How to Analyze a Multi-Family Deal with Expansion Upside

Question

The upside here is potential expaision. The site has preliminary approval to build 10 additional 2-bedroom units. Based on rough numbers, the ROI is very good — for the expansion.

Unfortunately the ROI is very low for the acquisition itself. Without expansion, the deal fails our analysis.

Our analysis consists of a spreadsheet that was developed for cash flowing properties. My wife and I don't consider ourselves the most sophisticated investors. We like property that is tenanted. Land development is not.

We're excited about this deal because of the mix. The existing tenants will cover the cost of acquisition. And the ROI — for the expansion — is very good.

But what if the expansion is delayed for whatever reason? What techniques are available to model the mix? Ultimately, we would like to calculate a fair target price — for the acquisition.

Thank you in advance for your insights, suggestions, and participation in this discussion.

Leo Di Croce · Answer

Joseph - Thank you. Yes, I think I was one of those guys: wanting the land for free. But, fair is fair. We are willing to pay for the land. How does one establish a value for the land separately?

Greg - Thank you. Yes, the seller said preliminary approvals — though informal — are in place. We had a chat with the town to confirm; they are happy with the preliminary site plan. What did you mean by "peony's?" Was that a typo? As for construction costs, we're using a rough guide published by the Toronto Real Estate Board (TREB) for now. TREB says $149 (CAD) per square foot. We'll firm up construction costs during due diligence. So, I think we have enough information to work the numbers backwards to a land basis, as you put it. But how? Also, yes to your question about factoring in the cost to carry the extra land and construction loan into the overall package and financial calculations. Not sure what you meant by raising equity and adding to the reserves. We spoke with our mortgage broker about financing construction costs in general. And we modified our spreadsheet to determine the cash we need specifically for this deal — for the acquisition and construction.

We modified our spreadsheet to calculate Acquisition and Development returns separately, and overall. But the Land Value is still a big question mark. I wish we had a formula to determine land value. Currently, we are using an Excel feature called Goal Seek, which helps us play with certain values — land for instance — to achieve certain goals, like ROI.

Greg Dickerson · Answer

Do you have to value the excess land separately. First thing is to check with the city or county and make sure that you can definitely add the extra units and what is involved in the process of getting your approvals and how much it will cost for peony’s and how long it will take to get those entitlements.  you also need to find out what your construction costs will be from a general contractor that builds the type of buildings that you want to do.

Once you have all that information then you can work the numbers backwards to a land basis. Do you want to factor in the cost to carry the extra land and construction loan into the overall package and financial calculations. If you are raising the equity do you want to make sure you add that to the reserves.

Joseph Cacciapaglia · Answer

When I've modeled deals like this in the past, I established a value for the land separately from the apartment property. Even if you can't actually separate them, this helps to see if you're overpaying for the deal as a whole. There are a lot of investors that basically want the land for free in this situation, but I think if you're getting a good price for both, then you're doing pretty well.