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Shorenstein Company LLC

Real Estate Case Study

Presentation to Yale UniversityEcon 450A: Investment AnalysisDavid Swensen and Dean TakahashiOctober 18, 2004

Table of Contents


Questions for Discussion

Exhibit A: Investment Scorecard

Exhibit B: The Park Avenue Building

Exhibit C: The Lexington Avenue Buildings

Exhibit D: Debt Assumptions

Exhibit E: Glossary of Terms

1

8

9

12

18

24

26

R e a l E s t a t e C a s e S t u d y 1


Overview

In the summer of 2004, two office properties near Grand Central Terminal in Midtown Manhattan weremarketed for sale. Shorenstein Company, one of the country's largest and oldest real estate organizations,was interested in increasing its portfolio in New York City, and both properties represented attractive invest-ment opportunities with value-added or redevelopment potential.

The first property, located on Park Avenue (the “Park Avenue Building”), is a Class B+ building that presentedan opportunity to acquire a well-located asset with a stable, diversified, high-quality tenant base. The ParkAvenue Building also offered significant potential for additional long-term value creation through theredevelopment of the lobby and retail spaces.

The second property (the “Lexington Avenue Buildings”) consisted of two, interconnected Class B+ buildingsthat occupy an entire city block between Lexington Avenue and Third Avenue. The owner of the buildings, alarge pension fund, was also the lead occupier utilizing the property as part of its national headquarters.The pension fund was due to vacate over 50% of the net rentable area by December 2005, which presentedan opportunity to re-lease and redevelop an entire city block in the Grand Central submarket in Manhattan.

Company Overview

Shorenstein CompanyFrom its beginnings in 1924 as a regional brokerage and property management company, ShorensteinCompany has evolved into a fully integrated investment company, active on a national scale in all aspects ofownership, management, leasing, and development of high-quality office properties. Depending on invest-ment activity, the company’s portfolio usually consists of 20 to 25 million square feet of premier officeprojects around the country. It is privately owned and is headquartered in San Francisco, employing over250 professionals engaged in all aspects of real estate ownership.

Shorenstein seeks to generate appropriate risk-adjusted returns through investments in high-quality, well-located office properties in major urban centers. In seeking to achieve this goal, it approaches real estate asa long-term operating business set against a backdrop of powerful market cycles driven primarily by capitalflows. With this goal and orientation, Shorenstein has executed an investment strategy built on a numberof core principles:

■ Invest only in high-quality, well-located office buildings with demonstrated and sustainable leasingadvantages over their competition that allow Shorenstein to keep a property well occupied duringdownturns in leasing cycles.

■ Structure capital investments to mitigate downside risks.

■ Add value during the holding period through Shorenstein’s substantial in-house operating andleasing expertise.

■ Utilize prudent debt levels to enhance returns while protecting invested equity through marketcycles.

■ Maintain durable cash flow through a high-credit, carefully managed rent roll, and maximize tenantretention through the delivery of excellent service to tenants.

■ Closely monitor capital markets for advantageous dispositions or refinancings.

R e a l E s t a t e C a s e S t u d y2

The Fund Structure

Between 1992 and 2003, Shorenstein has sponsored six closed-end investment funds with a substantial

investment by Shorenstein in each fund. The investors are primarily college endowments, foundations, and

high net worth individuals. The funds had a total of $1.5 billion in equity capital; with leverage (averaging

approximately 65% loan-to-value ratios), this amounts to approximately $4.3 billion of transactions.

Shorenstein is currently completing the investment of its sixth fund (“Fund Six”). In 2004, Shorenstein

closed its seventh fund with $775 million in equity. This fund will begin investing once Fund Six is fully invested.

Fund Six was closed in August 2001 with $609.4 million in equity capital. At the time of this investment

decision, approximately 60% of Fund Six had been invested; the purchase of either the Park Avenue Building

or the Lexington Avenue Buildings would be its ninth investment and would result in Fund Six being

approximately 85% invested. The first eight investments by Fund Six are:

■ 500 West Monroe – a 45-story, 920,000 square foot Class A tower located in the West Loop sub-

market of Chicago.

■ Two Liberty Place – a highly structured debt and equity investment in a 57-story, 1.26 million square

foot Class A tower located in the Central Business District of Philadelphia.

■ 450 Lexington Avenue – a 40-story, 911,000 square foot Class A tower in the Grand Central sub-

market of New York City.

■ US Bank Plaza – a 25-story, 429,000 square foot Class A tower located in Downtown Sacramento.

■ 123 Mission – a partial interest in a 29-story, 330,000 square foot building located in the South

Financial District submarket of San Francisco. Fund Six’s partner in this investment is Shorenstein’s

fourth fund.

■ Hamilton Square – a 9-story, 237,000 square foot Class A building located in the East End submarket

of Washington, D.C.

■ 1440 Broadway and 350 Madison Avenue – a junior mezzanine loan collateralized by equity interests

in a joint venture which owns 1440 Broadway and 350 Madison Avenue, located in New York City’s

Times Square and Grand Central submarkets, respectively.

■ 1111 Pennsylvania Avenue, N.W. – a preferred equity investment in a 14-story, 331,000 square foot

building, also known as the Presidential Building, located in the East End submarket in

Washington, D.C.

A summary of the Shorenstein funds and their performance is attached as Exhibit A. Additional information

about Shorenstein can be found on www.shorenstein.com.

Case Study continued

http://www.shorenstein.com



Market Summary

Shorenstein believes that a majority of each fund should be invested in major urban office markets suchas New York City, Washington, DC, Boston, San Francisco, Los Angeles, and Chicago. These markets tend toenjoy greater leasing velocity and capital markets liquidity than secondary ones (Charlotte, New Orleans,Phoenix, etc.) during most points in the economic cycle. While all markets experience the benefits of aneconomic expansion, increases in leasing activity and rental rate growth in major markets often outpace thesecondary markets. In periods of economic recession, the major markets have repeatedly proven moreresilient. They are often the last markets to decline and the first to recover, due to greater depth in theleasing market (by both size of tenants and diversity of industry). Investments in major markets have alsoproven to be more liquid and financible due to greater investor and lender interest.

For this reason, Fund Six was eager to invest again in New York City. In addition, the Park Avenue Buildingand the Lexington Avenue Buildings were near Grand Central Terminal and the largest of Fund Six’s invest-ments, 450 Lexington Avenue. Shorenstein knew the Grand Central submarket very well, having over 15years of experience in the area.

Midtown Manhattan Overview

Midtown Manhattan is the largest Central Business District (“CBD”) office submarket in the United States,comprising 207 million square feet among 434 buildings. Of these, 277 buildings and 168 million squarefeet are considered Class A.1

As of the second quarter of 2004, while 22% lower than the record-setting highs in 2000, rental rates inMidtown had increased by over 44% in the prior 10 years. After negative net leasing absorption of over 5.8million square feet from 2001 to 2003, the market had begun to rebound in mid-2004 -- net leasing absorptionwas nearly 2.7 million square feet in the first two quarters of the year. While the rebound had thus far beenseen in leasing volume and velocity, it had not yet been reflected by a significant increase in rental rates.However, rents had stabilized and concessions (free rent, tenant improvement allowances provided by thelandlords) had decreased. Assuming continued job growth in the service sector, especially in financial andlegal jobs that largely drive the Midtown economy, it was expected that rents would increase over the nextseveral years.

Columbus Circle

Penn Plaza/Garment District

Times Square

Grand Central

Plaza District

Total/Average

Source: Torto Wheaton Research, 2004 Q2

Submarket

19.8

40.7

23.4

41.4

81.4

206.7

6.8%

7.4%

7.3%

10.1%

7.6%

8.0%

Total Inventory(MM, SF)

Total Vacancy(includes

sublease space)

Class A Inventory(MM, SF)

16.8

13.7

20.3

37.4

80.2

168.4

7.1%

4.1%

9.0%

10.0%

7.6%

8.0%

Class A Vacancy(includes

sublease space)

Class A GrossRental Rate

(PSF)

$49.33

$36.47

$51.11

$46.27

$56.92

$51.43

(1) Though Shorenstein classified both target properties as Class B+ buildings, they appear in many databases as Class A buildings. They are included in the Class A statistics shown.


Grand Central SubmarketThe Grand Central submarket consists of all properties south of East 47th Street, north of East 30th Street,east of Fifth Avenue, and west of the East River. Within Midtown, the Grand Central submarket is the secondlargest Class A submarket both in terms of area and the number of buildings, encompassing 83 buildingsand over 41 million square feet. Grand Central has historically enjoyed strong leasing activity because of itsconvenient proximity to major mass transportation hubs.

As of the second quarter of 2004, the Class A vacancy rate in the Grand Central submarket was 10.0% andthe weighted average gross rent was $46.27 per square foot. This was 23% lower than 2000, but was over50% higher than the rental rates recorded a decade before and 5% higher than in the prior year. While totalnet leasing absorption was a negative 1.9 million square feet over the prior three years, in the first twoquarters of 2004, net leasing absorption had been a positive 637,000 square feet.

Manhattan Investment Sales

With such strong real estate fundamentals, especially relative to other markets around the country, mostinvestors remained optimistic that an improving economy would only reinforce Midtown Manhattan’s stability.Because of a confluence of historically low interest rates and an abundance of available capital, Manhattaninvestment sales activity in 2003 and 2004 was very brisk; in the first half of 2004, over $1.5 billion in ClassA office building transactions had been completed with an average price of $400 per square foot.

Recent Sales Comparables

In tandem with gains in leasing activity and rental rate growth, the debt markets increasingly drove invest-ment sales activity. Due to the low-interest rate environment, many investors took advantage of “PositiveLeverage” in pricing assets. Whereas lenders had previously been comfortable with lending 65% to 75% ofthe acquisition cost, some transactions were financed with loan-to-value ratios of up to 85%, and sometimeseven more. Buyers were able to either borrow at tight, competitive pricing on a short-term floating basis, orlock in fixed, low rates for a longer term. Commensurate with the low interest rates, capitalization rates had also fallen to historically low levels.


Building Size (SF)

717 Fifth Avenue

600 Third Avenue

530 Fifth Avenue

885 Third Avenue

261 Fifth Avenue

1775 Broadway

Source: Real Capital Analytics, July 23, 2004

450,000

525,000

497,000

592,000

426,500

625,000

Sale Price (PSF)

$778

$404

$423

$397

$267

$400

Property Sale Date

Jul-04

Jul-04

May-04

Mar-04

Feb-04

Jan-04



Capitalization rates on First Year Net Operating Income (“Initial Cap Rates”) had fallen to levels that typicallyranged from 5.0% to 6.5% depending on location, quality and leasing profile. Capitalization Rates onstabilized Net Operating Income (“Stabilized Cap Rate”) ranged from 6.0% to 8.0% over the holding period.(A property would be stabilized when below-market occupancy or in-place rental rates reflected normalmarket conditions.) These Cap Rates are 100 to 200 basis points below historic averages.

Please see Exhibit E for a glossary of many of the real estate terms used above, as well as other commonlyused terms.

The Park Avenue Building

The Park Avenue Building is a 25-story, 575,000 square foot building. The property presented Shorensteinwith an opportunity to acquire a very well located, Class B+ office building with a high-quality tenant rosterand stable revenue stream. These attributes alone made the property a desirable investment expected todeliver an attractive return throughout the holding period. In addition, several opportunities existed tocreate additional value through the redevelopment of public and retail spaces and to reposition the propertyin the market through an aggressive leasing campaign. This investment presented a challenge and anopportunity to reposition the building to Class A- status. Coupled with its Class A location, the repositionedproperty would be very attractive on exit to “core” investors (e.g. pension funds), a buyer pool which is verydeep and willing to pay a premium in return for acquiring very high quality, stable real estate with reduced risk.

Shorenstein liked the Park Avenue Building for the following reasons:

■ Location: The property was located across the street from Grand Central Terminal. Direct subwayaccess was also available through a station entrance on Park Avenue. Thus, the property’s premierlocation offered tenants convenient and flexible commutes that would be a primary leasing advantageover other competitive properties.

■ Asset Quality: The property was built in 1923; however, over $26 million was spent on renovationsin the last 3 years. These renovations included the overhaul or replacement of several majormechanical systems and the improvement of the façade, building entrances, sidewalks andcommon areas.

■ High Quality Tenant Roster: The property was home to 14 office and 6 retail tenants thatrepresented diverse industries such as publishing, insurance, real estate, advertising and media.Eight of these tenants had investment-grade ratings and in total occupied 48% of the property’s netrentable area.

■ Stable Occupancy: Only 50% of the property’s leases expired between 2004 and 2009, roughlyhalfway through the projected holding period. This expiration schedule produced a steady streamof secure income, but also presented the opportunity for solid income growth as in-place leaseswere marked to market.

■ Below Market Rents: The average office rent was estimated to be 17% below market and theaverage retail rent was estimated to be 24% below market, providing an excellent opportunity toincrease revenues over the holding period.


■ Identity Creation / Lobby Renovation: The Park Avenue Building lacked street presence--theprimary entrance was a narrow, unimpressive vestibule that led to the main lobby and receptiondesk. The property also lacked a strong identity, as the seller was not aggressive in promoting thebuilding in the Grand Central submarket. The potential existed to relocate the building’s entranceand/or redevelop the lobby to provide more of a high-quality “boutique” look and feel. Theseimprovements, in combination with a more aggressive marketing program, could solve theseproblems of perception and aesthetics.

■ Retail Redevelopment: The main retail tenant was a service firm that enjoyed a double-heightceiling with large, arched windows that overlook Park Avenue and 42nd Street. The primarycustomer service provided by this retailer was in decline. Shorenstein believed that this spacecould be re-leased to a higher-quality retail tenant that would pay a premium for the visibility fromPark Avenue and Grand Central Terminal. The addition of a higher-profile, “destination” tenantcould significantly strengthen the property's presence in the market.

With input from its Leasing, Property Management, and Capital Markets groups, Shorenstein developed a“Base Case” proforma. A second proforma was also developed to represent the value-added opportunitywhere money was spent to redevelop the lobby and retail space, resulting in an increase in office and retailrents. The proformas, and the assumptions used to construct them, are attached as Exhibit B.

The Lexington Avenue Buildings

The Lexington Avenue Buildings are a single office complex comprised of two office towers of 34 and 31

stories, totaling 1.66 million square feet. They are interconnected on the ground floor and share some

mechanical systems. Like the Park Avenue Building, the Lexington Avenue Buildings offered Shorenstein the

opportunity to acquire a well-located asset in the Grand Central submarket. It also offered a redevelopment

opportunity, but on a much larger scale. The buildings were built in 1959 and were similar in quality to many

other generic institutional properties built along Third Avenue in its era. However, after a full redevelopment

and re-leasing effort, the property could be repositioned as a Class A/A- asset. While the challenge was

large, the rewards could be larger.

For the last 25 years, the owner of the buildings, a large pension fund, was also the lead tenant using the

property as part of its national headquarters. Due to corporate restructuring, which included moving a

significant number of employees to another state, the pension fund had vacated most of its space in one

building (“Building One”) and had begun to lease space to other tenants (although it planned on keeping a

few floors through 2009). It occupied all of the office space in the second building (“Building Two”), but was

planning on moving out completely by the end of 2005.

As part of the sale transaction, the seller offered to enter into a master lease for the entire project through

December 2005 at a net rent of $20 per square foot ($40 per square foot gross, including expenses),

totaling approximately $33.2 million annually. This guaranteed annual net operating income would give

Shorenstein the ability to start a marketing program ahead of the known vacancy date and defer lease-up

costs. The seller hoped that this strategy would result in higher pricing for the asset.




Shorenstein liked the Lexington Avenue Buildings for the following reasons:

■ Redevelopment Opportunities: Despite a lobby renovation in 1988, the buildings still lookeddated. The opportunity existed to redevelop the property into a premier single- or multi-tenantasset located blocks away from Grand Central Terminal. Few opportunities existed in Manhattan,much less in Midtown, on such a large scale. Strategies included façade renovations, newstreetscape designs, or even the creation of a mixed-use complex with multiple components -- thezoning of the parcel allowed additional uses aside from office use, including hotel, residential, andretail. In its Base Case proforma, Shorenstein underwrote $78 million in new capital for re-tenantingand allocated $25 million for the renovation of the lobby and the entrances (a full renovation,including façade work and system upgrades could cost much more).

■ Market Fundamentals: Market statistics showed that large blocks of space were diminishing inManhattan, especially in the Midtown office market. At the time of the sale, only 9 blocks of spaceover 250,000 square feet were available for lease, totaling 3.4 million square feet. At the sametime, demand for space was increasing -- 2004 net absorption in Midtown Manhattan showedhealthy gains after 3 years of losses. It was estimated that over 20 large companies were in themarket looking at their options for space in excess of 150,000 square feet, potentially totaling over8.0 million square feet.

The large amount of available space at the property was expected to be attractive to manypotential tenants, and would be one of a few locations that could accommodate a large corporateuser, offering such user the ability to name and establish a large headquarters presence inMidtown. Just a few months earlier, a major publishing firm had signed a 15-year, 260,000 squarefoot lease for six floors of Building #1, space that was formerly occupied by the pension fund. Therent was $34.50 per square foot, with $4 per square foot increases every 5 years.

■ Below Replacement Cost: The replacement cost of a Class A building in Midtown was estimated at$550 per square foot. Due to the age and vacancy of the buildings, Shorenstein estimated that thevalue of the asset in its present condition was far below that level, even when adding in the cost ofthe anticipated re-leasing and redevelopment costs. Based on preliminary valuations, the discountto replacement cost was estimated to be as much as 30% to 40%.

■ Location: While not across the street from Grand Central Terminal like the Park Avenue Building, theproperty was only a couple of blocks away, still a distinct leasing advantage over many competitiveproperties in the market.

Like the Park Avenue Building, a “Base Case” proforma was developed for the Lexington Avenue Buildingswith input from the various Shorenstein business groups. A second proforma was also developed torepresent a more aggressive view of the redevelopment opportunity, with higher market rents and anaccelerated lease-up schedule. The proformas, and the assumptions used to construct them, are attachedas Exhibit C.


1. We have given you the reasons why Shorenstein considered buying each property. What reasonsare there for Shorenstein not to buy each property?

2. What would you pay for each property? Which one would you rather buy?

3. What are the risks involved for each building? What do you think an appropriate rate of returnshould be for each investment opportunity?

4. What would be your financing strategy for each investment? What is an appropriate Loan-to-Valueratio? What loan terms would you underwrite? Can you explain the effect of Positive Leverage?Please refer to Exhibit D for loan pricing guidance.

5. How long would you plan to own the property? What would be your exit strategy?

6. Given the information provided on Shorenstein Company’s history, strategy, and investmentperformance, which property do you think is a better fit for Fund Six?

A glossary of common real estate terms is attached as Exhibit E.

Questions for Discussion

Exhibit AInvestment Fund “Scorecard”

R e a l E s t a t e C a s e S t u d y1 0

Exhibit AInvestment Fund “Scorecard”Summary of all Fund Activity as of September 30, 2004

Internal Rate of Return

Fund

OneTwo

ThreeFourFiveSix

Date Formed

1992199419961997199920012004

Gross Projected onProperties Held

N/A12.5%18.9%15.7%10.3%N/MN/M

Gross Realized onProperties Sold

18.5%15.0%22.4%52.5%14.7%N/MN/M

Net Realized/Projected Fund

Total

16.3%11.9%17.9%16.9%8.3%N/MN/M

Equity Multiples

Loan-to-Value Average

Annualized Operating Cash Flow Distribution Yield

Committed Capital

MillionMillionMillionMillionMillionMillionMillion

$160.0 $200.0 $151.2$100.0 $281.5$609.4$775.0

Inception to Date

6.7%6.5%8.9%7.5%5.1%8.3%

Current

58.6%

Realized Returnof Capital

1.00x0.78x0.65x0.14x0.39xN/M

Total RealizedEquity Multiple

2.09x1.35x1.27x0.80x0.61xN/M

Projected EquityMultiple

N/A1.77x2.19x2.74x1.41xN/M

Operating CashFlow Distributions

0.47x0.39x0.35x0.40x0.20xN/M

On Acquisition

63.0%

Methodology■ IRRs and Operating Cash Flow Distribution Yields are compounded monthly over the holding period.

■ Results for assets that have not been sold are based on the operating cash flow distributions anticipated to be realized over the projected holding period and the disposition proceeds anticipated to be realized upon sale at the end of the projected holding period.

■ Total fund results are net of all Sponsor fees and Sponsor distributions Held and Sold Property IRRs are gross of all Sponsor fees andSponsor distributions.■ N/A = not applicable

■ N/M = not meaningful(a) Fund Seven investment period commenced in July 2004.

RealizedAppreciation

0.62x0.18x0.27x0.26x0.02xN/M

OneTwo

ThreeFourFiveSix

Seven

Fund

Fund

OneTwo

ThreeFourFiveSix

(a)

Exhibit BThe Park Avenue Building


Exhibit B

The Park Avenue Building

Square Feet Vacancy

Office

Retail

Lower Level Retail and Storage

Total

523,458

38,413

13,342

575,213

17,195

0

10,000

27,195

Vacancy as % of Total SF

3.0%

0.0%

2.0%

5.0%

Square Feet % of Total SF

Vacant

Month-to-Month

2004

2005

2006

2007

2008

2009

2011

2013

2014

2018

Messenger Center

Total

5%

1%

3%

1%

8%

12%

12%

12%

30%

2%

14%

1%

0%

100%

Cumulative % of Total SF

5%

6%

9%

10%

18%

30%

42%

54%

84%

85%

99%

100%

100%

Year


Publishing Company

Publishing Company

Financial Company

Business Services Company

Real Estate Company

Financial Services Company

Advertising Company

Service Company (Retail)

143,075

68,878

58,615

56,752

50,571

44,363

29,054

24,057

25%

12%

10%

10%

9%

8%

5%

4%

Lease Expiration Date

12/2011

6/2009

7/2008

8/2014

5/2006

12/2007

2/2011

4/2007

Tenant

Size & Vacancy

Lease Expiration Schedule

Major Tenants

27,195

5,609

19,506

3,416

45,542

69,553

66,595

68,878

172,129

9,028

80,562

5,500

1,700

575,213

Year

1Ye

ar 2

Year

3Ye

ar 4

Year

5Ye

ar 6

Year

7Ye

ar 8

Year

9Ye

ar 1

0Ye

ar 1

1IN

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Rent

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e20

,70

0,0

90

21

,70

4,0

38

23

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24,6

46,9

17

26

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,371

27,9

25,7

08

28,8

78,0

31

28

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1,54

4

33

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35,1

71,6

39

36,3

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78

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4,34

9,2

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4,49

4,71

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4,56

2,26

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8,1

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4,19

9,3

78

4,0

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4,

235,

398

3,6

74,6

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3,6

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3,

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4,42

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87

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451,

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5,

162,

280

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3


Park Avenue Building

Base Case ProForma Assumptions

2004

Office

Low-Rise (Floors 3-12)

High-Rise (Floors 13-25)

Retail

Ground Floor

Concourse

Lower Level

$43.00

$45.00

$175.00

$70.00

$20.00

Growth Rates2005 - 2008, 2009+

5%, 7%, 5%, 5%, 3%+

5%, 7%, 5%, 5%, 3%+

5%, 7%, 5%, 5%, 3%+

5%, 7%, 5%, 5%, 3%+

5%, 7%, 5%, 5%, 3%+

2004 - 2006

New Leases

Renewals

8 months

3 months

2007+

6 months

2 months

2004 - 2006

Office

New Leases

Renewals

$45.00

$15.00

2007+

$35.00

$10.00

Growth Rates

2.5%+

2.5%+

Market Rent

Free Rent

Tenant Improvements

Year

1Ye

ar 2

Year

3Ye

ar 4

Year

5Ye

ar 6

Year

7Ye

ar 8

Year

9Ye

ar 1

0Ye

ar 1

1IN

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ntal

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me

20,7

00,0

90

21

,704

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22,9

66,2

85

23

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28,0

66,4

82

30

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31,4

75,5

71

31

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37,8

44,8

23

38

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38,9

33,5

67

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tion

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4,34

9,23

2

4,49

4,73

6

4,

513,

768

4,

471,

451

4,

126,

418

3,

943,

778

4,

180,

458

3,

609,

067

3,

583,

970

3,

954,

020

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390,

296

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671

342,

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352,

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363,

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374,

424

385,

657

397,

227

409,

144

421,

417

43

4,06

1

44

7,08

2

Co

llect

ion

Loss

(1

98,9

38)

(2

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17)

(288

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(380

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(384

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)

(420

,195

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(4

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31)

(448

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(4

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(4

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5


Park Avenue BuildingProForma 2: Value-Added OpportunityAssumptions

All assumptions remained the same as in the Base Case Proforma with the following exceptions:

Lobby and Retail Redevelopment

It was assumed that the Lobby and Retail Redevelopment commenced and was completed in 2007, at atotal cost of $10 million.

Market Rent

Office Market Rent assumptions were the same as in the Base Case Proforma until 2008, at which timethey were increased, reflecting its upgrade in status to a Class A- building:

Office



Retail

Ground Floor

Concourse

Lower Level

2008 Rent Increase

+ $2.00

+ $4.00

+ $25.00

+ $55.00

+ $20.00

Exhibit CThe Lexington Avenue Buildings


Exhibit C

The Lexington Avenue Buildings

Square Feet Vacant SF

Office

Retail

Other

Total

712,468

33,077

21,361

766,906

184,072

8,972

11,592

204,636

Vacant(% of SF)

26%

27%

54%

27%


Vacant

2005

2008

2009

2012

2013

2014

2017

2019

2021

Total

215,216

846,304

1,380

93,310

26,968

67,653

17,220

123,867

8,736

261,495

1,662,146

13%

51%

0%

6%

2%

4%

1%

8%

1%

16%

100%

Cumulative % of Total SF

13%

64%

64%

70%

72%

76%

75%

83%

84%

100%

Year


834,230

43,955

17,055

895,240

0

8,028

2,552

10,580

Vacant(% of SF)

0%

18%

15%

1%


1,546,698

77,032

38,416

1,662,146

184,072

17,000

14,144

215,216

Vacant(% of SF)

12%

22%

37%

13%

Building One Building Two Total Property


Building One

Publishing Company

Pension Fund (Seller)

Accounting Company

Financial Company

Building Two

Pension Fund (Seller)

Parking Company

Retail 2

261,495

93,310

85,682

49,989

834,230

22,425

17,220

34%

12%

11%

7%

93%

3%

2%

Lease Expiration Date

2/2021

6/2009

7/2017

4/2013

12/2005

11/2012

11/2014

Tenant

Size & Vacancy

Lease Expiration Schedule

Major Tenants

YYeeaarr

11YYee

aarr 22

YYeeaarr

33YYee

aarr 44

YYeeaarr

55YYee

aarr 66

YYeeaarr

77YYee

aarr 88

YYeeaarr

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aarr 11

00YYee

aarr 11

11IN

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78,6

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79

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80,4

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67

83

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87,3

37,9

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86

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88,6

36,1

14

89

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Esca

latio

n In

com

e-

3,

058,

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8,56

3,35

6

9,64

0,76

9

10,5

96,8

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11

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12,9

20,4

88

14

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14,9

94,7

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17,5

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(4

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)

(4

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(5

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(4

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(5

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9


Lexington Avenue Buildings

Base Case ProForma Assumptions

2004

Office



Retail

Side Street Retail

Avenue Retail

Other

Storage

$43.00

$45.00

$85.00

$100.00

$20.00

Growth Rates2005 - 2008, 2009+

5%, 7%, 5%, 5%, 3%+

5%, 7%, 5%, 5%, 3%+

5%, 7%, 5%, 5%, 3%+

5%, 7%, 5%, 5%, 3%+

5%, 7%, 5%, 5%, 3%+

2004 - 2006 2007+

New Leases

Renewals

8 months

3 months

6 months

2 months

2004 Growth Rates

Office

New Leases

Renewals

$45.00

$15.00

2.5%+

2.5%+

Market Rent

Lease-Up AssumptionsThe existing vacant space and the space to be vacated by the Pension Fund/Seller was leased up as follows:

Square Feet Lease-Up

Building 1

Building 2

Building 1

Building 2

Building 2

Building 1

Building 2

94,198

171,211

265,409

41,291

204,241

245,532

293,139

293,139

69,147

176,219

245,366

4/2006

4/2006

7/2006

7/2006

10/2006

1/2007

1/2007

% of Total Vacancy

25%

24%

28%

23%

Building Space

Free Rent Tenant Improvements

Year

1Ye

ar 2

Year

3Ye

ar 4

Year

5Ye

ar 6

Year

7Ye

ar 8

Year

9Ye

ar 1

0Ye

ar 1

1IN

CO

ME

Re

ntal

Inco

me

33,2

42,9

20

41

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,324

8

1,16

5,13

2

8

1,8

28,7

59

8

2,6

22,2

41

8

3,52

7,24

8

8

8,9

66

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6

90

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89

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9

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7,9

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9

2,70

8,7

29

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Lexington Avenue BuildingsProForma 2: Aggressive CaseAssumptions

2004

Office



$48.00

$55.00

Growth Rates2005 - 2008, 2009+

5%, 7%, 5%, 5%, 3%+

5%, 7%, 5%, 5%, 3%+

2004 Growth Rates

Office

New Leases

Renewals

$35.00

$15.00

2.5%+

2.5%+

All assumptions remained the same as in the Base Case ProForma with the following exceptions:

Lease-Up Assumptions

Square Feet Lease-Up

Building 1

Building 2

Building 1

Building 2

Building 2

Building 1

Building 2

128,844

469,358

265,409

23,342

204,241

245,532

37,187

171,211

208,398

12,298

245,366

1/2006

1/2006

4/2006

4/2006

7/2006

7/2006

10/2006

% of Total Vacancy

57%

22%

20%

1%

Building Space

Tenant Improvements

Exhibit DDebt Assumptions


Exhibit D

Debt Assumptions

The cost of debt is often predicated on the amount of debt relative to the total asset value ("Loan-to-Valueratio" or "LTV"). In addition, other property specific factors, such as Debt Service Coverage ratios (a property'sNet Operating Income relative to debt service - see below) will affect risk and loan pricing and terms.

Generally, the higher the Loan-to-Value ratio, the more expensive the debt, since the risk profile (thepossibility of default) increases. However, with Positive Leverage (see Exhibit E for a definition), the totalreturn (IRR) increases on the levered amount of equity. Lenders will often quote prices with fixed rates,based on Treasury rates, or floating rates, based on LIBOR (London InterBank Offered Rates). Borrowers willusually decide on the term and the type of loan based on their holding strategy and appetite for risk.

The chart below outlines estimated pricing for fixed 5- and 10-year loans on a Class A/B+ building inManhattan. The "Spread" is the risk premium that lenders will charge over the 5- or 10-year Treasury rate,and is added to the Treasury rate for the overall interest rate.

For this exercise, assume that the 5-year Treasury rate is 3.75% and the 10-year Treasury rate is 4.50%. Alsoassume that the loan is interest-only (there are no amortization payments.) What loan-to-value ratio wouldyou apply? What loan term?

Things to Consider:

■ If you choose to hold the property longer than your loan term, you must refinance the property. Inthat case, assume that Treasury rates have been increasing 0.35% per year, starting in Year 2.

■ In evaluating the appropriate level of leverage for a property, lenders will calculate a property'sDebt Service Coverage Ratio ("DSCR"). The DSCR is most often calculated as the ratio of aProperty's Net Operating Income ("NOI") to Debt Service Payments. While the DSCR calculated onactual Debt Service Payments are important, lenders will usually impose a DSCR "test", whichuses a hypothetical Debt Service payment using a historically stabilized interest rate (currently7.50% - 8.0%), which in today's low interest rate environment, can be significant. Lenders typicallyrequire that the DSCR test result in a DSCR of 1.10x to 1.25x.

For instance, assuming a 75% LTV, $100,000,000, interest-only 10-year loan, annual debt service is$6.25 million [= $100,000,000 x (4.50% + 1.75%)]. An NOI of $10 million would result in an actualDSCR of 1.60x [= $10,000,000 / $6,250,000].

However, a lender may require that a borrower apply a test, using hypothetical debt service, basedon a loan with a 7.5% interest rate and a 25-year amortization schedule. For such a loan, annualdebt service would be $8.87 million, and the test DSCR would only be 1.13x.

For this exercise, assume that the lender will require a DSCR test using an 7.5% interest rate and a30-year amortization schedule. The DSCR test cannot result in a ratio lower than 1.10x.

■ How would you fund large cash deficits? Would you borrow more money or would you put inadditional equity?

Loan-to-Value Ratio60% 65% 70% 75% 80% 85%

5-Year Loan Spread 1.65% 1.75% 2.00% 2.25% 2.75% 3.25%10-Year Loan Spread 1.15% 1.25% 1.50% 1.75% 2.50% 3.00%

Exhibit EGlossary of Terms


Exhibit E

Glossary of Terms

1. Capitalization Rate ("Cap Rate"): The rate of return generated by income as it relates to propertyvalue. It often refers to the ratio of the first year's Net Operating Income divided by the Purchase Price:

Capitalization Rate = Net Operating IncomePurchase Price

"Cap Rate" is sometimes used to refer to the "Initial Cap Rate", which is calculated using the NetOperating Income in the first year. It can also refer to the "Stabilized Cap Rate", which uses the NetOperating Income in a year that is considered "stabilized" (e.g. after a building leases an abnormallylarge block of space, or a below-market lease is renewed at market levels).

2. Cash-on-Cash Return: The rate of return generated by cash flow (before debt service) as it relatesto property value. The ratio used here is:

Cash-on-Cash Return = Cash Flow (before Debt Service)Property Value

3. Internal Rate of Return ("IRR"): A discount rate where future Net Cash Flows equal the initialinvestment. In other words, a discount rate where the net present value (NPV) is equal to zero.

NPV = Initial investment + CF1 + CF2 + CFY

(1 + IRR)1 (1+IRR)2 (1+IRR)Y

4. Leveraged Return: The rate of return generated by net cash flow (after debt service) as it relatesto invested equity. The ratio used here is:

Leveraged Return = Net Cash Flow (after Debt Service)Invested Equity

5. Loan-to-Value Ratio ("LTV"): The ratio of a mortgage loan principal (value of loan) to the property'svalue/sale price. For example:

If a property is purchased for $300m and our target LTV is 65%, our loan would be$300,000,000 x 65% = $195,000,000. Accordingly, our equity contribution would be35% or $105,000,000.

6. Net Cash Flow ("NCF"): Net Operating Income less Capital Expenditures and Debt Service.

NOI - Capital Expenditures - Debt Service = Net Cash Flow

7. Net Operating Income ("NOI"): The balance remaining after deducting Total Expenses (fixedproperty expenses and operating expenses) from Total Revenues (Gross Receipts less a vacancyand/or credit loss allowance), but before Capital Expenditures and Debt Service.

Total Revenues - Total Expenses = Net Operating Income

R e a l E s t a t e C a s e S t u d y 2 7

8. Positive Leverage: Positive Leverage occurs when leverage increases the return on the investedequity. When cash-on-cash return is greater with financing than without, positive leverage exists.That is, the rate of return on the investor's equity is greater if the investor borrows part of theproperty cost than if the investor pays all cash for it. This usually occurs when the property isearning a return at a greater rate than the cost of borrowing money. (Conversely, Negative Leverageoccurs when cash-on-cash return is less with financing than without. Such a situation occurswhen the cost of borrowing money is greater than the rate at which the property is earning a return.)

9. Replacement Cost: The cost of constructing a building with current materials and techniques thatis identical in functional utility to the structure being evaluated. The costs include Hard Costs(e.g. building materials, furniture, fixtures, and equipment), Soft Costs (e.g. architectural, legaland other professional fees, permits and licenses, and insurance), Leasing Costs, Financing Costs,and Land Costs.

10. Tenant Improvement ("TI's"): Tenant Improvements are any physical improvements made to atenant's space. Tenant Improvements are typically offered by the Landlord as a means of attractingnew tenants and are modeled for new and renewing leases.

Glossary of terms continued

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