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Real Estate Case Study – 30-Minute Office Acquisition Modeling Test – SOLUTIONS
You are an institutional investor contemplating the acquisition of an 85% leased, 251,743
rentable-square-foot office building in Irvine, California (“Culver Drive Tower”). Comparable
properties have sold for between $300 and $340 per square foot (PSF), and you believe a fair
price for this property is $320 PSF.

You believe the Irvine office market is set for a recovery over the next few years, and you
believe that rents will rise at above-market rates while vacancy rates will fall. To take advantage
of this trend, you plan to acquire the property, hold it for five years, and sell it.

Please use the following assumptions and complete the Excel template that has been provided
to you. You have 30 minutes to make the calculations and respond to the case study questions.

Operating Assumptions:

• Average Annual Rent per Square Foot: $38.40; 6% growth declining to 3% by Year 4.
• Expense Reimbursements per Square Foot: $0.25; 3% annual growth.
• Property Management Fees: 3.0% of Effective Gross Income.
• Operating Expenses per Square Foot: $5.00; 3% annual growth.
• Real Estate Taxes: 1.12% of property value initially; 2% annual growth.
• Replacement Reserves per Square Foot: $0.40; 3% annual growth.
• Capital Costs per Square Foot for New Tenants: $7.00; 3.0%.

Capital Costs include Capital Expenditures, Tenant Improvements (TIs), and Leasing
Commissions.

Assume that the General Vacancy declines from 15% in the historical period to 10% by Year 5.

For the existing tenants, assume that leases corresponding to 10% of the rentable square feet
expire in Year 1, followed by 5% in Year 2, 10% in Year 3, 5% in Year 4, and so on.

Also, assume that it takes 6 months to find a new tenant following each expiration and that
each new tenant receives 3 free months of rent. For simplicity, assume there are no renewals.

Acquisition & Exit Assumptions:

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Assume an acquisition price of $320.00 per rentable square foot. Acquisition costs represent
1.0% of the gross price. A local bank has agreed to issue Senior Debt to support the deal, with
the following terms:

• Loan-to-Value (LTV) Ratio: 65%

• Interest Rate: 3.50% (fixed)
• Loan Amortization Period: 30 years
• Loan Maturity: 5 years
• Issuance Fee: 1.0%
• Minimum Debt Service Coverage Ratio (DSCR): 1.9x; Minimum Debt Yield: 10%

Assume that you can sell the property in Year 5 for a 7.50% Cap Rate and that Selling Costs
represent 2.0% of this exit price.

Based on that information, please complete the model and respond to the following questions:

1) What is the unleveraged IRR of the investment?

11.5%.

2) What is the leveraged IRR of the investment?

22.1%.

3) Does the Senior Debt comply with the bank’s requirements? If not, how might you
change the terms to achieve compliance?

Yes, it does, because the lowest DSCR is 1.95x, which is above the 1.9x minimum, and the
lowest Debt Yield is 10.6%, which is also above the 10% minimum. If it did not comply with
these requirements, we might tweak the terms and negotiate for a longer amortization period
in exchange for a higher interest rate (for example). Or we might ask for a lower LTV Ratio,
which would increase both metrics (at the expense of reducing the leveraged IRR).

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