The Millegan Creek Apartments project is a 390-unit apartment project in Austin, Texas. Fleet Bank is looking into a loan for the construction of the project. This case study looks into the factors which affect the decision of taking up a construction loan.
John H. Vogel
Harvard Business Review (395118-PDF-ENG)
December 22, 1994
Case questions answered:
Case study questions answered in the first solution:
- Should Fleet Bank underwrite JPI to build Millegan Creek Apartments? Provide a cash flow statement.
Case study questions answered in the second solution:
- Would you recommend that Fleet make this loan on the terms negotiated? Justify your answer.
- Is the project likely to be successful? What do you think of:
a. The location
b. The product and
c. The pricing?
d. How does it stack up against the competition? Questions (c) and (d) require quantification.
- How much profit can the developer expect to receive from this project?
- What are JPI’s biggest risks?
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Case answers for Millegan Creek Apartments
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Overview – Millegan Creek Apartments
Tom Hayden is preparing to present to Joanne McClatchy, the senior credit officer in commercial real estate, about his proposition for a $15,715,000 loan for the 390 unit Millegan Creek Apartments. There were items that Joanne needed to go over – a new market, a new developer, and a large loan. Also, some of the biggest worries to cover are JPI’s financial capability, since there is no takeout commitment, construction risks, and protection against interest rates.
The Millegan Creek Apartments would be a typical JPI luxury apartment complex. The apartments would target rents with higher incomes where they can probably afford a single-family home, but wanted to live in apartments. The apartment complex will include two swimming pools, a clubhouse, a fitness center with sauna and steam rooms, and laundry facilities.
The apartments included nine-foot ceilings, security systems, crown molding, and upgraded appliances. There are also optional premium amenities, limited on availability, such as 160 detached and in-line garages for $70 a month. There was also a premium on apartments with fireplaces and vaulted ceilings.
The apartments will be located near Austin’s many high tech companies. For example, Texas Instruments is located right across the street. Other companies in the area included: Abbott Laboratories, Tandem Computers, 3M, and State Farm Insurance.
Fleet Bank is looking to diversify from the Northeast region and provide big loans. Thus, the housing market in Austin could be an excellent place to enter and have good returns. Many factors can show that the loan is a good idea.
First, the Austin city younger population is expected to increase. The five colleges in the area contribute to the large younger population as there are over 100,000 students who live in Austin. The number of people in Austin is expected to increase as predicted by the US Census Bureau to 913,998 people in 1995 (Appendix 1). As the case mentions, UT Austin ranks second to Harvard for admitting National Merit Scholars, which indicates that there is a high potential for employers to seek out Austin students.
Appendix 1: Austin Population Growth
*Estimates and projections
Source: US Census Bureau and Austin Insight Report
Additionally, the Austin companies, such as Texas Instruments and Dell, employ many students, and they are seeking to hire more. For example, Apple, IBM, and Motorola signed a joint lease for over 68,000 feet for the new project. The state capital is also looking to increase their workforce, as they added 30,000 jobs in between 1992-1993. The unemployment rate as of September 1993 was at 45%, and Austin added around 30,000 jobs in 1992 and 1993. The Texas Comptroller of Public Accounts projected job growth to continue to grow in the 3% to 3.2% range in 1993-1994.
In November 1993, Austin was ranked number one in the United States for economic growth in the last three years with a 12.2% growth rate and ranked fifth on Fortune’s list of 10 best cities for knowledge workers. Also, in October 1993, Entrepreneur magazine ranked Austin among the top 20 cities to locate a business, and Ernst and Young ranked Austin sixth in the nation as a preferred location for a new manufacturing facility.
Following, JPI would be a stable company to underwrite a loan for as they are experienced in developing large scale apartment projects in Texas. When the real estate crash hit Texas, JPI found that their apartment projects fared better than their other real estate properties. This led to JPI focusing more on the development and management of luxury apartments.JPI is looking for development opportunities that provide a return on assets of at least 10% of the project.
Therefore, Millegan Apartments could help reach his set goals for the commercial real estate division: reduce concentration in the franchise geographic area, improve credit quality through experienced developers, increase average loan portfolio, and meet or exceed corporate financial targets. JPI will be able to meet these expectations.
Moreover, loaning to JPI would be the first step that Fleet Bank can take to be able to enter new markets away from the Northeast. As shown in appendix 2, although the housing market experiences dips in 1986 and 1987, the market has improved rapidly since 1989 and has been displaying reliable results in the last three years, 1991 – 1993. Even though new units were being built in the early 1990s, more people continue to move into Austin and rent apartments, as indicated by Appendix 3.
However, there are still environmental risks that need to be taken into consideration. Austin is very strict with the environmental rules, and construction has been held up because of the reviews and regulations. All properties need to be examined for the Bracted Twist flower that only blooms in April. Any trees cut down must be replaced with new ones. Furthermore, Millegan Creek contains Karst Caves, which means that these two acres need to be preserved and untouched.
There are some differences between Millegan Creek Apartments and the nearby apartments. This includes…