Reference no: EM133334542
Case: On March 10, 2006, HDP Development, LLC purchased a 30-unit apartment property located in the vibrant neighborhood of North Hollywood (Los Angeles, California), for a total consideration of $4,525,045 or $150,834 per unit. The subject property was originally built in 1985 and consists of a three-story building totaling approximately 27,950 square feet of gross building area (GBA). The units range from 755 to 927 square feet rising over a ground floor parking garage providing 60 parking spaces. The property was purchased with the intent of converting into a for-sale condominium project which required an estimated $1,300,000 in hard costs, $300,000 in soft costs and $500,000 in carrying costs. The transaction was financed with a first trust deed of $5,030,000 provided by First Commercial Bank of Hollywood, and $1,595,045 in equity provided by the Borrower. HDP was forecasting sale prices to average $330,000 per unit.
The Borrower ran into some issues obtaining a final condo map from the City of Los Angeles and sales did not start until November 2007. By then, the real estate market had already turned sour: as of March 2008, only six units sold at prices varying between $250,000 and $315,000, depending on the size of the units. A declining economy with tighter underwriting standards and the oversupply of for-sale properties were main reasons for the housing market's softening. Prospective homebuyers were unable to obtain credit, which had a significant impact in the volume of buying activity in the market. According to DQNews.com, the median price for a single-family residence as of December 2008 in Los Angeles was $334,500, down 39.2% from the previous year.
As sales activity slowed dramatically, the loan interest reserve depleted and HDP ran out of money. The bank elected to restructure the loan rather than classify it as a non-performing asset on its balance sheet, in part to avoid regulatory oversight. On September 15, 2008, the Borrower and the Bank executed a loan modification which reset the unpaid principal balance, and called for the principal balance plus accruing interest to be paid by April 5, 2009. By April 5, 2009, no new sale closed and the loan matured. The bank elected to immediately file a Notice of Default and commenced the foreclosure process. Starting on the date of the NOD, the loan balance started accruing at the prescribed default rate. The bank short of liquidities due to the real estate downturn chose to market the note for sale.
On April 30, 2009, PLIMSOL Real Estate Fund, LLC purchased the promissory note and obligations therewith. PLIMSOL, an experienced private equity fund focusing on the purchase and restructuring of non-performing real estate assets, immediately negotiated a forbearance agreement which essentially forced the Borrower to sell the units at reduced prices to payoff its loan obligation in lieu of foreclosure. The forbearance, which was executed on May 12, 2009, called for the foreclosure to be postponed as long as the Borrower sells a minimum of 2 units per month with minimum net proceeds of $185,000 per unit. A forbearance is not a loan modification, therefore the Borrower is still in default and interest accrues at the default rate.
HDP reduced its asking prices to an average of $235,000 per unit and sold off the units in the prescribed time frame. On November 15, 2009 HDP paid off its loan obligation in full at the sale of the 22nd unit. PLIMSOL successfully restructured the loan and the booked a pre-tax internal rate of return on its investment of 142%.
The CFO of PLIMSOL tells you that $50,000 at closing of the loan purchase brought taxes current, which amount was added to the loan balance. Taxes then accrued unpaid until close of escrow at an average of $2,000 per unit per year. Other operating costs are covered 85% by the HOA fees, paid monthly at a rate of $250 per unit per month, paid the first of each month. Both taxes and HOA fees are prorated at closing. Sale commissions and closing costs averaged 6% of gross sale prices.
Question: PLIMSOL's CFO is looking for a new accountant and determines that one who can determine the actual purchase price of the promissory note and the return on equity is worthy of the position. Assume money for each sale is distributed back into the Fund at the close of each escrow.