I think the sponsor's TI reserve is half of what it should be

The 65% renewal probability is the assumption I'd argue with first, and I'd argue it upward for the physician suites and downward for the ASC. Independent practices with their own money in the build out renew at rates well above 65% in my experience managing this kind of space. An ASC is a different animal because those get acquired and consolidated into system platforms, and when that happens the new owner has a location strategy that has nothing to do with your building. Ask what percentage of the rent roll is already system owned versus independent. That single split changes the whole rollover picture.

$1.75/sf/yr on a 1987 building is a reserve for a much newer property. Ask what capital is in the plan outside TI. Chillers, rooftop units, parking lot, elevator modernization if the 2016 work was cab finishes rather than controls. Medical buildings run their HVAC harder than office because exam rooms need air changes and the tenants complain fast.

Parking ratio? Medical runs 5 to 6 spaces per 1,000 sf and a lot of 1980s buildings were built to 4. If the site is short, every new tenant conversation includes a fight about it and expansion is off the table.

Your instinct on the exit cap is arithmetically correct so let me put a number on it rather than agree. Year 6 NOI at their assumptions is presumably around $1.03M. At 6.25% that's $16.5M gross. At 6.75% it's $15.3M. Selling costs aside, that's $1.2M off the top, all of it equity, against a raise of maybe $6.2M. So roughly 19% of the equity sits on 50 basis points of exit cap. Combine that with your TI shortfall and you have two independent problems that together consume about a third of the equity in the downside.

The supply picture in medical outpatient genuinely does look tight and completions are expected to fall, which is a reasonable argument for rent growth. It's a weak argument for cap rate compression, because cap rates track debt costs more than they track occupancy. I'd separate those two in the conversation with the sponsor. Ask them to hold rent growth and flex the exit cap only. If the deal survives 6.75% and $90/sf TI, it's a real deal. If it only works at 6.25%, they're selling you an interest rate forecast.

Dumb question from the outside of this. If the building is 91% leased, what's in the vacant 9%, and how long has it been vacant? Four thousand square feet sitting empty in a supply constrained market for two years tells you something about the space that the market study won't.

@plumb that's not a dumb question, it's the one I'd ask second. Long term vacancy in medical is often a suite with no plumbing stack access or an interior block with no windows. Those are the suites nobody wants and the sponsor's pro forma leases them in month 14 at market rent.

Fee load. 1.5% acquisition on $14.2M is $213k, 2% asset management on invested equity is roughly $124k a year, 1% disposition is another $165k at their exit. Call it $1.0M across five years against a $6.2M raise. That's 16% of equity going to the sponsor before the promote and before they've earned the pref. It's not out of market but it means the deal has to work harder than the headline 6.6% suggests. Model your own IRR net of fees, don't take theirs.

I'm early in all this and mostly reading, but sextant's split between rent growth and cap rate compression just clicked something for me. Those are two different bets and the model presents them as one story.

The three leases with 2% or CPI floors are worth a specific ask. Have the sponsor produce a lease abstract table with the actual escalation language per suite, signed off by whoever did the lease audit. If the model says 3% and the documents say 2%, that's not a modeling philosophy difference, that's an error, and the way they respond to being shown an error tells you more about the sponsor than the deal does.

What's an ASC?

@rigging ambulatory surgery center. Outpatient surgical facility, so procedures where the patient goes home the same day. They matter here because the build out is heavy, sterile processing, medical gas, generator backup, high air changes, and it's the most expensive space in the building to re-tenant if it goes dark. It's also usually the strongest tenant while it's there.

meridian, on your actual decision. I've asked sponsors to re-run sensitivities maybe a dozen times and about half do it properly. The half that do usually already had the downside case built and just didn't lead with it. The ask that gets answered is specific: "please send the model with new lease TI at $90/sf, renewal TI at $40, and exit at 6.75%, holding everything else." A vague "can you stress it" gets you a paragraph. And ask for their realized TI numbers on the last two medical assets they re-tenanted. Actual dollars spent, not budget.

$55/sf for second generation medical does not buy much once you're moving plumbing. Sinks in exam rooms mean cutting slab if the stack isn't where you need it, and in a 1987 building the stack is where it is. If the new tenant's layout roughly matches the old one you can land near $55. If it doesn't, you're in the nineties per foot before you've bought a door.

Read the LPA before you argue about TI. Specifically: who funds a capital shortfall, on what notice, and what happens to a non-contributing LP. If the answer is a dilutive capital call at a punitive conversion, then your $700k to $900k TI gap isn't a return problem, it's a dilution problem, and it lands hardest on the smallest checks. Also look for whether the sponsor can extend the hold past five years unilaterally and whether the asset management fee keeps running while they do. I've read a lot of these where the extension is at the sponsor's sole discretion and the fee never stops.

fathom, that capital call point is the one I never think about. Is there a normal version of that clause or is it all over the place?

@vellum it's all over the place, which is why people read it. Some agreements make a shortfall a pro rata call with straightforward dilution, some let the sponsor bring in preferred capital ahead of everyone, some allow a member loan at a high rate that gets repaid before any distributions. Same words on the cover, very different outcomes.

meridian, my question is simpler than everyone else's. Why is the seller selling a 1987 building at 91% leased into a market the sponsor describes as supply constrained with rent growth ahead? If the answer is a fund life ending or a partnership dispute, fine. If nobody can tell you, assume the seller knows the TI number and you don't.

I'd take the reduced allocation off the table as an option. Writing a smaller check into a deal you think is mispriced doesn't fix the pricing, it just makes the loss smaller if you're right and the gain smaller if you're wrong. Either the re-run comes back and it clears at $90/sf and a 6.75% exit, or you pass and stay on their list for the next one. Sponsors remember the LP who asked a precise question far better than the one who took a token slot.