90-748 Real Estate Development

Term Project Report

Date: 12th December 2018

Project Proposal for Fifth and Dinwiddie

Analysis of the Project from a Value Maximization Viewpoint

Instructor: Prof. Thomas Link

Submitted by: Abhishek Bhattacharyya, Anuroy Vyas, Cheryl Rozinski,
Ian Friedman, James McHugh, Matthew Romeike
Executive Summary
The Pittsburgh URA has released a RFP to redevelop the Department of Public Works building and the
opposing parking lot, which is currently owned by the URA, at Fifth and Dinwiddie. Three weeks ago, our
team of analysts set out to evaluate whether our firm should submit a proposal. In this report, you will
find our proposed development program, our assumptions for our development pro forma, our capital
stack, an economic return analysis that includes a sensitivity analysis for our assumptions, and our
ultimate recommendation to invest.
Our proposed development includes a 45:25:30 ratio of office to retail to housing, with 80% low-income
housing. The team’s assumptions are listed in the Development Pro Forma section. The construction
financing includes 60% construction debt, 10.9% tax equity, and 29.1% private equity, while the
permanent financing includes 61.9% permanent debt, 10.9% tax equity, and 27.2% private equity. Our
economic return analysis of our base-case leads to a 9.6% IRR, $6,174,853 NPV, and 1.93x cash-on-cash
return, which we recommend pursuing.
We recommend investing in this project because of our promising economic return analysis, and our
belief that we will be able to meet the needs of the community and build a symbiotic relationship which
will have lasting, beneficial impacts on the development. In addition, due to their vested interest in this
project, we expect the City and URA to continue to be involved with the project. Specifically, we expect
they will expedite the process of issuing permits and approvals for the project, thereby decreasing the
time and resources spent on related tasks internally. We hope you will approve our proposal idea so
that we can submit our official response to the URA.

Proposed Development Program

Proposing A Design To Meet Community Needs

In our subsequent analysis, we explain our process to find the optimal design to redevelop the
Department of Public Works building, and the opposing parking lot owned by the URA at Fifth and
Dinwiddie. Our selected design will meet the needs of the local community, which will lead to a
symbiotic relationship that increases our revenue streams.
To best meet the needs of the local community, the City of Pittsburgh has partnered with the URA to
host design charrettes, community meetings, and various other events pertaining to the development.
These events have resulted in valuable community input about the kinds of amenities, conceptual
designs, and ultimate vision for redevelopment. Implementing the input of community stakeholders
into our proposal is vital to igniting a communal sense of belonging and acceptance around the project.
If the community is positive about our design, we will optimize usage and occupancy. In particular, we
expect that community members will be drawn to the public amenities requested like public parks and
plazas, which will increase traffic and revenue for the retail tenants. This will increase the amount of
rent that retail tenants will be willing to pay for the space. This symbiotic relationship between
community members and businesses will create a sustainable ecosystem within the development. To
elaborate on the symbiotic relationship, we think that proposing a development plan which is derived
from stakeholders’ inputs will rejuvenate the area while providing for community needs and generating
a steady stream of cash flows annually.
We carefully scrutinized the conceptual designs that came from the design charrettes to find the best
possible solution to the community’s needs based on the designs’ feasibility, practicability, and
sustainability. We chose the design concept which addressed the community’s desire for public space,
townhouses, height regulations, retention of existing building etc. We believe this concept is beneficial
from a development viewpoint because:
● Retention of the existing building is economically suitable.
● The site’s location allows for high traffic from the surrounding area and has the potential to
become an integral part of the community.
● The site is already zoned for retail, parking, apartments and office spaces.
● The building design allows for natural light and ventilation thereby decreasing the utilities and
maintenance costs.
● A grocery store tenant would likely be very successful in the space because the site is located
within a food desert.
By proposing one of the designs generated by the community, we will redevelop to meet their interests,
which will lead to their increased involvement in the project and create unique opportunities for us to
generate revenue.

Determining Our Proposed Development Program

In the community plan, the ratio of office, retail, and housing areas is 45:25:30. Office space represents
45% of the redevelopment because of the existing constructs of the building. We chose for retail to
represent 25% of the redevelopment in order to maximize the high income-producing retail area on the
first floor of each building.
Apartments are a crucial part of neighborhood rejuvenation as they increase the population, improve
the livability, promote local businesses, decrease crime-rates, and keep property rates from falling.1
Providing 30% of the area to housing will create as many as 66 apartments, and 80% of these (53 units)
will be affordable, which is a substantial number given that the shortage of low-income housing in the
city is upwards of 17,000 units.2 We considered building 100% affordable housing units; however, we do
not believe the market (specifically the retail tenants of this property) would be willing to see the
percentage of low-income housing expand beyond 80%.3
Given the outcomes of the design charrettes, we believe that providing a high rate of affordable housing
units will win favor from the community, thus increasing the likelihood that the URA will select our
proposal and assist us in bringing in lucrative tax credits. Given our analysis of local demographic
statistics, we propose that 70% of the total apartments are 2-bedrooms, and 30% are 1-bedroom
apartments. More specifically, we found that the nearby population is largely comprised of multi-

1
Principles for Inner City Neighborhood Design: Hope VI and the New Urbanism (Washington: U.S. Dept. of Housing
and Urban Development, 2000).
2
https://projects.publicsource.org/guide-to-affordable-housing-pittsburgh-pennsylvania/
3
Principles for Inner City Neighborhood Design: Hope VI and the New Urbanism (Washington: U.S. Dept. of Housing
and Urban Development, 2000).
generational families and single parents.4 Therefore, we prioritize 2-bedroom apartments over 1-
bedroom apartments as they are more likely to meet community needs.

Highlighting the Community Vision

In our research, we found that the community most values access to healthy foods, an increase in
affordable housing and presence of accessible public parks. Our proposed development plan responds
to these three values while also creating an area division that allows us to generate revenue. We believe
that this symbiotic relationship created between our investment firm and the Fifth and Dinwiddie
community will have lasting, mutually beneficial impacts.

Development Pro Forma

Below you will find our development, lease up, holding, and exit assumptions. You will also find an
analysis of our Net Operating Income.

Development Assumptions

Our new building will comprise 166,000 square feet with 72,000 of square feet to redevelop, which means that we
will need to build 70% of work from the ground up.

Our proposed parking ratios are in line with generic guidelines, with higher allocations for the office/commercial
spaces and lower allocation for the apartment units.

Our proposed lease rates are based off CBRE observations, with affordable housing units priced per URA
guidelines.5

Lease Up Assumptions

The construction schedule includes a 2-year period to completion and another year of lease-up where we assume
that average occupancy will be around 70% over the course of the entire year (i.e. faster than pro rata ramp up).
While a 70% lease-up occupancy rate is higher than normal development projects. We agree with this
assumption for 4 reasons.

1. Since 80% of the housing is ‘affordable’ and the demand for affordable housing in the
present Pittsburgh market is very high, we expect lease-up to happen very quickly.

4
ESRI - Tapestry Segmentation

https://www.esri.com/en-us/arcgis/products/tapestry-segmentation/zip-lookup
5
Pittsburgh Office Market View Q3. CBRE. https://www.cbre.com/research-and-reports/Pittsburgh-Office-
MarketView-Q3-2018
 2. We expect that the project will experience a jump-start which could be partially
attributed to the involvement of City of Pittsburgh, URA, neighborhoods and nearby
communities.
3. Since the project is in a food desert, a grocery store will attract a lot of traffic, which
could result in a quick lease-up period.
4. The proposals many supportive stakeholders could create a positive buzz around the
whole project, which may lead to media coverage and local newspaper mentions,
resulting in beneficial (and free) advertising.
In addition, please note that under the base case there is an equity dividend of $1.459 at term conversion

Holding/Operating Assumptions

We assumed the efficiency rates according to generally accepted and realistic rates by our company’s
precedence. Due to old design and architecture, old structures generally have lower efficiency rates
than new structures. We assigned 82% to existing structures and 90% to the proposed new construction.
In addition, we assume that all leases are on a triple net basis, escalating at 3% annually, vacancy rates are from
market observations per Department of Numbers statistics report, 6 and operating expenses are held at 19% of
effective gross income.7

Please note that real estate taxes are the only non-operating expense assumed for purposes of NOI calculation,
with a fixed tax during construction supplanted by standard millage rates over the life of the operating asset.

Exit Assumptions

The equity exit at 10-years assumes a terminal cap rate of 6.5% and full repayment of the remaining debt balance
on the sale (i.e. asset level sale).

Net Operating Income

The NOI is the relevant cash flow used to cover debt service. We assumed that there are no further agency fees,
preferred returns or maintenance reserve charges that will be deducted from the NOI, as would be the case in a
comprehensive exercise.

The financing schedule is tied to our construction schedule, specifically, we source a $45mm 3 year construction
loan covering 60% of construction cost, to be taken out by a 7-year $46.5mm term loan with sculpted
amortization. This gives us a 1.10x coverage ratio on NOI sizing towards an ending balance of $168/sf which implies

6
Pittsburgh Pennsylvania Residential Rent and Rental Statistics, Department of Numbers.
https://www.deptofnumbers.com/rent/pennsylvania/pittsburgh/
7
State of Downtown Pittsburgh. Pittsburgh Downtown Partnership. January 2018.
http://downtownpittsburgh.com/wp-content/uploads/2017/01/SODP-Final.pdf
a 70% LTV based on a cap rate valuation of the property using NOI and a cap rate of 6%, which is the best estimate
of market cap rate in Pittsburgh.

The tax equity investment of $8.2mm utilizes the full 70% subsidy rate for LIHTC, and a 94% advance rate in line
with observed realizations after 2017 tax reform, covering 11% of the total cost of construction.

Given these assumptions, our stabilized NOI is $3,982,003.

Outlining Our Development Budget

We derived a development budget of $68,233,000 via the calculations below. We believe the cost
assumptions to be valid in the current market.

Development budget breakdown

Land Acquisition: $ 2,800,000

Hard Costs: $ 54,527,500
Soft Costs: $ 10,905,500 [Hard Costs * 20%]

Total Development Budget: $ 68,233,000

Hard Cost Components

Office: $ 16,301,250 [93,150 sf * $150 per sf]

Retail: $ 9,504,250 [54,310 sf * $150 per sf]
Apartments: $ 10,032,000 [66 units * $152,000 per unit]
Parking: $ 17,940,000 [598 spaces * $30,000 per space]
Public space: $ 750,000

Total Hard Costs: $ 54,527,5008

Building a Capital Stack

Our capital stack will be instantiated pre-construction with a mixture of debt, private equity, and LIHTC
equity; the latter’s contribution is a crucial aspect for this project’s feasibility. Our primary strategy in
financing this project is to maximize the debt on the property for both the construction and permanent
loans in order to minimize the equity injections required by our private investors; this will maximize the
return to shareholders.

In order to estimate the debt portion for construction, we assume the maximum allowable loan value
given a 60% loan to cost constraint, yielding $45,036,000 in available funding. This leaves approximately
$30mm in construction costs to cover, which we plan to fund with LIHTC equity and private equity. We
have proposed that 80% of our apartments be built as LIH-units, which allows us to apply for the 9%

8
Please note, cost assumptions were given in the assignment document.
credit on approximately $9.63mm of affordable housing costs. Assuming $0.94 for each credit, we will
capture $8.15mm of tax equity value to alleviate the large commitment from private equity. The
expected capital stack for the construction phase of the project is shown below.

Value ($US) % of Total Costs

Construction Debt $45,035,969 60.0%

Tax Equity $8,147,589 10.9%

Private Equity $21,876,390 29.1%

Total $75,059,948

Table: Construction Financing Capital Stack

The uses of our capital include servicing the construction debt (assuming 5.25% interest), payment of
real estate taxes, land acquisition, and the soft/hard costs associated with construction.

Value ($US) % of Total Costs

Construction Hard Costs $54,527,500 72.6%

Soft Costs $10,905,500 14.5%

Interest During Construction $6,700,220 8.9%

Land Acquisition $2,800,000 3.7%

Real Estate Tax $126,728 0.2%

Total $75,059,948

Table: Uses of Capital

We will handle the permanent financing phase in the same strategic manner by levering the project with
the maximum allowable term debt based on the lesser of 70% loan to value or 1.10x DSCR. We plan to
use the permanent debt to close out the construction loan and to provide a dividend payment to private
equity sponsors, which will shift the construction of our capital stack into a more leveraged state.

Value ($US) % of Total Costs

Term Debt $46,495,319 61.9%

Tax Equity $8,147,589 10.9%

Private Equity $20,417,040 27.2%

Total $75,059,948

Table: Permanent Financing Capital Stack

Debt balance, $/sq.f.

$250

$200

$150

$100

$50

$0
1 2 3 4 5 6 7 8 9 10

Construction debt Permanent debt

The LIHTC portion of this capital stack is absolutely vital to the feasibility of this project, the sale of
which provides the cash flow that ultimately leads to a return that will attract investors. Without the
LIHTC in our capital stack, we do not believe we would be able to provide a return that would secure
equity funding. We elaborate on this reasoning in the economic return analysis.

Conducting an Economic Return Analysis

Noting Potential Scenarios

While our model assumptions reflect what we believe to be the most likely market scenario upon
project execution, to respond to potential fluctuations, we developed three scenarios which capture the
worst/base/best case for our economic return. The table below shows the assumptions we are floating
for each case, and variables not listed have been held constant.

Worst-Case Base-Case Best-Case

Terminal Cap Rate 7.00% 6.50% 6.00%

LTV (Perm Loan) 60% 70% 80%

DSCR (Perm Loan) 1.10x 1.10x 1.10x

Loan Interest Rates 6.00% 5.25% 4.50%

Office Lease Rate $30/sq ft/year $35/sq ft/year $37.50/sq ft/year

Retail Lease Rate $40/sq ft/year $45/sq ft/year $50/sq ft/year

Analyzing the Sensitivity Analysis

The worst-case scenario consists of our company receiving poor loan terms, experiencing a decline in
the market rate for our non-residential leasable property, and failing to reduce our cap rate upon exit.
In contrast, the best-case scenario reflects an advantageous loan negotiation, considerable reduction of
the property’s cap rate, and a strong market for our office and retail floor plans. While we believe that
the base-case is the most likely outcome, we varied assumptions that we have little control over in order
to aid investors’ decision making process. The table below shows the returns for each scenario with a
discount rate of 5.5%. We believe this is a reasonable rate given that the US 10-Year Treasury Bond is
2.85%9; we have essentially doubled the risk-free rate to account for project uncertainty.

NPV IRR Cash-on-Cash

Base-Case $6,174,853 9.6% 1.93x

Worst-Case ($4,666,486) 2.7% 1.30x

Best-Case $16,640,154 15.9% 2.70x

NOI vs. Debt Service

$5,000,000
$4,000,000
$3,000,000
$2,000,000
$1,000,000
$0
1 2 3 4 5 6 7 8 9 10

Net operating income Total debt service

Our sensitivity analysis shows that this project could be very lucrative in a rosy-scenario but has the
potential to be underwater if certain conditions move against us in unison. We will focus on the base-
case for the remainder of the economic analysis. The return metrics for the base-case lead us to
recommend proceeding with the development of this project provided that we can secure Low-Income

9
Daily Treasury Yield Curve Rates (Treasury.gov)
Housing Tax Credits. The criticality of the proceeds from LIHTC is evident in the cash flow to equity table
below.

Debt sizing
Sizing cash flow $0 $0 $0 $3,620,003 $3,704,543 $3,790,154 $3,876,779 $3,964,354 $4,052,806 $4,142,056

Beginning Balance $ $0 $0 $0 $46,454,483 $45,273,341 $43,945,648 $42,462,641 $40,815,150 $38,993,592 $36,987,949

Principal amortization $ $0 $0 $0 $1,181,142 $1,327,693 $1,483,008 $1,647,491 $1,821,559 $2,005,643 $2,200,189
Ending balance $ $0 $0 $0 $45,273,341 $43,945,648 $42,462,641 $40,815,150 $38,993,592 $36,987,949 $34,787,760
Interest expense $ $0 $0 $0 $2,438,860 $2,376,850 $2,307,147 $2,229,289 $2,142,795 $2,047,164 $1,941,867

Total debt service $ $0 $0 $0 $3,620,003 $3,704,543 $3,790,154 $3,876,779 $3,964,354 $4,052,806 $4,142,056
DSCR x N/A N/A N/A 1.10x 1.10x 1.10x 1.10x 1.10x 1.10x 1.10x
Debt/leasable sq.f. $/leasable sq.f. $0 $0 $0 $219 $212 $205 $197 $188 $179 $168

Reviewing Economic Return Indicators

In year 3, upon completion of construction, our $8.15mm in expected tax credit equity can be used to
pay for the construction loan’s interest (approximately $2.36mm) and subsequently deliver a dividend to
equity shareholders with the remaining $5.78mm. This financial decision provides a large benefit to
shareholders early in the project’s life, which improves the project’s IRR substantially. Without the
LIHTC, our IRR falls to 5.1% and the corresponding NPV plummets to -$763,746. These indicators prove
that the LIHTC is non-negotiable to ensure this project is viable. If our ability to acquire the LIHTC is
jeopardized, we will change our recommendation from proceed to pass.

This highly leveraged transaction presents upside opportunity and downside risk, which will be reflected
in the interest rate we are able to secure. If we are able to secure even minor improvements in the
interest rate, we decrease our necessary equity injection for covering construction loan payments and
can also deliver more cash flow from operations to our investors during the operational phase. The
chart below shows the debt interest rate impact on debt at sale and IRR.

Interest Rate 4.75% 5.00% 5.25% (Base) 5.50%

Debt at Sale $33.14mm $33.99mm $34.79mm $34.79mm

IRR 10.6% 10.2% 9.6% 9.1%

Running IRR
50.0%

0.0%
1 2 3 4 5 6 7 8 9 10
-50.0%

-100.0%

-150.0%
The lower interest rate scenarios allow us to apply more cash toward the principal for each of the
amortized payments, and this benefit is transferred directly to shareholders at the sale of the property
in the form of a lower debt burden to cover with the sale proceeds. If we are able to lock in a lower rate
than we propose in the base-case, we will improve our IRR with each basis point in rate reduction. For
example, a 4.75% interest rate improves cash to shareholders at sale by $1.65mm.

Assuming that the LIHTC can be secured, we recommend this project for investment. While the 9.6% IRR
does not match the S&P500’s annual return over the last decade, we do not believe this should be cause
for investor concern. Our belief is based on equity volatility over the last two months, which portends
concern in the stock market that is likely to be beneficial as investors consider alternatives.10 More
specifically, as investors flee equities, we expect an uptick in investments in property development,
which would act to improve the potential terminal value of our property as demand for profitable
operating assets rises. Combined with the strong cash-on-cash returns and a satisfactorily positive NPV
in the base-case, this project is deemed economically feasible by our firm.

Final Investment Recommendation

Given our economic analysis of this investment opportunity, we recommend that our firm
prepare and submit a formal response to the Urban Redevelopment Authority’s Request for
Proposal because our vision is in line with that of the URA’s Eco Innovation Plan. Our proposal
offers a developmentally feasible and economically viable real estate plan that boldly
progresses the community’s interests by promoting inclusive growth at little to no expense to
its historic urban character.11
Our proposed development plan relies on a multi-source income portfolio with an office, retail,
and housing ratio of 45:25:30. We believe that this ratio best meets the needs of local
stakeholders as outlined in the URA’s RFP. With a financing gap of roughly $30 million for
construction, our team decided to redevelop 80% of our housing into low-income units so that
we could apply for Low Income Housing Tax Credits from HUD. If we are approved for the
LIHTC, we will sell them and net upwards of $8.15mm. This sale will make our private equity
requirements more palatable and our economic gains more attractive.
In addition to the financial benefits of an 80% affordable housing ratio, this housing will make a
positive contribution to broadening families’ economic and community access, which will be
attractive to City Planning, the Planning Commission, and the Zoning Board. Due to their vested
interest in our proposal, we project a diminished timeline for zoning and permit approvals, we
expect for the URA Board to accept our proposal. In addition, due to the high demand for

10
“Direct real estate’s potential to improve returns and reduce risk for target-date funds.” TIAA. Spring 2017.
https://www.tiaa.org/public/pdf/C38616-Direct-RE-Exposure-TDF-Summary.pdf
11
“Recap of the Uptown Open House” Urban Redevelopment Authority, City of Pittsburgh.
“http://www.ecoinnovationdistrict.org/whats-happening-now/posters-from-the-uptown-open-house-fifth-and-
dinwiddie-designs-1”
affordable housing, we expect the lease-up timeline to be shorter than for traditional
proposals.
From an economic standpoint, this proposal is forecasted to generate an internal rate of return
in the best-case of 15.9% with the base-case settling at a still-healthy 9.6%. Our net present
value is projected to be $16.64 million in the best-case and $6.17 million in the base-case. If our
assumptions hold, the proposal’s economic returns are not merely viable, but rather, soundly
preferable.
As we have learned about this community, our motivation to submit a proposal has
transformed beyond financial gain. Transforming the Fifth and Dinwiddie plot into an
economically thriving space that is open to a wide range of families and community members is
a vision that we now have in common with the URA. As we have shown, this project is
economically feasible, so we will be successful in achieving this vision. We urge you to accept
our request to submit an RFP response.