1. Steel Street Case Study Ruthie Americus & Anil Cheerla

2. Case Facts
Vincent Colmo (Ex HBS) & cousin Daniel Delconte – partnered to form River Triangle Associates, a profitable RE investment firm specializing in buying apartment bldgs & strip malls below replacement costs, rehab/re-position them and sell them for strong returns.
Average returns to investors – 14%
Rents 30% below new construction
Vincent was responsible for buying, renovating and maintaining properties while Daniel managed finances and investor relationships
Project selection based on:
Returns, Renovations within 6-9 months to avoid carrying costs, Bypass city regulations & Target middle-income market
With commercial RE unwinding, RTA focused on office properties in Pittsburgh’s Southside, adjacent to CBD – a hip neighborhood known for vibrant night life, shopping, cafes and business incubation.

3. Overview of the Space 6 story; 1920 building located in Southside
5 floors of office space; 1 floor (ground floor) of retail space
49,000 gross sq. ft.
Estimated renovation costs are $69/sq. ft.
Hope to increase rents from $8/sq. ft. to $15/sq. ft.

4. Plan to accrue rent during renovation phase
Pros/Cons
Pros
Cons
Steel Street renovation is only expected to costs $69/sq. ft. as opposed to $150/sq. ft. for new construction
This is River Triangle Associates first office space renovation (they are only experienced at residential renovations)
Building is in desirable location and rents will increase after renovations
They will need to continue renting some of the space while completing construction (which tenants might not like)
Plan to accrue rent during renovation phase

5. Strategic Advantages of Steel Street
Located in Southside, a hip neighborhood with many startups
Limited space availability for new development
Potential to attract large new employers – business office space combined with retail
Proximity to a new popular retail complex
Replacement cost $69/sq.ft vs. $150 for new office construction
Market wise – Pittsburgh had a diversified economic base, low unemployment, no overcapacity, insulation from RE downturn & growth prospects

6. Renovation Schedule & Funding Sources

7. What went wrong? Causes Effects
The architect was getting behind schedule and her designs were being repeated reworked and costing much more than the original estimates
The leasing of the space was not going well because prospective tenants wanted to see the finished space before signing a lease
First, the cousins chose an architect that had high fees. Also she thought their original budget was too small to work with
The architect and the contractors have never worked together before and there is some large disconnect between the architect’s vision for the building and the contractor’s work style
The city building inspector walked through the site and was not pleased with the safety of the conditions that the contractor was working within

8. What is next…
After owning the property for almost 1 and months of construction, in September of 2009 what is next…
1- Find a new construction team
2- Recruit new investors to cover budget shortfalls
3- Ask hedge fund to convert debt into equity
4- Contribute from their personal finances
5- Give incentives to leasing agents and tenants
6- Lose some green elements to the building

9. Option 1 Option 1: Find a new construction team
Not an option since hiring a new contractor would
result in:
Additional costs
Construction delay
Incoherence with existing work already done
Threat of losing at least ½ year job with additional modifications to project scope and schedule
Also, being a lump sum contract, Harper & Polowski agreed for a fixed price, so it is in the best interests of RTA to continue working with the existing contractor.

10. Option 2 Ruled out because of the following factors:
Option 2: Recruit new investors to cover budget shortfalls
Ruled out because of the following factors:
Credit markets were in turmoil
Liquidity was lacking
The MBS markets were shrinking
Sponsors did not have office building experience
Current project situation is not helping anyway

11. Option 3 Option 3: Ask hedge fund to convert debt into equity
Hedge funds specialize in short-term trading strategies, are open-ended vehicles permitting both periodic subscriptions and redemptions.
So holding a illiquid asset will go against their business strategy.
May even argue that given low yield, low volatile market conditions, Harvard group may find this equity return attractive.

12. Option 4 Option 4: Contribute from their personal finances
As per the agreement terms, RTA were to extend financing to the partnership of up to $200,000 as an uncollateralized 10% interest bearing loan.
Personal B/S shows that the cousins can part with capital for additional overruns, but given the risks involved, our opinion was that they would not make any new additional investments.
Initial equity of $563,885 would result in 1,284,886 after 5 years

13. Option 5 Option 5: Give incentives to leasing agents and tenants
To compensate for the leasing agent’s slow movement, the cousins will provide a $20,000 signing bonus to any brokers who sign leases with tenants for over 5,000 sq. ft.
This added bonus will only decrease the IRR from 28% to 26%, and will hopefully drastically improve the leasing situation. Good option, but may have to reduce their returns overall. Will work to mitigate vacancy by having large, clients sign up long-term leases with sound credit

14. Option 6 Option 6: Lose some green elements to the building
May not be a wise choice as the bldg may not appeal to new tenants or even existing lease renewals.
Cannot justify higher rental rates of $15 psf.
Will not bring in the energy efficiencies expected
May not compete with other “green” properties in the market.

15. Original Pro Forma Levered Returns Initial Outlay 2009 2010 2011 2012
Initial Outlay
2009
2010
2011
2012
2013
Initial Equity
$ (563,885)
Building Renovations
$ (794,000)
Annual Cash Flow
$ ,787
$ ,256
$ ,108
$ ,108
$ ,108
Sales Proceeds - Mortgage Repayment
$ ,175,871
Total Cash Flows
$ (1,357,885)
$ ,407,979
Annual ROE
5.29%
14.53%
17.09%
IRR
28.16%

16. Modified Pro Form with Leasing Bonus
Levered Returns
Initial Outlay
2009
2010
2011
2012
2013
Initial Equity
$ (563,885)
Building Renovations
$ (794,000)
Annual Cash Flow
$ ,787
$ ,256
$ ,108
$ ,108
$ ,108
Sales Proceeds - Mortgage Repayment
$ ,175,871
Total Cash Flows
$ (1,357,885)
$ ,407,979
Annual ROE
5.29%
2.74%
5.31%
17.09%
IRR
24.44%

17. Looking back: Issues at Stake
Issues with re-positioning a property
Problems with development teams
Impact of weak credit markets on RE financing
Cost overruns and poor management
Volatile markets – impact on rental/vacancy rates
Importance of risk assessment, planning and mitigation
Lack of expertise in RE domain – Office properties

18. What-if analysis
To understand the impact on RTA returns, we did sensitivity analysis on the following:
If vacancy rates fluctuate –
If rental rates vary
If additional leasing commissions of $20,000 are provided
If costs escalate beyond control
If existing retail tenant breaks lease and collects $25,000 as damages
If one of the Banks/Hedge funds withdraws financing

19. Vacancy & Rental rates
Vacancy rates vary Rental rates vary

20. LC & Increasing Equity
Brokers incentivized Cumulative impact (LC+Eq)

21. Questions???