Case Assignment: Jackson Lamb

Jackson Lamb runs a small investment advisory firm based in Jersey City, New Jersey. For the past few months, Jack's attention has been focused on his clients Philip and Elizabeth Jennings. Elizabeth was the developer of an app called Yip Yap that used different sounds from dogs - barks, howls and whimpers - to create aural emojis. Elizabeth sold the app to a social network for a tidy sum and invested most of the proceeds in stocks, bonds, and short-term securities. She and Philip were looking to diversify their holdings and, as Philip's family had some experience owning and managing a small apartment building, they decided to put the funds that remained into real estate. The Jennings have been looking over investment opportunities for some time now without much to show for it. They first considered multi-family units in Hoboken and Jersey City, but residential properties in the area seemed expensive and just didn't make sense based on their cash flow projections. As for commercial property, institutional investors have decreased the minimum size of acceptable investments in real estate and the additional capital allocated to the market for class A office made that sector similarly expensive. With Philip and Elizabeth on the verge of giving up, Jackson made the suggestion to look at class B office properties. One in particular, the Maxwell Medical Center, seemed like an attractive investment opportunity. The Maxwell Medical Center is located on Willow Avenue, not far from the Hoboken Uni- versity Medical Center. The property offers 32,000 square feet of rentable space and is on the market for $7.6M. The building was constructed in the 1920s and has been renovated several times since, the last major face lift was performed in 2000. The property is currently fully leased with three tenants. Based on conversations with the property management company, the current tenants find the space to be satisfactory and its location near the Hoboken train station is a big plus. The largest tenant, occupying nearly half of the building's space, Squill Pharmaceutical, has been in the building now for more than 10 years. Finally, the medical practice on the ground floor has just renewed and signed a new 5-year lease. A few back of the envelope calculations suggested that the property seemed to be a good investment. Jackson put the Jennings with QOD Bank and, based on the rent roll and a rough pro-forma, QOD was willing to lend up to $4.94M toward the purchase of the building. The debt service on the loan is based on a 5.75% contract rate and 30-year amortization. Just as Philip and Elizabeth had come to the point where they had decided to make an offer on the Maxwell Medical Center, Jackson was informed by a local broker of another property, The Colgate Building, that was coming onto the market. The Colgate Building is a relatively new office building on the corner of Sussex and Hudson streets in Jersey City. The building is larger and a little more expensive than Maxwell. The asking price for the Colgate Building is $8.2M and offers 38,750 square feet of rentable space. While the Colgate Building came to market well after the COVID-19 pandemic had subsided, they still had some difficulty attracting tenants as there was less demand for office space as many employees were still working from home. The slow absorption of the space has made life difficult for the developers and now that the building is fully occupied, they want to sell as quickly as possible. The largest tenant, the biotechnology firm Lumon Industries, occupies 18,000 square feet of space and has been in the building since it came to market. Two years remain on their lease and they have expressed interest in renewing under the right circumstances. It took almost a year after that point to find a tenant for the ground floor retail space, Barg'n Hut. As Barg''n Hut is an upscale grocery store with an emphasis on organic food, the recent increase in residential development in the area made the space quite attractive and they signed a longer term net lease. While their reimbursements to the owners will be significant, they prefer this to some of their rent being determined by a percentage rent. The final tenant, Hampton DeVille, has agreed to take on the remaining space as of January, 2025. After a few quick calculations, it appeared that The Colgate Building also provides most of what the Jennings are looking for in an investment property. QOD was also willing to provide financing for this acquisition, but on more conservative terms, as they had little experience with underwriting retail space. In the end, QOD agreed to lend on the same rate and amortization period as offered for the Maxwell Center, but only up to a 55% LTV ratio based on the asking price for the property. On the surface, the Jennings thought that The Colgate Building seemed to be the most attractive alternative but.Jackson suggested, as he does with all his clients, to first look at the numbers. If the properties are roughly equivalent in terms of risk and return, then qualitative and personal preferences should be the deciding factors. If not, then it is important to make an informed, quantitative decision. While transactions volume typically slows during the holiday season, Jackson noted that there is currently a limited set of available properties on the market and that if they, the Jennings. do not act quickly, these opportunities may be snapped up by someone else. You interned at Jackson's firm during the summer between your junior and senior years at Rutgers. As a member of a small and busy firm, you had an assortment of different responsibilities in a variety of different deals. After the summer, Jackson offered you the opportunity to return as a financial analyst after completing your education and you accepted. After graduating in the spring of 2023, you settled into your new job. Your first responsibilities involved many hours of cash flow modeling in Excel and Argus, but, as time passed, Jackson offered you a more intimate look at the deals that his high net worth clients were considering. You toured several properties with Philip and Elizabeth and had done most of the basic financials for these two opportunities. In the past, Jackson had taken your preliminary work and then constructed detailed cash flow projections and investment recommendations for his clients. This time, however, Jackson had to leave town due to a family emergency and asked vou to complete the work needed to make an informed recommendation. Just before leaving, Jackson turned over the work he had already completed for Maxwell Medical, along with a few notes about The Colgate Building. You need to complete a set of cash flow projections for The Colgate Building, produce the metrics that the firm uses to evaluate investments, and then make a written recommendation to the Jennings. Most of the information for the financial analysis is provided in the spreadsheets Jackson gave to you. There are a couple of elements associated with The Colgate Building that he highlighted: e Base your analysis on taking control of the property as of January 1, 2025. e Given that the Colgate Building is newer than Maxwell, the market rent is expect to increase at a slightly higher rate. e The newest tenant, Hampton DeVille, will take occupancy as of January 1, 2025. As part of the sale agreement, the sellers will pay the TI expense and leasing commissions associated with the tenant in the first year. Note, however, that the lease expires after 5 years and the Jennings will be responsible for these expenditures when a new lease is signed in year 6. e The expense reimbursements for Barg'n Mart are based on a net structure. It is easiest to treat the recoveries as a modified gross lease but with an expense stop of $0 in each year. e The real estate tax expense grows at 2% annually. This is in contrast to the other expense that grow at the expense inflation rate. The Jennings are willing to contribute up to $4M as their equity contribution to the invest- ment. They are somewhat risk averse and are looking for a minimum after-tax return of 10%. Based on the information they provided, the Jennings' current household income puts them in a 37% marginal income tax bracket. Their capital gains and depreciation recapture rates are 20% and 25%, respectively. Instructions: This is the first part of a two-part case assignment. In this part, vou will generate cash flow projections for a 5-year holding period for The Colgate Building. A template, Colgate blank, is provided. To check your work along the way: The unlevered IRR is 10.49%. the before-tax IRR is 14.70%. and the after-tax IRR is 10.95%. Your objective is to match these returns based on the information and modeling performed in Excel. You can work either individually or in pairs. You and your partner should work as an independent unit. Do not copy vour spreadsheets from other sources or from students outside of your team. Your team will receive a zero on this assignment if it is determined that your spreadsheets were copied from another source. If you or your group need clarification about something from the case or are having trouble, please feel free to contact me. Send a copy of vour spreadsheets no later than 6:00 pm on November 26th