Hurdle Rent and Land Residual Value
Analysis Explanation
Introduction: This property is a proposed mixed-use building consisting of ground floor commercial and second floor through seventh as multifamily. The commercial space will be “black box” unfinished space and adaptable to retail or office.
Cost Allocation: Because the uses are mixed it is necessary to separate the cash flows and cost allocations in order to apply the appropriate cap rate. I allocated the land cost based on a pro rata basis using the square footage. The site preparation and demolition costs needed to prepare the site for development are also allocated to the two uses, commercial or multifamily, based on their square footage.
Development Cost Breakdown: The site prep and demo cost were treated as outlined above. For the Development cost the given “totalfile.pdf” file was used to derive the appropriate cost allocation. I used the $166.50 per sq. ft. amount from 55,000 sq. ft. exterior brick with concrete block on steel frame. This was applicable to a 7 story multifamily building of similar size, but the ground floor was going to be a commercial shell. From the data given, I believe the best way to achieve the ground floor cost is to deduct the interior finishes that were included in the above $166.50 PSF. After any of these adjustments the cost is regionally adapted per the instructions. This breakdown is in the attached excel file.
Development Margin: The margin is given to be 10%. I believe this is high, and this contributes to the infeasibility of the development at the land price based on my analysis.
Operating Expenses: For the multifamily portion a percentage of effective gross income of 41.2%. This number was derived from the IES Executive Summary 2012 of operating income and expenses for apartments. For further analysis, there will need to be a comparison of amenities and other features that contribute to this OPEX. For the commercial I allocated 30% even though the Lease will be Triple Net. I then deduct this OPEX psf to get the NNN lease rate. The reason for this is so that the vacancy is accurate. When the property is vacant there will be lost reimbursement revenue so this needs to be accounted for.
Market Comps: For the commercial space the market comps given needed to be adjusted to reflect the unfinished space of the proposed ground floor space. Normally an appraiser would adjust the comps but for ease of use, I adjusted subject space. To do this I added back in the development cost that were previously deleted excluding the residential specific costs. (the architectural, engineering, and contractor mark-up for the shell cost was used for estimating purposes). This cost was then amortized over an assumed 10 year lease. Adding this Tenant Improvement cost onto the Lease Rate (NNN) came to a hurdle rate of approx. $13.50 PSF. This was still lower than the comps provided, but the space is still 2-3x the size of comps, so some discount is expected for larger spaces. For the multifamily, the provided comps are much less expensive than the hurdle rent I derived. To obtain the hurdle rent, these apartments will have to be the highest class in the market.
Acquisition & Reversion Cap Rate: The cap rates used were derived from the Viewpoint 2013 IRR Perspective. I used the 2012 cap rates and referenced Birmingham, AL and Columbia, SC. I used both for size references and that colleges were present. But, Columbia is a capital city so the office cap rates will be stronger than the subject site. I used 6.25% for the going-in Cap Rate based from the Columbia, SC urban multifamily number. For the commercial, I used the 8.5% going-in Cap Rate from the Birmingham, AL rate. The reversion cap rate for commercial was referenced from Retail of Birmingham, AL at 8%. The office rates for Columbia and Birmingham were both higher. The multifamily reversion cap rate was taken from the Columbia exit rate because these two cities better reflect the college environments.
Conclusion: The land residual value combined came to roughly $350,000, or half of the sales price value. I think some of the allocation is disproportionate because the commercial is below the given comps and the residential is above, but I do not believe the rebalancing will solve the problem because the commercial is a minimal part of the project, 14%. I do believe the development Fee of 10% is too high, but this is the developer’s requirement.
Written by Josh Lowder, CCIM MRED, 2013