Wildcat Capital Investors Case Analysis

Morteza Nejad, Brian Crider, Mahshid Fardadi

1. Complete the waterfall shown in Exhibit 10 using the benchmark assumptions outlined in the case.
Under these assumptions, calculate the expected return to Wildcat and its limited partners and
compare those returns to the property-level return on Financial Commons if it is sold after three
years. Note that returns to Wildcat should be calculated without including its management fee.

In the base case the Unlevered and levered IRR at deal level, are 14.23% and 24.98% consequently.
However, the IRR for WildCat is 70.40% and for investors is 21.24%. Numbers are shown in Table 1 and
Table 2, and for further information please check the attached excel file. Table 3 to Table 6 show the
sensitivity analysis of GP IRR and LP IRR, to the Promote (Excess split), Pref., and LTV.

Table 1 Financial model for calculation of IRR

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 Table 2 Financial model for calculation of IRR

Table 3 Sensitivity analysis for LP IRR based on different preferred return and excess splits

Table 4 Sensitivity analysis for GP IRR based on different preferred return and excess splits

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 Table 5 Sensitivity analysis for GP IRR based on different preferred return and loan to value

Table 6 Sensitivity analysis for LP IRR based on different preferred return and loan to value

2. For each of the following scenarios, recalculate spreadsheets for Exhibits 9 and 10. With the
exception of the changes noted below, keep the benchmark assumptions constant. Each scenario is to
be recalculated independently; that is, each scenario is to be treated as a distinct variation from the
benchmark. Assume that outside investors will become partners with Wildcat only if they believe that
they will receive an IRR of at least 20 percent, and Wildcat will only close on the property if it believes
it can earn a 50% IRR. Discuss whether or not the deal will proceed.
a. North Shore Bank does not renew its lease at the end of Year 3 and its space remains
vacant in Year 4. A new tenant begins leasing the space in Year 5 at $18/square foot on a
triple-net (NNN) lease requiring $5/square foot expense reimbursement. The new lease
does not contain any rent escalation clause. To make the space suitable, capital
expenditures of $4/square foot are required in Year 5 for tenant improvements. A leasing
broker charges Wildcat two percent of the first year's rent as a commission. As a result
of this turnover, Wildcat holds the property for five years.

In this case the Unlevered and levered IRR at deal level, are 10.04% and 14.55% consequently. However,
the IRR for WildCat is 30.74% and for investors is 13.25%. Numbers are shown in Table 7 and Table 8,
and for further information please check the attached excel file. Table 9 to Table 12 show the sensitivity
analysis of GP IRR and LP IRR, to the Promote (Excess split), Pref., and LTV. As it shows the vacancy
of the biggest office has drastically made things worse for both GP and LP. In general, having too much
concentration on one tenant (52%) is very concerning.

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Table 7 Financial model for calculation of IRR

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 Table 8 Financial model for calculation of IRR

Table 9 Sensitivity analysis for LP IRR based on different preferred return and excess splits

Table 10 Sensitivity analysis for GP IRR based on different preferred return and excess splits

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 Table 11 Sensitivity analysis for GP IRR based on different preferred return and Loan to Value

Table 12 Sensitivity analysis for LP IRR based on different preferred return and Loan to Value

b. All tenants renew according to the benchmark assumptions. However, due to continued
weakness in commercial property demand, Wildcat holds the property for five years.
During its hold period Wildcat makes capital expenditures of $500,000 in Year two for a
new roof, and $150,000 in Year 3 for a new parking lot.

In this case the Unlevered and levered IRR at deal level, are 10.94% and 16.41% consequently. However,
the IRR for WildCat is 32.87% and for investors is 13.26%. Numbers are shown in Table 13 and Table
14, and for further information please check the attached excel file. Table 15 to Table 18 show the
sensitivity analysis of GP IRR and LP IRR, to the Promote (Excess split), Pref., and LTV. If all
assumptions are true, it’s not in their interest to keep the property for longer than 3 years.

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Table 13 Financial model for calculation of IRR

Table 14 Financial model for calculation of IRR

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 Table 15 Sensitivity analysis for LP IRR based on different preferred return and excess splits

Table 16 Sensitivity analysis for GP IRR based on different preferred return and excess splits

Table 17 Sensitivity analysis for GP IRR based on different preferred return and Loan to Value

Table 18 Sensitivity analysis for LP IRR based on different preferred return and Loan to Value

c. After more careful underwriting, the life.insurance company offers a reduced loan-to-
value of 60-percent, and an interest rate of seven percent. Assume a three-year holding
period.

In this case the Unlevered and levered IRR at deal level, are 14.25% and 22.27% consequently. However,
the IRR for WildCat is 53.81% and for investors is 17.13%. Numbers are shown in Table 19 and Table
20, and for further information please check the attached excel file. Table 21 to Table 25 show the
sensitivity analysis of GP IRR and LP IRR, to the Promote (Excess split), Pref., and LTV. In
comparison with base
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case, we see that GP has a better IRR, despite less LTV and more equity involved. The reason is GP puts
5% and for a big portion of the project benefits from 30% of saving on the interest.
Table 19 Financial model for calculation of IRR

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 Table 20 Financial model for calculation of IRR

Table 21 Sensitivity analysis for GP IRR based on different preferred return and excess splits

Table 22 Sensitivity analysis for LP IRR based on different preferred return and excess splits

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 Table 23 Sensitivity analysis for LP IRR based on different preferred return and Mortgage interest
rate

Table 24 Sensitivity analysis for LP IRR based on different preferred return and Loan to Value

Table 25 Sensitivity analysis for GP IRR based on different preferred return and Loan to Value

d. The outside investors are nervous about the economic climate. As a result, they demand
the following investor-friendly changes to the waterfall structure. Assume a three-year
holding period.

i. Outside investors will provide only 90% of the required equity.

ii. Outside investors will receive a 10 percent preferred return.
iii. Outside investors will receive a 12 percent IRR preference, meaning that, at
reversion, after invested capital has been returned to the outside investors and Wildcat,
the outside investors will receive additional cash until they achieve a 12 percent IRR
over the lifetime of the investment. Remaining cash will then go through the promote
structure.
iv. Cash flows in the promote structure will be split 80/20, instead of 70/30.

In this case the Unlevered and levered IRR at deal level, are 14.34% and 25.04% consequently. However,
the IRR for WildCat is 26.05% and for investors is 21.92%. All numbers at deal level stay as base case
(table 1) and at the partner level numbers are shown in Table 26 and Table 27, and for further information

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please check the attached excel file. Table 28 to Table 32 show the sensitivity analysis of GP IRR and LP
IRR, to the Promote (Excess split), Pref., LTV, and mortgage rate.
Table 26 Financial model for calculation of IRR

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 Table 27 Financial model for calculation of IRR

Table 28 Sensitivity analysis for GP IRR based on different preferred return and excess splits

Table 29 Sensitivity analysis for LP IRR based on different preferred return and excess splits

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 Table 30 Sensitivity analysis for LP IRR based on different preferred return and mortgage interest
rate

Table 31 Sensitivity analysis for LP IRR based on different preferred return and Loan to value

Table 32 Sensitivity analysis for GP IRR based on different preferred return and Loan to value

3. Evaluate the benchmark assumptions Zaski made. Would you have made different assumptions? What
do you think is the fair market price for Financial Commons? Explain why your answer does or does
not differ from $10.4 million.

Table 33 Key Benchmark Assumptions

● Revenue Growth Assumption: The revenue growth rate assumption is relatively conservative and
is potentially reasonable given the current market environment (declining property sales and a slowing
office market). The existing leases have built in rent escalators of 2.0% (as shown below in Exhibit 6) but
it may be hard to get these escalators for the vacant space given the weak demand for office space right
now. Exhibit 7 shows that rental rates have been flat since 2005 - so while there are rent escalators in the
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lease, they may have to offer concessions to resign tenants and to fill the existing vacant space. These re-
lease spreads are unlikely to be achieved given the market environment.

Additionally, the company’s tenant mix is highly concentrated in the financial sector - which is highly
sensitive to a recession and suffered greatly during the 2008-2009 financial crisis. As a result, I would
expect that a major tenant like North Shore Bank & Trust Co. knows that it has significant leverage in
tenant negotiations since it occupies 52% of the building and would likely negotiate concessions given
the financial instability of banks during this time. As a result, we would have made more conservative
assumptions for rent growth given that market rents have been flat for several years and the building’s
tenant mix is concentrated in at-risk financial companies - many of whom will likely request rent
deferment or concessions.

● Vacancy Assumption: Zaski made a common error in her vacancy assumption - where she
forecasts vacancy rates of 6.8% in Yr 1, 3.3% in Yr 2, and 0% in Yr 3 and Yr 4. Per Exhibit 3, the market
vacancy rate is 9.70% in the Near North submarket and over 15% in the greater Chicago market indicated
that her vacancy projections are optimistic at best. Additionally, the historical rent roll indicates that
vacancy is currently 9.5% despite the fact that the property was recently renovated just 2 years prior. This
is not a good sign. Furthermore, she should never really use a vacancy rate of 0% since there is always
down time between lease expirations, unit repairs, and releases of the units. This gap will ensure that
there will always be some vacancy. In comparison, we would have used the market rent rate of 9.70% for
the Near North submarket as our base case and stress tested it with higher vacancy rates as leases start to
renew.

Table 34 Exhibit 6

*Note: Property was built in 1981 and renovated in 2007. The case takes place in 2009.

● Credit Loss Assumption: Zaski stated that she assumed an additional 3.5% of realized rental
revenue for credit losses - based upon historical norms. However, Zaski knows that the economy is
entering a recession since it’s 2009. She should significantly increase this amount and use it as a stress
test variable within her financial model. While it is impossible to derive the “right” number, it is certainly

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too low given the finance-oriented tenant base. For example, consultants and the CFA institute will suffer
greatly in this market environment and may not be able to make rent.

● Operating Expense Assumptions: Zaski assumed that historical expenses were fixed at 61% of
realized rental revenue. However, many of these expenses are variable and should be forecasted
individually - separating fixed and variable expenses. As a result, the reasonableness of these assumptions
are suspect and could be significantly higher or lower based upon occupancy.

● Capital Expenditures Assumption: The analyst forecasts no major capital expenditures during the
holding period. At first glance, this may appear reasonable since the property was recently renovated in
2007 (2-years prior) but we don’t know what exactly was renovated or how much as spent. As a result, I
think we should budget for some capital expenditures given that there are large one-time CapEx items,
such as a roof replacement, that should be saved for over time. As a result, there should be a Replacement
Reserves account at the very least (usually 1-2% of EGI).

● Cap Rate Assumption for Terminal Value: Zaski assumption of an 8.4% cap rate for the terminal
value is concerning because she has no market data to derive a market based capitalization rate and is
using a historical rate “based on experience.” However, the economy is entering the Great Recession and
cap rates are likely to rise significantly above historical norms. The cap rate drives the entire terminal
value calculation and investor returns but appears to have been given the least thought and no market
support.

Furthermore, Zaski justifies her cap rate assumption by “backing into a cap rate at a $140/SF sale price.”
If we look at sale comparables, there just isn’t enough market data to justify a $140/SF fair market value
conclusion. Most of these sales took place before the financial crisis really deepened (i.e. Lehman Bros.
bankruptcy was in Sept. 2008). As a result, this data just isn’t useful. It appears that Zaski is using a
simple average to justify her $140/SF sale price. However, sale comparable #1 was located in Evanston
and is near the waterfront so it’s not a good comparable to benchmark the subject property. Sale
comparable #2 was obviously distressed and should be used as a comparable. Similarly, sale #3 and #4
sold before the market crash. As a result, the Zaski cannot rely on comparable sales data to derive a cap
rate or price per square foot estimate.

Table 35 Sale Comparable

The other issue with the cap rate assumption is that the property has significant tenant concentration with
North Shore Bank & Trust Co. occupying 52% of the net rentable area and a remaining lease term of only
3 years. As a result, this tenant’s lease space will expire right around the forecasted sales date - being a

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major risk factor to a potential buyer and will negatively impact valuation since a buyer would likely
demand a much higher cap rate. In our opinion, the terminal value should be increased by at least 300
basis points to account for the added risk. Ideally, Zaski could look at sale comparables outside of this
particular market to get an idea of how much office cap rates have risen during the recession and add that
to her 8.4% estimate. It’s not perfect, but in the absence of data it is better than nothing.

● Final Value Conclusion: Given the deteriorating market environment and optimistic assumptions
in the financial projections, we would offer significantly less than the $10.4 million ($121.19/SF) asking
price. There is simply too much risk given the tenant concentration and their sensitivity to the on-going
recession to have any faith in the financial projections. This property could easily end up in distress and
thus, we wouldn’t buy it unless there was a substantial discount in the sale price. Finally, it must be noted
that Skokie is a very suburban location and is technically a “village” in Cook County, Illinois with a
population of only 63,280. This is a B or C location at best. As a result, there are simply too many
unfavorable risk factors (unstable cash flows, tenant risk, and locational risk among others) to justify the
$10.4 million asking price.

4. If you were an outside investor approached by Wildcat, and were shown the financial projections from
the analyses above, what additional information would you seek before investing?

In addition to questioning all of the assumptions noted above, we would like to see the following items
from the GP:

A. Sponsor Participation: First, we would want to make sure that the Sponsor (Wildcat) has
substantial “skin in the game.” Why are they only putting in 5%? They are only risking $182,000 in
capital, while the LP investors are risking $3,458,000. While it is common for GP’s to only take a 5-10%
interest in a property, we would require them to put in substantially more capital for a deal with this level
of risk. This is a win-win situation for them. If it works out, they earn substantial returns but if it does not,
they lose very little. As a result, we would need to know how much capital Wildcat Capital Investors has
under management. If they only have $182,000, then that might be reasonable. However, if they have
millions in assets under management, then we have no faith in their investment proposal.

Table 36 Capital Structure

B. Lease Extension: We would require a signed lease extension from North Shore Bank & Trust Co.
since they occupy 52% of the net rentable area and losing them as a tenant could destroy the entire
project. Preservation of capital is of the utmost importance and the loss of one tenant that occupies 52%
of the property is a risk that isn’t worth taking at this asking price. Even if Zaski’s financial projections
materialize (which they won’t), the existing tenant concentration is too risky given that banks are in
distress and their lease is up in 3 years. The project’s IRR is not high enough to justify the risk for an LP
investor.

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C. Additional Fees: We would require a full disclosure of all fees that Wildcat will be collecting. It
is quite common for Sponsors to earn additional returns through various fees, such as an acquisitions fee,
credit enhancement fee (if they can get a better rate on a loan via the parent company), disposition fee,
and/or an asset management fee. We would require full disclosure from the firm and see if they are
reasonable given the current market. In times of distress, fees should decline and sponsors should be
willing to risk more of their capital in the project.

D. Sponsor Team, Track Record, and Geographical Competence: We would also require that the
Sponsor provide their track record and audited investor returns. Since Wildcat is mostly a mezzanine debt
shop, not an equity investor, we would require detailed background on the team members and their
experience in this particular market. As the case notes, most of their prior projects were high-profile debt
deals in Chicago’s South Loop. Skokie is a very different, suburban location. In fact, it’s technically a
village in Cook County and is definitely not part of Chicago. As a result, we do not think management has
adequate locational expertise in this market.

E. Due Diligence & Property Management: We would also want the firm to provide all of their due
diligence for the project to make sure it is satisfactory. In addition, we would like to know if the property
will be self-managed or managed by a third party? If so, we would require similar due diligence on the
property management team.

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