The best way
to buy real estate is using a convertible bond analogy. Buy a property
with a building that can be used for a higher and better use (different
building), but has current income. The current use has a current
"bond" yield. Conversion is the way to tap into the unrealized
"equity" value in the land.
Here’s an
example using a piece of property of some interest in downtown San
Rafael. Empty building of 5,000 feet. Land has been previously
approved for 14,000 feet of mixed use. Building for sale at $1.3mm.
Cost to build (one quote) is $5mm (I don't know if that includes soft costs -
interest, taxes, etc. or not, for now I will assume that it does). $6.3
total cost. What's the property worth?
Capitalized
Value AFTER teardown and new building
11,000 rentable feet * $2.50/ft/mo = $27,500 * 12 = $330,000 revs $3/ft means revs of $396,000
Vacancy
$15,000
Taxes $6.3mm *
1.1% = $69,300
Insurance
$25,000
Maintenance,
etc. $20,000
Operating
expenses
$129,300
Net Operating
Income $201,000
$267,000
Cap rates
4%
4.5% 5%
5.5% 6% 4%
4.5% 5% 5.5%
6%
Values
mm
$5.025
4.467 $4.020
$3.655 3.350 $6.675
$5.933 $5.340 $4.854 $4.450
None of these
values support paying $1.3 million for the current building and immediately
tearing it down, ie, paying $1.3 million for the land. All except one
scenario at $3/ft and 4% cap show new building value at LESS than $6.3 million
cost.
A realistic
probable value for the new building is $5 million. That's $357 per foot.
Cost would
also have to include a profit for the developer's risk. Let's pick
$500,000. So, even assuming that the construction can be squeezed down to
$4.5 million, the land is worth $0 under THIS redevelopment plan and cost
estimate. The plan needs more square footage, rents higher than $3 or
lower construction costs for the land to have any value.
Capitalized
Value after rehab of existing building
So, can
something be done to the building so that one can afford to hold the land for
the time in the future when rents are higher?
4 apartments @
$1,200 each/mo = $57,000
2 retail
spaces of 1,000 @ $2/ft * 12 = $48,000
Gross annual
rent $105,000
Net after
vacancy
$100,000
Taxes
$15,000
Insurance
9,000
Garbage
1,500
Utilities
1,000
Maintenance
5,000
Operating
expenses $31,500
Net Operating
Income
$68,500
Cap rates
4% 4.5% 5%
5.5% 6%
Values
$1.713 $1.522
$1.370
Costs
Hard rehab
costs $180,000
Operating cost
during 1 year construction
25,000
Interest carry
during construction/lease up
55,000
Leasing
commission, miscellaneous
15,000
Builder/manager
profit
50,000
Total other
than building
$325,000
Building
ask
1,300,000
Total
cost $1,625,000
Break even
value at 4.2% cap rate, which is below market.
Using a 5% cap
rate.
$68,500/.05=
$1,370,000 @ 4.5% cap is
$1,522,000
- Costs
-
325,000
-
325,000
Building
value = $1,050,000.
$1,197,000