30% Cash on Cash on New Construction Enough?

Question

Hoping to get some opinions on a deal I'm looking at.

I have some land under contract to build a large commercial facility.  I have 3 tenants, large corporations, with verbal contracts for 5 years.  Obviously I will get hard written contracts before finalizing anything.

I'm calculating my Cash on Cash return at about 30%.  The total price of land and all construction will run about $10M.  Is this too risky with only a 5 year contract with these companies for 30% CoC?  I'm not concerned about the companies being able to pay as they are very large and profitable.  But I'm wondering if I should be shooting for something higher than 30% on new construction with only 5 years of Guaranteed tenants/returns.

Joel Owens · Answer

Value is generally tied to location,tenant type, rental increases, strength of guaranty, and length of primary lease term with no early termination rights.

By the way it doesn't matter if the company has 1,000 locations.

You could have parent corp. guarantee, subsidiary of say 100 locations, or they set up LLC for just that one location. They can easily bankrupt the one location and walk away.

Your verbal right now means nothing. You need to get to LOI stage. Then have commercial attorney work on the commercial leases. Lenders will want to see executed leases in place and commitments before breaking ground. Some exceptions can be made with some very experienced developers that have been doing it for many decades and projects.

5 years is just not enough time on the primary lease term. You need at least ten for resale purposes especially if tenant wants a lot of TI.

No legal advice given.

Roy N. · Answer

If you do not have experience with writing commercial leases, I would seek the assistance of someone who does.   You want to make it very easy for the tenants to renew early (limits their leverage) and inconvenient to leave.   I would also look at ways to stagger the lease maturities so they are not all turning over the same year.

I would want to try and secure these tenants for 10-20 years if I am building a new facility for them.