Lakeview Limited Partnership has been formed to acquire and operate an office building in Boston. For simplicity, assume that there are only 1 general partner and 1 limited partner. Based on the agreement
of the partnership, equity contributions are: general partner, 0%, and limited partner, 100%. Cash distributions from operations: general partner, 10%, limited partner, 90%. Taxable income and losses from operations: general partner, 10%, limited partner, 90%. Allocation of gain or loss from sale: general partner, 15%, limited partner, 85%. Cash distribution at sale: based on capital account balance. Note: the partnership initially decides to use 100% equity finance.
Property capital structure: Amount
Purchase Price $24,000,000
Organization Fees (Amortized over two years) 500,000
Syndication Fees (included in the original cost) 500,000
Less Mortgage Loan 0
Equity Requirement $25,000,000
Purchase Price $24,000,000
Land value (2,400,000)
Building Improvement $21,600,000
Depreciable Life (for the improvement) 39 years
Annual Depreciation $553,846
Tax Rate* 28%
Operational Year Year 1 Year 2
NOI at the end of year $2,000,000 $2,500,000
* Assume the tax rate for operational income and capital gains are the same.
The limited partnership is expected to sell the office building at the end of year 2 (Assume the partners make equity contributions at the beginning of year 1). The expected sales price is $30,000,000. Selling expenses will be 8% of the sales price.
1. What are the before tax cash flows from operation of the investment that would be distributed to the limited partner for year 1 and year 2?
2. How much capital gains would be allocated to the limited partner upon sale of the property?
3. What is the capital account balance for the limited partner after the two years?
4. What is the after-tax IRR on total funds invested in the property (ATIRRP)
5. Determine an estimated after-tax equity return (ATIRRE) for limited partner.
6. Suppose that a loan is available, with annual interest rate 8%, amortized over 25 years, and monthly compounded. The loan amount will be 80% of the initial purchase price. In this case, is there favorable financial leverage if the limited partnership borrows this loan? Why? [Hint: calculate the ATIRRE given the loan is borrowed]. Briefly discuss.
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