Trinity Development Company

Abstract

Trinity Development is trying to determine the best way to arrange permanent financing for a construction project. This case examines the decision to hedge that financing using financial futures.

Excerpt

UVA-F-0785

TRINITY DEVELOPMENT COMPANY

“I thought hedging would allow me to lock in a single, protected interest rate! This analysis tells me my interest rate could be anywhere from 8.5 percent to almost 10 percent. That differential would amount to over $ 925,000 a year in interest payments on my loan amount! Can't we be more exact?”

Chris Thomas was puzzled over a memorandum he had just received from Bart Meaker, Managing Director of Trinity Development's Investment Banking subsidiary in New York City. The memo outlined one alternative for managing the interest rate exposure implicit in the development of Chris' current real estate project. Chris was the regional Partner in charge of managing the construction of a 700,000 square foot building in Nashville, Tennessee. He had already obtained a floating rate loan to fund the project during the construction period. However, the construction was scheduled to be completed in 12 months, at which time a permanent loan would need to be placed. Chris anticipated that interest rates would increase during that time period and he wanted to lock in a lower rate today for his permanent long term debt. In his memorandum dated Friday, May 9, 1986, Bart had proposed a strategy of using financial futures to hedge the interest rate exposure. Chris was currently studying this possibility and wondered why it produced a range of possible costs (See Exhibit 1). How did this type of a hedge work and how was it different from other alternatives?

Trinity Development Company

Trinity Development was a private real estate development and investment firm that owned, leased and managed commercial properties nationwide. In 1986 the company and its partners owned and managed over 150 million square feet of space, and its assets were valued at over $ 5 billion. Since the late 1970's, when the company opened its Nashville regional office, the Partners there had developed over 5 million square feet of industrial (warehouse and office/service center), office and retail properties. Although the individual Partner was responsible for all phases of a project's development, he could also rely on the company's vast financial, marketing and administrative resources. Most of the company's financial consulting was done by its Investment Banking subsidiary in New York City.

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Keywords: capital markets, financing, futures, hedging, real estate finance, risk management