React: A loan with an 80% loan to value ratio is preferable to a loan with a 50% loan to value ratio.
React: When evaluating the attractiveness of an investment, you should mainly focus on your equity IRR because it tells you the return you will realize on your invested money.
React: If a buyer of a property says that they purchased it for a 9% cap rate, while the seller of the same property says they sold it for an 8% cap rate, one of them must be lying.
React: A loan with a 7% interest rate is more attractive than a loan with 7.5% interest rate as long as both loans are of the same length and the same amortization schedule.
React: Debt service coverage (DSCR) is the most important metric when considering the sizing of a commercial mortgage.
Wal-Mart has approached you with the opportunity to enter a sale lease-back transaction with them on a one million square foot warehouse that they have recently developed. In typical Wal-Mart fashion, they have given you a “take it, or leave it” final offer. The terms are:
Purchase Price: $165 million
Facility Size 1,000,000 SF
Lease Term 7 years
Rent $7 PSF NNN
Operating Expenses Wal-Mart (tenant) pays all operating expenses, utilities, and property taxes (owner pays none)
Renewal Options 7-year extension at $8 per ft2; a second 7 year extension at $9.50 per ft 2; a third 7 year extension at $11.50 per ft.2. All at Wal-Mart’s choice (i.e. it’s Wal-Mart’s option). Wal-Mart pays all operating expenses, utilities, property taxes, and capital expenditures undertaken during all lease renewal periods.
You know the market and feel that the location is good, and that the warehouse market is in good supply/demand balance. Vacancy rates are 4% – 5% in quality facilities, while net rents in the market are running about $7.50 – $8 PSF (i.e. a slight premium to the Wal-Mart lease). You have recently seen comparable sales that have traded in the range of $160 – $200 PSF. You also know that implied discount rates are currently at about a 3% premium to implied cap rates and capital costs are running at $0.50 PSF per annum.
You know from your Real Estate Finance & Investments classes that you can value a building using a direct capitalization approach, a comps analysis and a DCF analysis. You also have a handy template that you’ve been using for these analyses which you will need to complete in order to come to a view on value.
It’s decision time…would you agree to pay the $165 million that Wal-Mart is asking? Why or why not?
