Thursday, May 29, 2008
Exercise in Analysis of an "Upside" Investment
The scenario is that an investor is looking at a 50,000 square foot retail center. It is located in an acceptable part of town, but for some reason has a significant amount of vacancy to the tune of 18,000 square feet (36%). If the potential purchaser has a decent amount of confidence for this particular market, how would he value this deal?
I'll be the first to tell you that there are numerous reasonable ways to evaluate a property and I have found that each purchaser has his or her own unique touch. However, for the sake of the blog, let me share with you this simple approach.
The idea is that there are two investments going on with a property that has a more than normal amount of vacancy. (1) There is the portion of the property that has tenants occupying that are paying rent, and (2) the portion of the property that is vacant. Both have different evaluations.
The first portion that has tenants "looks" like a normal center that is in good condition and positioned well in the market. In this case 38,000 square feet is currently leased generating a net operating income of $305,000 per year. The current stream of cash is pretty easy to value. We merely factor the market return for the subject property type, in this case 8.75% and the result is $3,485,715.
The second part is to value the vacant space. We know that the market rent for a similar building is $12 per square foot net to the owner and we have 18,000 square feet vacant. The normal vacancy for the market is 5% which is equal to 2,500 square feet. If operating at average performance to its competitors in the market, this property should expect an additional 15,500 square feet occupied (18,000 - 2,500). The 15,500 difference is worth $12 per square foot which is equal to $186,000. Now comes the "fuzzy" math. There is more risk in the vacant space, right? So, there should be an equally higher return, right? This is where we get a little subjective, but one might consider a 14% return reasonable on the "potential" income. If we factor that in just like we did with the occupied space above the space is worth $1,328,571.
The combined value is equal to $4,814,286.
Other things that the buyer might want to consider as a reasonable reduction in the price is carrying costs of the vacant space, value added renovations to improve the property to market conditions, leasing fees, tenant improvement, et.al.
I'll be the first to tell you that there are numerous reasonable ways to evaluate a property and I have found that each purchaser has his or her own unique touch. However, for the sake of the blog, let me share with you this simple approach.
The idea is that there are two investments going on with a property that has a more than normal amount of vacancy. (1) There is the portion of the property that has tenants occupying that are paying rent, and (2) the portion of the property that is vacant. Both have different evaluations.
The first portion that has tenants "looks" like a normal center that is in good condition and positioned well in the market. In this case 38,000 square feet is currently leased generating a net operating income of $305,000 per year. The current stream of cash is pretty easy to value. We merely factor the market return for the subject property type, in this case 8.75% and the result is $3,485,715.
The second part is to value the vacant space. We know that the market rent for a similar building is $12 per square foot net to the owner and we have 18,000 square feet vacant. The normal vacancy for the market is 5% which is equal to 2,500 square feet. If operating at average performance to its competitors in the market, this property should expect an additional 15,500 square feet occupied (18,000 - 2,500). The 15,500 difference is worth $12 per square foot which is equal to $186,000. Now comes the "fuzzy" math. There is more risk in the vacant space, right? So, there should be an equally higher return, right? This is where we get a little subjective, but one might consider a 14% return reasonable on the "potential" income. If we factor that in just like we did with the occupied space above the space is worth $1,328,571.
The combined value is equal to $4,814,286.
Other things that the buyer might want to consider as a reasonable reduction in the price is carrying costs of the vacant space, value added renovations to improve the property to market conditions, leasing fees, tenant improvement, et.al.
Tuesday, May 13, 2008
What's your business quotient?
Tenant's, do you know your threshold of revenues that can be used for rent? Most small businesses don't, but the larger multi-location corporations surely do.
A few months ago, I was shopping around a cell phone dealer who was looking for space. I called one of the larger retail developers in the area inquiring about small inline spaces in his development. When I asked for a rate, he replied with, "what business does your client operate?" I told him it was a cellular phone dealer, and he said, "they can usually pay upto $25 per square foot". Sure I thought. That seemed like the top of the market, but it was not an obscene rate so I showed it to the prospect and let them direct me to their intentions. Well, I found out that the rate didn't shake them since they were accustomed to paying the high rates at other spaces.
Well, here I am months later realizing how all this fits together. Yep, the prerequisite for real estate brokerage is not necessarily genius. As a matter of fact, genius, can prevent success in many ways!
So what was really going on? The market has subtle supply and demand models that are applicable even down to the unique type of a certian business. Applying a little mind-strength and analytics to some of our data tools, we can make some since of the market.
One of our data sources tells us the market's total revenue for the business type and the number of businesses that are in operation. With that, we can determine an average revenue per business by dividing the total revenue by the total number of establishments. If the market is large enough, the action of adding one more business wouldn't skew the averages too much and we don't have to do any further calculations or assumptions. If the market is small enough that one business would dramatically change the equillibrium, then other assumptions should be entered into analysis. Once we have determined the average revenue that a typical business can generate, we use another data source that shows us the proportion of revenue that the subject business type can expect to pay in rent.
Marry the two figures together and you've got the amount that a business can usually pay in rent.
This is a good tool for the tenants out there and even better one for the landlords!
Another factor particullarly interesting to landlords might be the difference, if any, found as the sample of demand is increased further away from the subject site. If the revenue mean should significantly increase as the sample group expands further away from the subject site, then the local area market should be declining. In this situation, the landlord might consider selling the property before the total market dissolves as the trend hints.
Sorry if the analysis seems a little excentric, but these days we've got to get creative when finding an advantage for our clients!!! I hope it helps you too!
A few months ago, I was shopping around a cell phone dealer who was looking for space. I called one of the larger retail developers in the area inquiring about small inline spaces in his development. When I asked for a rate, he replied with, "what business does your client operate?" I told him it was a cellular phone dealer, and he said, "they can usually pay upto $25 per square foot". Sure I thought. That seemed like the top of the market, but it was not an obscene rate so I showed it to the prospect and let them direct me to their intentions. Well, I found out that the rate didn't shake them since they were accustomed to paying the high rates at other spaces.
Well, here I am months later realizing how all this fits together. Yep, the prerequisite for real estate brokerage is not necessarily genius. As a matter of fact, genius, can prevent success in many ways!
So what was really going on? The market has subtle supply and demand models that are applicable even down to the unique type of a certian business. Applying a little mind-strength and analytics to some of our data tools, we can make some since of the market.
One of our data sources tells us the market's total revenue for the business type and the number of businesses that are in operation. With that, we can determine an average revenue per business by dividing the total revenue by the total number of establishments. If the market is large enough, the action of adding one more business wouldn't skew the averages too much and we don't have to do any further calculations or assumptions. If the market is small enough that one business would dramatically change the equillibrium, then other assumptions should be entered into analysis. Once we have determined the average revenue that a typical business can generate, we use another data source that shows us the proportion of revenue that the subject business type can expect to pay in rent.
Marry the two figures together and you've got the amount that a business can usually pay in rent.
This is a good tool for the tenants out there and even better one for the landlords!
Another factor particullarly interesting to landlords might be the difference, if any, found as the sample of demand is increased further away from the subject site. If the revenue mean should significantly increase as the sample group expands further away from the subject site, then the local area market should be declining. In this situation, the landlord might consider selling the property before the total market dissolves as the trend hints.
Sorry if the analysis seems a little excentric, but these days we've got to get creative when finding an advantage for our clients!!! I hope it helps you too!
Friday, May 9, 2008
Friday Surprise!
I received a great market analysis put together by the really smart guys in the home office. I've created a link to the market summary. I hope you like me, can take some useful information from the report. I have read the document which takes a national perspective and already see some factors that don't quite match up with our local economy in Birmingham, Alabama, but overall the facts are very handy to have and continue to watch.I guess there's no second best for good local knowledge! That's why I still have a job!
Subscribe to:
Posts (Atom)
