs which were estimated to total $150K. Operating expenses, including CAM,
were to be paid by the tenants. The lease term would range from five to ten years

b) What were the pros and cons concerning the delay in closing the deal?

- One pro is that he property value continued to increase without the building being constructed. The
park developers had sold building A for $345 per square foot, which meant that the deal had gone up in
value by approximately $1M. Another pro is that their mortgage interest rates dropped significantly,
causing their monthly debt service to drop from $12,500 to $7000. One of the cons concerning the delay
were that the owners couldn’t start the rent-up period. Another con was that since the developers
weren’t meeting the construction deadlines, the investors had the option to exit the deal. Additionally,
with the recession, the developers had to put $600K of their own money up to renegotiate the mortgage
to bring it down from $2.5M to $1.9M.

c) Why would the developer desire to refinance the property so quickly?

- HMS signed a two-year purchase and construction loan for the property. This was a recourse loan that
was personally guaranteed by the borrowers. Therefore, the developer was motivated to refinance this
property as quickly as possible. The short time window (2 years), coupled with the fact that it was a
recourse loan meant that the developer would want to refinance quickly. In addition, the lenders were
offering very attractive financing once the space was fully rented. The new loan would have a 10-year
term, 85% LTV, 7% adjustable IR and most importantly 7% cap rate valuation. The developers believed
that at this cap rate, the value of the property would increase significantly based on the NOI projections.
High rents per square foot 7% cap would significantly increase the value of the property. Refinancing
may allow the developers to take out some of the cash they had originally put down in order to make
the purchase.

d) What would have been the projected benefit (profit) of a quick refinance?

- The developer’s debt service was growing significantly, and with only 20% of the property being
rented, they were losing a significant amount of income. The only reason they were able to pay off their
debt service was because mortgage rates were dropping to historically low levels due to the recession. If
they did not do a quick refinance, and the mortgage rates recovered, the developers would incur a
significant increase in debt service, leading to more loss. With a quick refinance, the developers would
be able to cut some of their accumulating losses and allow their debt service to lower to a level where
their 20% rented income would cover the costs.

e) Calculate (estimate) the 2011 cash flow situation.

- In 2011, the tenant State Farm signed a lease which provided the developer with an extra $2,500 per
month, and $30K annually. Assuming State Farm pays CAM, they will also pay an additional $12,000 per
year. Adding in the already existing Dunkin Donuts income of $78K per year, they have a total of $120K
of income per year. Factoring in operating expenses of $24K, the net income is $96K.

f) In 2015, should they lease the remaining space to the new proposed tenant (Classic Wines)? How

would you propose to respond to the Tenant?

- No, in 2015 HMS should not lease the remaining space to Classic Wines. The proposed terms of the
lease (Exhibit B) indicate that Classic Wines is only willing to pay $1.00 per square foot which is
significantly lower than the rents being charged to other tenants. In 2013, Title Max signed a lease for
five years with a rent of $1.25 per sf for the first five years and then increasing 3% per year for the
second five years. It is always better for HMS to have paying tenants in the space, but they should
negotiate for a higher price per square foot for the wine store. There is also a contingency in the lease
for the approval of all required licenses. This contingency should be taken out of the lease agreement.

g) What would be your overall recommendations to HMS for this property?

- I would recommend continuing to hold this property, assuming HMS was able to get another 4-year
extension on the existing loan. The case only mentions HMS received the 4-year extension in 2009 while
having to pay down the mortgage by 600k with their own money. This brings us to Spring 2013; we can
assume they got another extension since we know the building becomes fully occupied in 2016. The Oct
2016 YTD Income Statement still shows a negative NOI with a fully leased building, but this is primarily
due to the 69k of tenant improvements. Moving forward the building will be fully leased and in positive
NOI territory with all operating expenses passed through to the tenants. Since HMS has shown such
commitment to this property by paying down the 600k, back in 2009 we feel it would be worth holding
through the latest extension taking advantage of those positive cash flows. Once the extension is up it
may be worth analyzing what they could sell the property for.