First, analyze the asking price to determine whether the asking price is fair and competitive. Second, determine whether the leverage situation is positive or negative based on the asking price of $13.5M and assuming the Alcorn uses the outstanding mortgage balance of $9,045,000 and the equity investment that will be required to complete the transaction. Write a memo discussing your analysis, conclusions and recommendations
TASK 2: How Best to Finance the Transaction by Alcon Partners:
There are other complicating issues. First, the maximum equity investment that Alcon Partners can make towards the purchase of the property is $2,895,750. The partnership has concluded that any amount of equity investment in excess of this amount is not financially prudent and Alcorn will not invest more than the maximum equity investment of $2,895,750. Furthermore, Alcorn wants an equity dividend rate (EDR) or return on equity (ROE) of at least 10% to make this transaction attractive for the partnership. If Alcorn is correct in its assessment that leverage is in fact negative, this will imply that the EDR from investing in the property will be below its required hurdle EDR of 10%. This is because at the asking price of $13.5M, which is a firm price, and by assuming the existing outstanding balance of $9,045,000, the equity investment will be greater than the maximum equity of $2,895,750 Alcorn can tolerate.
The situation is further complicated. Although adverse national office market conditions have improved, the availability of new commercial mortgage loans is still limited. Market interest rate on straight commercial mortgages hovers around 9.5%, at least. Alcorn is not optimistic about getting a straight loan from a commercial lender at any rate below the market rate figure of 9.5%. However, Bayview Investment Partners (the owner of the property) believes that a wraparound mortgage can be realistically structured to satisfy the constraints of Alcon Partners and make the sale possible, which means that in the process of structuring wraparound mortgage Alcorn Partners (the buyer) must also realize its hurdle rate of at least 10%. Bayview Partners is prepared to make the wraparound and the lender on the existing first mortgage will have no objection to a wraparound mortgage that includes the outstanding amount on the existing first mortgage. However, the wraparound must also satisfy the normal characteristics of wraparounds in terms of its contract rate being below market rate but above the contract rate on the existing first mortgage, and the yield (internal rate of rate return) to the wrap lender (Bayview Investment Partners) must exceed the contract rate on the wraparound mortgage and the prevailing market interest rate.
Taking into consideration the above constraints facing Alcorn Partners, the potential purchasers of the property and the yield requirement of Bayview Investment Partners, your firm has been asked to structure the wraparound mortgage that will satisfy both Alcorn (the buyer of the property), the wrap lender (Bayview, the seller of the property), so as to make the transaction feasible. Your solution must be practical, in the sense that it must satisfy the characteristics normally associated with wraparound mortgages as discussed in the course and above. That is both the lender/seller (Bayview) and the equity investors (Alcorn) must realize their objectives. Please include a memorandum explaining your analysis, major findings, conclusions and recommendations
HINT IN SOLVING THIS PART OF THE CASE: In structuring the wraparound you should note that the term of a loan is not necessarily equal to its amortization period. Therefore, you can take advantage of the balloon mortgage format to structure a feasible wraparound.
TASK 3: Refinancing of the Property by Bayview and Holding it in its Portfolio for 10 years.
It is also likely that market rates would decline in about two years. So as an alternative, Bayview is also considering holding the property for two more years instead of selling it now with a wraparound mortgage. The existing mortgage is three years old at the point of the sale of the property. It is projected that market situation would have improved by the end of the two-year period to permit refinancing of the property at reasonable terms: interest rate of 7.5%, 30-year amortization with monthly payments. The refinancing cost on the new loan is projected to be 3 percent of the amount being refinanced, i.e. the outstanding balance. The old loan also requires a yield-maintenance premium to be paid to the lender for any unscheduled principal payment during the first six years of the loan. Refinancing will occur at end of 5th year (3+2) of the existing loan at which time the balance on the existing loan will be repaid; thus there will be one year remaining in the yield maintenance period. At the time the existing loan was originated the yield on Treasury securities was 6.5 and at the prepayment date when the refinancing is to be undertaken the Treasury yield is forecasted to be 4.75%. After refinancing, Bayview Investments plans to hold property for ten more years and prepay the balance of on the new (refinanced) loan. The discount rate for Bayview Investment on alternative risk of similar risk is 10%.
Now assume your firm is also retained by Bayview to assist in this proposed refinancing decision. Analyze this refinancing proposition by computing the NPV and the internal rate of return from the refinancing.
TASK 4: Your Complete Report
Finally, write a report to the senior partner of Bayview Mr. Will McLean detailing your analysis, findings, and interpretation of the results, conclusions and recommendations. In your report be sure to discuss your analysis of selling price of the property, analysis of the issue of whether or not Bayview should do the wraparound and sell the property now or hold on to the property and refinance two years later. What are the advantages of doing the refinancing? What are the limitations of your analysis? Feel free to include other arguments for and against each scenario.