Well Street Investment Paper

Added on 23.01.2016 14:05
You have the opportunity to purchase a small mixed use property at 664 North Wells Street (the property actually includes 664, 666, 668, and 678 North Wells), in the heart of the River North district. You want to acquire this site and plan a development that will include high-rise residential above and retail/entertainment on the ground floor. It will take over a year to plan the development, but you want to acquire the property now before property prices rise too much in this hot area. You will likely hold this property for 18-24 months before beginning your development project.

The River North area is a mixture of office, restaurant, retail, and over the past decade the residential population grew dramatically, as you found on your Site To Do Business exercise. Following a pattern exhibited in many older urban centers, over 30 years ago art galleries began to move into the former industrial lofts. A number of buildings were torn down and replaced by new construction or by parking lots.

Major national restaurant chains have moved into the South and Eastern part of River North to create a restaurant strip on Dearborn and added to the already thriving Rush Street nightlife scene. The most western parts of River North have developed into loft and high rise apartments and condos with some retail on the ground floor. The heart of River North is the area we have been studying, and its direction is uncertain. Some of the property is historic or near-historic. The city maintains a list of properties that it monitors and it would be very difficult to get approval for these to be torn down. On the other hand there are some nearby blocks and half blocks that are parking lots or modern commercial properties.

From time to time individual properties come on the market, typically retail or restaurant on the ground floor and office or residential on the upper floors. The lot size ranges from about 18 to 30 feet wide, by 110 feet deep, and the buildings lend themselves to use as art galleries, small shops specializing in furniture and home decoration, and restaurants. There are some hotels in the area, including a recent conversion from single room occupancy hotel (SRO) for low income residents to an upscale boutique hotel called the Felix.

Financing is not easy, but with the properties fully leased it is possible to obtain a 75% loan based on appraised value that would be amortized over 30 years but would balloon in 7 years. This sort of loan would likely be based on an existing relationship with a bank and would be a recourse, rather than non-recourse loan. Current rates for bank loans are 4.5%, with appraisal costs of $5,000, closing costs of $7,500, and title costs of $2,000.

The property in question is the same property that you examined for re-tenanting, but we are going to assume that the existing tenants remain in place for now. Current in-place rental rates for the entire property are below.

664 N Wells 3410 sq ft Leased through 2015 $32/sq ft
666 N Wells 2750 sq ft Leased through 2017 $35/sq ft
668 N Wells 8910 sq ft Various tenants, through 2018 $25/sq ft
678 N Wells 3080 sq ft Leased though 2015 $30/sq ft

Although the property appears to be one building, it is 4 separate lots. These rather odd dimensions are a result of the 668 address having started off as an L shaped store, wrapping around the corner store at 678, and extending over to Huron. Subsequently the spaces have been cut up differently and there is now a Subway restaurant facing Huron Street, but it remains part of the PIN (Property Identification Number) for 668 N Wells. As it happens, all of the properties are owned by a single owner and you can simply treat the combined parcels as one retail/entertainment strip of 18,150 square feet.

The taxes for the property will be passed through, with the tenants having net leases and paying the full amount. Insurance for the property will be $1 per square foot per annum. This will cover fire and other hazards, liability, loss of rents in the event of a disaster, etc. The tenants pay their own electric and gas bills, and the landlord pays the water bill, which can be estimated at $200 per month. Since there is no common area, all of the janitorial expense will also be the tenants responsibility. Tenants are responsible for their own trash removal to dumpsters in the alley. It is common to allow 5% of PGI for vacancy and credit loss and 5% of PGI for management of the premises.

You need to look at your rent roll and identify if any leases need to be renewed or extended in order to qualify for financing. Leasing expense for the retail will be approximately 4% of each years rent and for this exercise treated as Cap Ex above the line. A lease that is extended typically does not have a leasing fee.

Typically, small retail properties are sold based on projecting their first year stabilized income and dividing that by a market capitalization rate, which reflects market requirements for both a return on, and a return of the overall capital invested. That would give you a total value of the property. In todays market place these properties would probably command a 7% capitalization rate.

In order to borrow 75% of the value, you will be required to submit a financial statement showing your assets and liabilities and your income, and for the purposes of the case we are going to assume that both are adequate. You can calculate mortgage payments using the Mortgage Calculator or the Loan Constant Chart, both of which are posted on D2L

ASSIGNMENT

Your assignment is to develop your first year Net Operating Income (NOI) statement, including first year NOI and Before Tax Cash Flow, estimate of value, loan amount, DCR and debt yield ratio. How much equity do you need to purchase the property? Then, in 2-3 pages explain how you did all of your calculations and arrived at your estimated value. Include tables in your memo that summarize your calculations and also include your calculations spreadsheet as a separate document. The question before you is what is the price you would be willing to pay for the property and why?

As with the previous assignment, this is a memo to your boss regarding your recommendation to acquire and redevelop this site. This memo should stand on its owndo not assume your boss will know anything about River North or this site. This is your chance to make your case to the investment committee that your firm should go ahead with this acquisition and at what price.