Quick Deal Analysis

[Andrew Noway]

For a commercial medical building:

Basics

Building Purchase Price: $4,000,000

Building Appraisal: $4,300,000

Estimated Deal Term: 10 years

Senior Debt: 3 million

Equity Raise: $1,000,000

Acquisition Costs: $85,000

MP Contribution: $50,000 (5%)

LP Contribution: $950,000 (95%)

Returns

Pari Passu: 9%

After 9% IRR: 30% MP, 70% LP

After 15% IRR: 50% MP, 50% LP

Estimated multiple

LP Equity Multiple: 2.55x ($1,500,000 total)

MP Equity Multiple: 20.86x ($1,000,000 total)

Of course, I shouldn’t necessarily be looking at what the MP (syndicate—an individual in this case) makes on the deal. I should look at the LP numbers and, if they make sense after DD and I am comfortable with the return, I should move forward.

However, this deal appears to be very rich for the MP. After an 85K acquisition fee, they are netting some serious returns with only 50K skin in the game (which probably came from the acquisition fee). Can anyone more experienced with commercial real estate take the general temperature of this deal and give thoughts? Is this disparity between LP and MP larger than usual?

Thanks in advance!

[Daniel Chang]

Always start with the investment product itself, not with the structure of the investment.  Look into what the syndicator's plan is.  Given the 10 year term, is this simply a buy-hold?  Or is it a value add?  If it's the former, then very little "work" needs to be done.  If it's the latter, what is the plan for value-add.  Does the plan make sense?  If the plan or the investment doesn't make sense, then stop there and go no further.  If it does make sense, then go to the next step, which is analyzing the structure.

The acquisition fee is a bit rich.  Sometimes, richness is deserved.  However, what sets off alarm bells is that, no only does the syndicator have very little skin in the game, he is paid first.  That means, if he runs the investment into the ground after 1 year, he already made most of his money already by the upfront fee.  Looking it another way, with $1MM in total equity, your investment is immediately devalued 8.5% when you put in your investment.  If you invest $100K, it immediately becomes $91.5.  Now starting from there, you are hoping that syndicator creates enough value to bridge the gap and then earn you a return.  

In terms of the loan, perhaps the acquisition fee is well deserved if the syndicator is personally guaranteeing the loan.  That puts a lot of pressure on him to do well.  However, if it's non-recourse financing, as I imagine it is, then it goes back to the little skin in the game argument.  

You also have to ask what happens on the downside. What if the IRR is -9%. What happens then? This is rarely addressed in the PPM's/ prospectuses that I've seen. Everything in prospectuses is always up and up, no one stops to ask, "what if it goes down?" Is there a capital call? Does syndicator shoulder more responsibility if it goes down, since he's taking more rewards if it goes up?

I do agree this deal seem to unjustly reward the syndicator at face value.  However it may still be a great deal for the investor depending on multiple of other variables that you did not describe.