All Forum Posts by: Nick L.

@Account Closed No problem! I have been working on a similar but larger project for a few months. It took me a few false starts to figure out the right model! Post here or PM me for more details.

There are a number of ways you could do this. The essential problem you are trying to solve is to prove that there is a market demand for the space at a rent that would justify development. The easiest way is to do the following:

1. Comp out the space against similar ones in similar local trade areas. Make sure the comparisons are like for like in terms of NNN vs modified gross, annual bumps, TIs etc. A commercial broker can help with this.

2. (Optional) Find a couple of live prospects to prove there is active demand for this space. Again a broker can help you with this if you are not connected to the industry.

3. Work with a construction company to get an estimate for the type of building that would be required

4. Verify that you have appropriate zoning and entitlements, or can get them easily.

With this information in hand you can build a plausible business case showing your construction costs and operating income/expenses. 

You can then use this business case to attract partners, financing and whatever else you need. If you have a specific named restaurant interested you can build to suit; otherwise you can move forward with planning and tailor it to a specific tenant later on.

@Matt Dorsten Yeah I hear you on the billboard but it hardly seems worth the expense and hassle of running a breakeven industrial building to get the billboard income. Are cap rates in Denver so compressed that this looks like a killer deal? :) Tail wagging the dog, as you say.

OK so scraping won't be viable. The cap is nice.... IF you have 100% occupancy and get all the rents you want at absolute net with no landlord TIs. I don't know the specifics of this property but I definitely wouldn't count on that in my market. I'm going to guess that by the time you figure in your real expenses you will be at about a 6 or 7 cap. 

That might be worth it if the property is in the path of progress and likely to become more valuable. If not, you could probably get a better return elsewhere.

@Matt Dorsten Interesting project, I have considered something similar in the past.

Some questions:

- What do you estimate as the raw land value if it were scraped?

- What would the highest and best use be?

- Does current zoning allow this highest and best use, or could it be changed easily?

If the answers to the above are favorable, the project looks much more attractive. If not it could still be a yes, just more along the lines of letting the property pay for itself while you wait for the land value to appreciate.

3s and 4s are the perfect place to start, especially if you can "house hack" by living in one of the units to get favorable owner-occupied terms.

Of course that assumes you have the income and downpayment to make it work. If not, start where you can and build from there.

I would start by talking with a few local lenders and seeing whether you could get the funds to perform the rehab.

The bank or a commercial broker can help you build a pro forma for financing and income after the rehab so you can decide whether to hold it or sell it.

First, thanks to @Douglas Dowell and others for switching me onto Glenn Mueller. His latest commercial real estate cycle analysis is here: http://www.irem.org/File%20Library/Events/IFLC/IFL...

I am worried about overbuilding in Class A apartments and about the long-term prospects of big box retail, office and industrial properties with current employment and technology trends. But that doesn't mean we have to withdraw from real estate altogether.

Based on Dr Mueller's analysis and my own observations, I am looking at the following as good sectors to invest in real estate and ride out a possible crash in the next few years.

- Suburban B/C apartments. These are the workhorses of residential investing, and nobody is building new inventory so supply is constructed.

- Niche neighborhood plays. Every market is made up of individual pockets and they cannot all be oversupplied.

- Local retail and strip malls. If we are moving to a "gig economy" all those new business owners are going to need cheap space. Have to be careful not to rely on businesses that will be displaced by the internet.

- Hotels in the right market. Raleigh and Dallas stand out as two that seem underserved compared to the economic growth.

Do you guys have other good sectors or cities to weather the storm?

@Shane H. It looks like you've thought things through. It's an unusual deal but might work out well. 

As to valuation, I would run it two ways. One way is an as-is performance - you have already determined that to be a 4.5 cap. The other one is performance at the time of exercising the option (ignoring inflation to make them comparable). 

For example, say you figure that the valuation in 5 years is $3m (in 2015 dollars), and you have had to plug in $400k in improvements/TIs from your own pocket and pay off the seller at $2m. This gives you a $600k profit or 150% ROI on your capital invested. You can also compare the cap rate directly to the initial 4.5%.

Another way of looking at it would be on a post-option cash flow basis. You would exercise the option and be sitting on a $3m property with a $2.4m/80% loan and $600k/20% equity. (In this scenario the refi allowed you to pay yourself back the $400k capital invested.) You could calculate the cash flow at that time and figure it as a % of the $600k equity to get your ROE. 

If the future figures are attractive and feasible, then make the deal. If not then figure out what current deal terms would make those future profits and cash flow attractive.

@Shane H.

I don't see the value of the owner carry if you still need to put down 20%. You could just use regular financing. Or if is forced to carry the note because the buildings won't appraise out in regular financing due to the low cap rates, poor quality tenants and deferred maintenance, that strongly suggests it's a bad deal.

I could see the deal working per your option #2, where you have some sort of partnership with the seller that includes an option to purchase at a pre-determined price after say 5 years. @Joel Owens' suggestion of a master lease + option fits this model. You would still have to put time and money into maintenance, TIs and lease ups but at least you're compensated by not tying up a downpayment and getting an instant equity boost when you exercise the option. Of course you would have to be pretty sure you can get the properties financed on the terms you need at the end of the option period, otherwise you will have put in a lot of work and money for no reward.

I would also think very carefully about the competitive situation of the buildings. If tenants are getting lured away to better buildings at lower occupancy costs than you can offer, you are likely to be in a declining competitive position. Of course it's possible that the seller has just been lazy over the years and you can turn things around, but as @Christopher Brainard said it's also possible that he's trying to foist a bad hand onto a sucker. You have to be very sure which one it is!