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Hi Spencer/Michael,
I have come across a scenario that i’d be interested in getting your take on. The scenario is as follows:
Property Type: Multi-tenant Industrial Building
Building Size: 35,000 Sqft.
Broker’s Pricing Guidance: $7,000,000 ($200/SF)
Current Net Operating Income: $250,000 (considered to be significantly below market)
Stabilized NOI at Market Rent: $415,000
Market Cap Rate: 5.00%The component that I am trying to understand how to model is that I believe that the end play with this deal is converting it to industrial condos and selling the units at a price/SF of say, $350/SF. In calculating the investment’s total IRR, the cashflow analysis from simply moving the currently below-market rents up to market is straightforward. However, within the analysis, how would you go about showing the impact on your IRR if the reversionary value is not simply based on selling a stabilized income property, but changing the use to being industrial condos at a higher rate/SF?
This is a great (and fun) question – thanks for asking it! Rather than respond in writing, I thought I’d build a quick Excel model and record a short video to provide an answer.
Let me know if you have any follow up questions.
Click here to download the Excel file used in this video
That’s a great explanation spencer! Really appreciate the video/spreadsheet.
The only additional detail would be that the subsequent cash flows in the other months/years would need to be adjusted to reflect the loss in leasable sqft given that we’d no longer own those units in the property. As you’d tighten up your analysis, would there be any other key things that you’d suggest being cognizant of?
That’s a good observation and an oversight on my part. The Operating Cash Flow section would need to be dynamic to the reduction in space owned. So in the quick and dirty example I gave, cash flow from operation would be reduced in months 23 and 24 consistent with the fact that you own less space in those months. I’ve updated the file to reflect that fact (find updated link in my initial response).
Also, I performed my analysis on an unlevered basis but were we to perform this analysis on a levered basis, there would be some adjustments to the debt module as well. For instance, the lender by default wouldn’t likely allow you to pay down only a portion of the loan. So that right would have to be negotiated. And it will cost you more in the form of a higher rate.
Furthermore, the pay down of the loan would need to account for the fact that there may be prepayment penalties (depending on the amount of prepay flex negotiated) and the amount of the pay down wont’ be exactly proportionate with the amount of space being sold. So for instance, if you sell 33% of the building in one month, the lender will likely require you to pay down a higher proportionate amount (e.g. 110% – 125% of the allocated loan amount or ~36% – 41% of the loan amount).
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