Trojan Builders (TB), a housing developer, is preparing a conceptual proposal for a new luxury apartment complex in Culver City, California. TB has asked you to prepare a simple Pro Forma for the complex. The apartment complex will include 50 rentable apartments, a swimming pool, and a two-story underground parking garage. The estimated total project cost of construction is $16 million. Discussions with the lending bank indicate the following data on a prospective loan: maximum loan to value (LTV) ratio = 80%, capitalization rate = 10%, long-term debt service rate = 8.00% (constant), and minimum debt service coverage = 1.5. The bank has a policy of setting loan covenants that stipulate that if the borrower falls below the minimum debt service coverage during any annual period, the bank may require the loan to be immediately repaid in full. On the income side, TB plans on a lease rate of $4,000 per apartment per month and additional income of $10,000 per month from the parking garage. Historical averages indicate that this property should have a 6% vacancy rate and expenses will be 20% of adjusted (for vacancy) gross annual income; this will include the annual lease payment for the long-term ground lease for the property.

a) What is the maximum loan amount? Does this exceed the estimated construction costs? How should TB handle the difference between the loan amount and construction cost? b) Assuming TB takes the full loan amount, what is the annual, long-term debt service? Will this fit within the banks required minimum debt service coverage ratio? c) Assume the bank provides the full loan as calculated in a) above. What actual vacancy rate would just cause the developer to fall below the required debt service coverage? d) What are the primary risks TB faces in moving forward with this apartment complex project? What recommendations would you make to reduce these risks?