Am I wasting a year for 45 basis points of development spread?

The land basis is where I'd push. $1.2M on 4.5 acres is about $6/sf of dirt, which for shallow bay in a market where product trades at a 5.75 doesn't sound cheap enough to carry a 6.2 yield. Land is the one input you buy before you're committed to anything. Every dollar you overpay there shows up in the yield forever and can't be value engineered out later.

This is exactly the ceiling I keep running into. Everything I underwrite comes out between 6.1 and 6.3 on cost, and every construction lender I talk to wants to see something north of 6.75 before they'll size at 60 percent. So the deal doesn't die on my math, it dies on theirs. @cairn have you actually shown the 6.2 to a bank yet? I'd be curious whether they laugh or whether they counter with a lower LTC and more recourse.

What does the NNN in $12.50 NNN cover? Is the tenant paying taxes and insurance on top of that, or is that already in the 12.50?

@wren NNN means triple net, so the $12.50 is base rent and the tenant separately reimburses property taxes, insurance, and common area maintenance. A gross rent would have those inside the number, which is why you can't compare a gross quote and a net quote directly.

Since a few terms in this thread go past their usual definitions, the two doing the most work here are worth being precise about. Yield on cost is stabilized NOI divided by total project cost, so it answers "what return does the finished building produce on every dollar I put into building it." Cairn's 6.2 percent is $700k over $11.2M. A cap rate is NOI divided by what a buyer pays, so it's what the market charges for an already-finished building. Development spread is the gap between the two, and it's the compensation for taking construction and lease-up risk instead of buying something already leased.

The reason 45 basis points reads as alarming to the operators here is that it's smaller than the ordinary error bars on the inputs. A construction budget can miss by 5 percent without anyone doing anything wrong, and 5 percent of $11.2M is $560k, which is more than the entire spread is worth. When people say a development is "underwritten to the contingency," this is what they mean. The margin only exists if nothing moves.

5 percent contingency on $8.7M of hard cost is $435k. On renovation I won't go below 10 and I still get surprised. Ground up has fewer unknowns behind walls, sure, but it has all of them in the ground. Unsuitable soils, rock, a wet spring that pushes the pad and then the whole schedule. Ask your geotech what the undercut allowance is and whether the number in your budget matches what the borings suggest, because that single line has eaten more of my contingency than anything else.

@cairn get the structural system in writing before you trust $145. A pre-engineered metal building and a tilt-up concrete building are different money and different lease-up stories, and tenants in shallow bay increasingly want the concrete. Joist and deck lead times have been the schedule driver on the jobs I've been around, not permits, and a mill quote holds for a fixed window that's shorter than your closing timeline. If you don't buy out steel early you're carrying escalation risk on the largest single trade in the building.

Also 60,000 feet on 4.5 acres is a 30 percent coverage ratio. Check your local parking and truck court requirements before you assume that fits, because a 130 foot court plus a drive aisle eats land fast.

Nobody's put a number on the leasing side. Commission on industrial in most markets runs a few percent of gross lease value over the term, and on a five year deal at $12.50 across 60,000 feet you're talking real dollars, plus the tenant rep's half. On a spec building you pay that at signing, out of a budget that already has a 45 basis point cushion. @cairn is that line in your soft cost 15 percent or outside it?

Reading this whole thread as someone still deciding what to do, the comparison that lands hardest is that you could buy a leased shallow bay at a 5.75 today with no completion guarantee and no 30 month clock, and cairn's project produces 6.2 if everything goes right. 45 basis points is what you're being paid for the difference. I don't think I have the balance sheet or the stomach for that trade.

Basic question about the interest reserve since it came up twice. Is that money the lender holds and disburses to itself for the interest payments, funded out of loan proceeds, so it counts against my LTC? And if lease-up runs past what the reserve covers, do I write checks monthly or does the loan just go into default? I've never had to look at that mechanism.

Ran cairn's numbers with three exit caps. At 5.50 the building is worth $12.73M, so $1.53M of margin, 13.7 percent on cost. At 5.75 it's $970k. At 6.25 it's $40k, essentially free work for three years. At 6.50 it's negative $430k and the completion guarantee is the only thing between you and a bank. What that distribution tells me is that the project isn't an industrial development, it's a leveraged bet on cap rates staying where they are, with a construction job attached. If that's the bet you want, there are cleaner ways to make it.

@ledger that table is the most useful thing in the thread. I've modeled deals like this four different ways and the answer flips on a 25 basis point cap move every time, which means the model was never the decision. Something else has to be, and I don't know what that something is yet.

What makes a bay shallow? Is it just a smaller building or is it a specific depth?