Forward Sale
A binding contract between two parties to enter into a purchase and sale agreement at a fixed future date, the terms and conditions of which are agreed upon today.
Putting ‘Forward Sale’ in Context
AnchorPoint Net Lease REIT has entered into a forward sale agreement with Midwest Retail Partners, a single-tenant net lease (STNL) retail developer, to acquire a to-be-built standalone Starbucks located at the intersection of Lincoln and Diversey in Chicago, IL. The forward sale contract is finalized today, but the actual transfer of ownership will take place upon the building’s completion in 12 months. Starbucks has already signed a 10-year double-net (NN) lease, with rent commencement starting upon delivery of the property.
The Forward Sale Structure
In this forward sale agreement, AnchorPoint is taking on some cap rate risk by agreeing to purchase the property prior to completion, allowing them to negotiate a discounted cap rate compared to the projected market rate at delivery. Midwest Retail Partners could potentially sell the completed Starbucks at a cap rate of 6.00%, but the forward sale provides them certainty, locking in a buyer early and allowing them to focus on delivering the asset as promised.
The agreed sale terms are as follows:
- Purchase Price: AnchorPoint Net Lease REIT agrees to acquire the property for $2.69 million, reflecting a cap rate of 6.50%.
- Lease Terms: Starbucks has signed a 10-year NN lease with an annual base rent of $175,000, with rent commencing upon building delivery. The lease includes 2% annual rent escalations.
- Cap Rate: The agreed-upon 6.50% cap rate represents a discount to market rates, compensating AnchorPoint for assuming the forward sale risk, while also reflecting the prime urban location and creditworthiness of the tenant.
Financial Context
With the lease terms locked in and a known cap rate, AnchorPoint’s acquisition team can assess the value of the forward sale. The projected Net Operating Income (NOI) based on the Starbucks lease is:
NOI = $175,000
Given the agreed purchase price of $2.69 million, AnchorPoint can calculate the cap rate to confirm the economics of the deal:
Cap Rate = NOI / Purchase Price = $175,000 / $2,690,000 = 6.50%
Developer’s Perspective
Midwest Retail Partners is building this asset with a targeted development cost of $2.4 million, reflecting a 7.25% development yield (i.e. yield-on-cost):
Development Yield = NOI / Development Cost = $175,000 / $2,400,000 = 7.25%
While Midwest could potentially sell the completed Starbucks for around $2.92 million based on a 6.00% cap rate (the likely market rate upon completion), they have agreed to a forward sale at $2.69 million to lock in certainty today:
Sale Price at Market Cap Rate = NOI / Market Cap Rate = $175,000 / 0.06 = $2,916,667
For Midwest Retail Partners, the forward sale guarantees a profitable exit and removes the risk of market fluctuations or delays in finding a buyer after the building is completed. This allows them to focus on their core business of development, recycling their capital into future projects.
Timing and Risk Mitigation
Since the forward sale contract locks in the terms today, but the transfer occurs upon building completion, AnchorPoint is taking on construction timing risk. To mitigate this, Midwest Retail Partners provides a completion guarantee, ensuring the building is delivered on time and meets the required specifications. If the delivery is delayed, AnchorPoint has the right to adjust the closing date or renegotiate the sale terms.
AnchorPoint’s decision to enter into a forward sale for this Starbucks reflects their core investment strategy of acquiring long-term, stable cash flows from creditworthy tenants like Starbucks. Although they are purchasing the asset at a 6.50% cap rate (a slight discount to the potential market cap rate of 6.00% at delivery), this discount compensates them for taking on construction timing and cap rate risk during the development phase.
Conclusion
By agreeing to a forward sale, AnchorPoint Net Lease REIT secures a high-credit tenant in a prime Chicago location at an attractive price, while Midwest Retail Partners locks in a buyer early, ensuring a guaranteed exit upon completion. This forward sale structure benefits both parties, providing stability for the buyer and certainty for the developer.
Frequently Asked Questions about Forward Sales in Commercial Real Estate
What is a forward sale in commercial real estate?
A forward sale is a binding agreement between two parties to enter into a purchase and sale contract at a future date, with terms negotiated and fixed at the time of the agreement.
Why do developers use forward sale agreements?
Forward sales provide certainty and a guaranteed exit for developers. In the case of Midwest Retail Partners, the forward sale to AnchorPoint Net Lease REIT secured a buyer early, allowing the developer to focus on project delivery and redeploy capital upon completion.
What risks does the buyer assume in a forward sale?
The buyer assumes risks such as construction timing delays and future cap rate changes. For instance, AnchorPoint agreed to buy the Starbucks property before completion, accepting timing risk in exchange for a discounted 6.50% cap rate.
How is the cap rate determined in a forward sale?
The cap rate is fixed at the time of contract signing and reflects market conditions and perceived risk. In this case, AnchorPoint purchased the property at a 6.50% cap rate, slightly above the projected 6.00% market cap rate, as compensation for forward sale risk.
What are the financial benefits for the developer in a forward sale?
The developer locks in a buyer and sale price early, guaranteeing a return. Midwest Retail Partners agreed to a $2.69 million sale price, generating a 7.25% development yield based on a $2.4 million cost, despite a potentially higher open-market price.
How is NOI used in forward sale valuation?
Net Operating Income (NOI) is central to cap rate calculations. For example, the Starbucks lease had a $175,000 NOI. Using the agreed cap rate of 6.50%, the purchase price was calculated as $175,000 / 0.065 = $2.69 million.
What protections can be included in a forward sale contract?
Protections may include a completion guarantee from the developer and provisions allowing the buyer to adjust closing terms in case of delays. AnchorPoint received such protections to mitigate construction risk.
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