1i.ABC Fund has decided to enter into a joint venture with Newtown Development Inc. to develop and operate an office building that will require an initial investment of $100 million to cover all the development costs (hard and soft costs). There will be no debt financing for the joint venture. Each party invests its capital at the beginning of the first year and cash flow from operations is projected as follows:
It is expected that the property will be sold at the end of year 5 for $150 million.
ABC Fund will invest $45 million and Newtown Development Inc. will invest the remaining $55 million needed for the development costs. The $50 million development costs already include a developer fee to Newtown Development Inc. and the cash flow projections for each year above are net of a property management fee being paid to Newtown Development Inc.
ABC Fund will receive a 5 percent operating return that is noncumulative. That is, any shortfall is not carried over to the next year but is paid before Newtown Development Inc. receives any cash from operations. After ABC Fund is paid its preferred return, Newtown Development Inc. will receive a 5 percent operating return on its contributed capital. This is also noncumulative. Any remaining cash flow from operations is split 50–50 to each party.
When the property is sold, proceeds from sale will be distributed as follows:
First, repay the initial capital investment by ABC Fund.
Next, repay the initial capital investment by Newtown Development Inc.
Next, pay ABC Fund an 11 percent IRR preference on its investment.
Thereafter, split all proceeds 50–50.
Use the above assumptions to calculate the cash flows that each party will receive and its expected IRR.
1ii. What is the difference between an IRR preference and an IRR lookback?
2i. Venture Capital Limited has formed a private real estate syndication to acquire and operate the Tower Office Building. Venture will act as the general partner and will have 35 individual limited partners. The venture to be undertaken and relevant cost and financial data are summarized as follows:
a. Determine an estimated return (ATIRRe) for a limited partner. (Hint: Consider all 35 limited partners as a single investor.)
b. Determine an estimated return (ATIRRe) for the general partner.
c. Why do the returns differ for the general and limited partners?
2ii. What is the advantage of the limited partnership ownership form for real estate syndications?
3i. A and B form a partnership where A, the limited partner, contributes $500,000 and B, the general partner, contributes no cash. The partnership secures a $2 million (10 percent interest only) nonrecourses loan and acquires AB Apartments for $2.5 million. Assume that the results from the first year of operations of AB Apartments are as follows:
Assume that tax depreciation the first year is $250,000.
The partnership agreement provides that 90 percent of all taxable income, loss, and cash flow from operations is to be allocated to A and 10 percent to B. At resale, taxable gains or losses are to be split 50–50 between A and B, and cash proceeds are distributed first to A in an amount equal to his original investment less any cash distributions previously received, and then split 50–50 between A and B.
a.What are the capital account balances for A and B after one year?
b.Assume that AB Apartments is sold after year 1 for $3 million with no expenses of sale. How much cash is available (before tax) from sale?
c.How much cash would be distributed to A and B upon sale of the property?
d.How much capital gain would be allocated to A and B upon sale of the property?
e.Calculate the capital account balances for A and B after sale.
3ii. How can the general partner-syndicator structure the partnership to offer incentives to limited partners?
4i. Excel. Refer to the “Ch18 Partner” tab in the Excel Workbook provided on the Web site. Suppose the split between the limited and general partner is 99 percent for the limited partner and 1 percent for the general partner for equity contributions, income, and allocation of gain. How does this change the expected return to each partner?
4ii. Why is the Internal Revenue Service concerned with how partnership agreements in real estate are structured?
5.What is the main difference between the way a partnership is taxed versus the way a corporation is taxed?
6.What are special allocations?
7.What causes the after-tax IRR (ATIRRe) for the general partner to differ from that of the limited partner?
8.What is the significance of capital accounts? What causes the balance in a capital account to change each year?
9.How does the risk associated with investment in a partnership differ for the general partner versus a limited partner?
10.What are the different ways that the general partner is compensated?
11.Why do you think the Tax Reform Act of 1986 affected the desirability of investing in real estate syndications?
12.What concerns should an investor in a real estate syndication have regarding general partners?
13.Differentiate between public and private syndications? What is an accredited investor? Why is the distinction used?
14.How are general partners usually compensated in a syndication? What major concerns should investors consider when making an investment with a syndication
15.What is the main difference between organizing a real estate venture a corporation versus a general partnership? How does a limited partnership have some of the characteristics of both?