8.9% cap with 7 years left in a town of 3,400. I can't price the exit.

Freestanding discount retail box, 9,100 sf, small rural town, population about 3,400, on the state highway across from the school. Built 2011 for the tenant. Rent $73,500, so $8.08/sf, absolute net with a corporate guarantee from the parent. Asking $825,000, which is 8.9% and about $91 a foot.

Seven years and two months left on the original 15-year term, four five-year options at 10% bumps. Store looks busy every time I've driven it. No sales reporting.

What I like: I do nothing. Taxes, insurance, roof, lot, all theirs, and I read the whole document twice to make sure there's no carve-back to the landlord. There isn't one I can find.

What I can't solve is the exit. Local bank will lend but wants 25% down, 20-year amortization, five-year call, and their appraiser will care about the lease. So realistically I sell in year four or five with two to three years of term left, into whatever cap rate exists then. A 9% going in that turns into an 11% exit with three years of term is a loss even with seven years of coupon.

Alternative is I hold past expiry and either they renew at $8.88 or I own a 9,100 sf box in a town of 3,400. Second generation rent out there is maybe $4 a foot if I'm lucky and the building is worth land plus scrap sentiment.

So the question I'm actually stuck on is whether the coupon is enough to pay me for owning a residual I think is close to zero, and whether I should be underwriting this as a 15-year hold through two renewals instead of a five-year flip.

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2brandonlee36Passive

Run the exit properly and the answer usually falls out. Take your going-in basis of $825k, take four years of after-debt cash flow, then sell at year four with three years and two months of term at a cap 150 to 250 basis points wider than you paid, because that's what short remaining term does to a rural single tenant in every sale I've watched. If the numbers still work, fine. If they only work by exiting flat, you're relying on someone else making the same bet you're unsure about.

The better question is the 10% option bumps. Four options at 10% every five years is genuinely attractive if the store performs, and no sales reporting means you're guessing. Look at what you can see from outside. Is it the only one of that format within 20 miles, what's the drive time to the nearest larger town's competing box, has the tenant remodeled it recently. A remodel two years ago is worth more than any pro forma, because they don't spend that on stores they intend to close.

And price the downside honestly. At $4/sf second generation rent you're at $36,400 of gross rent on a building you'd then be paying taxes and insurance on yourself, in a market where you have no other assets and no relationships. That's not a coupon, that's a project 400 miles from your house. I'd want the going-in yield high enough that the coupon returns most of my capital before expiry, and 8.9% over seven years doesn't get there.

8.9% cap with 7 years left in a town of 3,400. I can't price the exit.

1 reply