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Wildcat Capital Investors:




Wildcat Capital Investors;Real Estate Private Equity;Okay. Now were even, said the voice on the telephone. As he hung up the phone, James;Tripp, managing director of Wildcat Capital Investors, thought back to that beautiful summer;evening two years earlier when he was about to enter Ravinia Park to enjoy a performance of the;Chicago Symphony with his friend, commercial real estate broker Katherine OBrien. The sound;of scraping metal had caught Tripps attention just in time for him to save OBriens lifeor so;he liked to claimby blocking an approaching bicyclist headed straight for OBrien in a reckless;attempt to cross the track ahead of an oncoming train. At the time Tripp had joked, Now you;owe me. Referring to the opportunity to purchase a piece of commercial property before the sale;became public knowledge, he continued, How about showing me a great off-market deal some;day? Now, in September 2009, it seemed that OBrien had indeed returned the favor.;The opportunity OBrien had just briefly outlined on the phone sounded perfect for Wildcat.;Financial Commons was a 90,000-square-foot office property located in the Chicago suburb of;Skokie. The building was 90 percent occupied and was being offered for what seemed like an;incredible price of $10.4 million. Given the bleak commercial market environment at the time;such opportunities were few and far between.;But Tripp knew there were many factors that could spoil this deal. As they did with several;properties each week, Tripp and Wildcats MBA-student intern, Jessica Zaski, would have to dig;deeper into the numbers. What were the economic fundamentals in the market? Who were the;tenants of Financial Commons? Would Wildcat be able to profitably exit this deal in three to five;years? Could it get the returns its investors demanded? And, in the midst of the worst credit;crunch in Tripps memory, would Wildcat be able to obtain financing?;Tripp called Zaski into his office. Her task would be to research the Skokie office market to;derive the realistic assumptions necessary to calculate the returns Wildcat could hope to achieve;by acquiring Financial Commons.;About Wildcat;Evanston, Illinoisbased Wildcat Capital Investors, LLC, was a privately held entrepreneurial;real estate firm that invested in a wide range of real estate assets on a deal-by-deal basis. Tripp;and his friend William Paris had founded the company in 2005 to serve the growing real estate;alternative investment space by raising capital from wealthy individuals and investing in;2011 by the Kellogg School of Management at Northwestern University. This case was prepared by Professor Craig Furfine and;Jessica Zaski 10. Cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements;sources of primary data, or illustrations of effective or ineffective management. To order copies or request permission to reproduce;materials, call 800-545-7685 (or 617-783-7600 outside the United States or Canada) or e-mail No part of;this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means;electronic, mechanical, photocopying, recording, or otherwisewithout the permission of the Kellogg School of Management.;This document is authorized for use only by Yan Mao in Cases in Real Estate 2014 taught by Richard Allen from;January 2014 to May 2014.;For the exclusive use of Y. Mao;WILDCAT CAPITAL INVESTORS;KEL553;commercial real estate not only through traditional equity investments but also throughout the;capital structure.;Wildcats early deals involved mezzanine loans to support multifamily development efforts.;It developed a niche in providing such debt on some high-profile projects in Chicagos South;Loop. At the beginning of 2009, however, Wildcat had determined that the best opportunities;were in acquisitions and began exiting its existing mezzanine deals at a profit. At about the same;time, the market for traditional real estate mezzanine finance dried up and many debt providers to;commercial real estate lost everything as they mistakenly shared the common market assumption;that rents and prices would rise forever. Thus, Wildcat had the financial resources to pursue;acquisitions, Financial Commons would be its first.;The Property;Through her research, Zaski learned that Financial Commons was a three-story, Class B+;office building located in the Chicago suburb of Skokie, Illinois. Zaski was pleased to find out;that although Financial Commons had been built in 1981, it had undergone a major renovation in;2007. The property sat on six and a half acres of land, with approximately 85,812 square feet of;rentable space and a large parking lot. In the fall of 2009, there were six tenants filling 90.5;percent of the rentable space. The building also had three small equal-size vacancies totaling;8,127 square feet.;The Market;Zaski knew that ensuring a good investment was about more than just the building attributes;alone. She next investigated the financial health of the Chicago area and Skokies future;prospects. She also wanted to make sure Financial Commons was well placed geographically so;that it was accessible and appealing to tenants and that it was not located in an oversupplied;market.;Through market research and Tripps discussions with local leasing brokers and investment;sales brokers, Zaski found that the Near North submarket of Chicago, of which Skokie was a part;contained approximately 14 million square feet of corporate office space occupied by strong;companies, including national businesses such as Peapod and Illinois Tool Works (see Exhibit 1;and Exhibit 2). Although Chicago had suffered a slight population decline over the previous;decade, Skokie and its immediate surroundings had seen slow but steady population growth.;Further, the submarket was one of the best-performing regions outside the downtown area of;Chicago in terms of its low vacancy rates and high quoted rents (see Exhibit 3).;In terms of location and appeal to high-quality office tenants, Financial Commons was well;positioned. The property was in an established business park that was home to dozens of;employers, primarily service and professional firms. The trade area encompassed some of;Chicagos most affluent zip codes and one of the regions strongest residential markets. The;building was also less than half a mile from a 2.7-million-square-foot super-regional mall;Westfields Old Orchard.;2;KELLOGG SCHOOL OF MANAGEMENT;This document is authorized for use only by Yan Mao in Cases in Real Estate 2014 taught by Richard Allen from;January 2014 to May 2014.;For the exclusive use of Y. Mao;KEL553;WILDCAT CAPITAL INVESTORS;The Deal Structure;Zaski knew that Wildcat, like most commercial real estate investors, would want to use a;combination of debt and equity to finance the acquisition of Financial Commons. She knew that;in the fall of 2009 a bank loan, especially a commercial mortgage, was unlikely due to the freeze;of the credit markets. National and regional banks had all been burned by real estate and;construction lending as defaults climbed, they did not have the appetite for even low-risk property;lending, and as a result loan origination had recently dipped to an all-time low (see Exhibit 4).;Consequently, sales of commercial property had also collapsed, which made finding comparable;salessomething buyers and sellers relied on to value their propertiesa difficult task (see;Exhibit 5).;She began by investigating a loan through Commercial Bridge Finance, a Chicago-based;mortgage broker that specialized in this market. Based on its market knowledge and relationships;with various non-bank lenders, the broker felt confident Wildcat could obtain a non-recourse 65;percent loan-to-value (LTV) loan from a life insurance company at a rate of 6.75 percent. The;loan would carry a five-year maturity and would amortize based on a twenty-five-year schedule.;The loan would require monthly payments andas was becoming typical in the tight credit;marketswould carry a 3 percent penalty on all prepaid balances if the loan were fully repaid;before maturity.;Like most real estate private equity firms, Wildcat did not want to put much of its own cash;into the deal, so it raised most of the equity for its investments from limited partners. As such;Zaski assumed that 95 percent of the required equity investment would come from outside;investors, with Wildcat putting up 5 percent. Should there be any cash inflows required over the;holding period, Zaski assumed that these, too, would be split 95/5. Outside equity investors;would be given an 8 percent preferred return (or pref), with any unpaid pref accumulating;forward until the property was sold. Any cash received in excess of the 8 percent pref would be;split between the outside investors and Wildcat at a rate more favorable to the sponsor (known as;a promote). For this deal, Zaski assumed that beyond the pref, Wildcat would keep 30 percent;of the cash and its investors would receive 70 percent, although promote structures had become a;key negotiation point in the difficult economic environment.;When Wildcat sold the property, Zaski assumed that after-debt proceeds would first repay;Wildcat and its investors their invested capital. If cash still remained, the investors would receive;70 percent, with Wildcat keeping the remaining 30 percent.;Wildcat would also earn a 1.5 percent fee annually, charged against the initial (outside);equity under management. This fee would be taken from the operating cash flow of the property.;The Underwriting;Given the assignment of building a financial model for Financial Commons, Zaski began;gathering the details she would need to build a six-year cash flow projection (pro forma). She;chose six years because Wildcat typically had a hold period of three to five years, and she would;need a forecast of net operating income (NOI) in Year 6 to estimate a projected sale price if the;property were held for the full five years.;KELLOGG SCHOOL OF MANAGEMENT;This document is authorized for use only by Yan Mao in Cases in Real Estate 2014 taught by Richard Allen from;January 2014 to May 2014.;3;For the exclusive use of Y. Mao;WILDCAT CAPITAL INVESTORS;KEL553;The challenge for Zaski was to make realistic assumptions about the cash flows associated;with the property, such as future rent and expenses. As her real estate finance professor often;cautioned, Skilled financial analysts can make a spreadsheet justify anythingso think carefully;about your assumptions.;Her plan was to build a benchmark scenario based on her expectations about what would;happen. She would then see how sensitive her results were to variations in her assumptions as;well as to a few specific adverse scenarios.;Tenant stability was especially important in the recessionary economy, property owners were;being hit hard by defaults and vacancies as tenants went bankrupt. The rent roll revealed that;Financial Commons tenants appeared to be a stable and diversified mix, including the largest;locally owned accounting firm in Illinois, the headquarters and lead branch of a significant local;bank, a trade association for CFAs, an investment advisory services group, a large auto lender;and a national risk and claims management services group. Zaski knew that tenant stability was;an especially delicate set of projections to make, as it seemed no one knew when a recovery was;coming, and it was difficult to know how these particular tenants would fare in the next few;years. However, she did feel confident that the Skokie area would support a steady demand for;B+ office space in the long run.;To begin constructing the pro forma, Zaski read through each existing lease carefully. All;leases were dated January 1 of various years and would expire on December 31 of the lease;expiration year. The leases were either triple-net (NNN) or modified gross, and Zaski made a;simple table (see Exhibit 6) showing lease terms for each tenant. The leases called for annual rent;increases of 2 percent. As owner, Wildcat would be responsible for paying all operating expenses;with the tenants reimbursing Wildcat a fixed amount (per square foot) depending on their lease;type, with the modified gross lease tenants providing reimbursements at a lower rate.;Zaski liked that no leases would be expiring in the next two years and that no more than two;tenant leases expired in the same year, reducing the risk of high concentrated vacancy. From what;she had learned, all of the tenants were pleased with management (which Wildcat planned to keep;on after the acquisition) and would most likely renew their leases as they came up. Balancing the;attractiveness of the local market against the more fundamental weakness in leasing markets;generally, Zaski assumed that all existing leases would renew at 2 percent above the previous;years base rent, contain the same 2 percent annual rent escalation clauses, and maintain the same;level of reimbursable expenses. She further assumed that she would not need to deduct leasing;expenses to renew existing tenants.;Zaski also thought it reasonable to assume that Wildcat could lease one of the three vacant;spaces in time to collect rent during the first year of ownership. She further assumed that one of;the remaining two vacant spaces would lease in Year 2, with the final space leasing in Year 3. To;determine the rental rate for the new leases, Zaski examined recent vacancy and leasing trends for;the area (see Exhibit 7). The average rental rate in the area was $21.80 per square foot at the end;of the second quarter of 2009, but Zaski felt that because of the market downturn, $21 would be;both prudent and realistic for the next couple years and that these new leases would not have;annual rent increases. Each new tenant would be found through the help of a leasing broker, who;would charge 2 percent of the first years gross rent as commission.;As was typical in the industry, Zaski assumed that an additional 3.5 percent of realized rental;income (potential gross income less vacancy) would be allocated for credit losses.;4;KELLOGG SCHOOL OF MANAGEMENT;This document is authorized for use only by Yan Mao in Cases in Real Estate 2014 taught by Richard Allen from;January 2014 to May 2014.;For the exclusive use of Y. Mao;KEL553;WILDCAT CAPITAL INVESTORS;She saw from the propertys financial statements that total operating expenses came to;roughly 61 percent of realized rental revenue, so she used this ratio to forecast operating expenses;in Year 1. Zaski assumed that these expenses were fixedthat is, independent of the level of;occupancyand that they would grow at 2.5 percent a year.;With an exit in three to five years, it was likely that Wildcat would not need to make any;major capital improvements to the property, so Zaski did not include these expenses in her;benchmark scenario.;Zaski also needed to plan for Wildcats exit. She estimated the sales price of Financial;Commons by applying an exit cap rate to the next years forecasted NOI. For instance, a sale in;Year 5 would be forecasted at a price equal to Year 6 NOI divided by an exit cap rate. Based on;the experience of Tripp and the rest of the Wildcat team, Zaski assumed an 8.4 percent cap rate;on exit. Although dismayed by the dearth of hard data and the complete lack of comparable office;transactions in the submarket for more than a year (see Exhibit 8), Zaski saw that Wildcat could;back into an 8.4 percent cap rate by assuming a sale at roughly $140 per square foot in three;years, which Tripp believed was at the conservative end of what the region would support after;credit markets stabilized.;The Deal;Wildcat was presented with the opportunity to buy the property for $10.4 million. This price;represented a 28 percent discount from the current owners purchase price and was more than 13;percent below the currently outstanding debt.;Zaski set to work to determine if Financial Commons was a worthwhile investment for;Wildcat in its real estate acquisitionsfocused business. She began by developing a cash flow pro;forma for Financial Commons assuming that Wildcat would sell the property after a three-year;hold using her benchmark assumptions (see Exhibit 9). Having completed that analysis, Zaski;next had to consider how the terms of the mortgage financing and the terms of the partnership;agreement would interact to determine the expected returns to Wildcat and its limited partner;investors. She developed a template for modeling the equity before-tax cash flows that each;investor group would receive (see Exhibit 10) and began her work.;As careful as she had been with the assumptions in her benchmark analysis, Zaski knew the;future had a way of diverging from expectations, so she began to review and test her underlying;assumptions to determine which were most important in determining the ultimate return received;by Wildcat and its investors.;KELLOGG SCHOOL OF MANAGEMENT;This document is authorized for use only by Yan Mao in Cases in Real Estate 2014 taught by Richard Allen from;January 2014 to May 2014.;5;For the exclusive use of Y. Mao;WILDCAT CAPITAL INVESTORS;KEL553;Exhibit 1: The Office Submarkets of Chicago;Source: CoStar Group.;6;KELLOGG SCHOOL OF MANAGEMENT;This document is authorized for use only by Yan Mao in Cases in Real Estate 2014 taught by Richard Allen from;January 2014 to May 2014.;For the exclusive use of Y. Mao;KEL553;WILDCAT CAPITAL INVESTORS;Exhibit 2: The Near North Submarket of Chicago;Source: CoStar Group.;KELLOGG SCHOOL OF MANAGEMENT;This document is authorized for use only by Yan Mao in Cases in Real Estate 2014 taught by Richard Allen from;January 2014 to May 2014.;7;For the exclusive use of Y. Mao;WILDCAT CAPITAL INVESTORS;KEL553;Exhibit 3: Performance of Office Submarkets of Chicago, Second Quarter 2009


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