I have been asked by more than a handful of friends and colleagues to write a post on a specific listing in Simi Valley, CA that was recently brought to market by CBRE. I decided to put my thoughts in writing and attempt to explain how exactly I would break this particular deal down and why the second I saw the offering information I knew the listing agents had priced the property significantly below its true market value.
Quick deal background: The property in question is a single-tenant Big 5 Sporting Goods in a 10,000 square foot freestanding pad building in a market-anchored center. The location is better than decent but nothing special. What was special about the offering was the price: $768,000, which translates to $76.80 PSF for the building. The parcel is exactly 1 acre ($17.63 PSF for the land). The building is constructed in roughly textured concrete block and has massive arched facades built up and topped with Spanish tiles. All in all, the building is fairly hideous looking, but aside from being ugly, appears to have decent fundamentals: the building is ideally situated on the parcel with parking surrounding all sides of the building (meaning options for access to the building if demised in the future); the building appears to be fairly square (100’ x 100’); and, it is situated as the adjacent parcel to the primary signalized point of entry to the center. Big 5’s lease term expires in January 2015 and the tenant has no remaining options to renew the lease. The property is operating (and is expected to do so for the remainder of the lease term) at an NOI of roughly $38,000 / year (4.95% CAP – marketed as 5.00%).
I received a phone call from a commercial mortgage broker I know asking me if I had a few minutes to offer some feedback on a deal for a client of his. I said no sweat and asked my friend to forward me the package and told him I’d get right back to him. I got his email about 45 seconds later, opened the PDF file and called him right back and told him the deal was totally underpriced. He asked if I would participate in a conference call with his client who was interested in purchasing the property. Within a few minutes I was on a conference call with the potential buyer discussing the opportunity. He stated that he “pretty much had the deal under contract” and just wanted to run it past me. I knew there was no way in the world he was even close to being under contract on the deal since it had only been exposed to the market that very morning and I was certain the price would be bid up way over the listing price in a matter of a few days, if not immediately.
The potential buyer wanted my thoughts as to how best to get this deal. He wanted to know how to approach the listing agents and structure his offer. He asked me at what price should he write his offer. I told him $50,000 over list price, attractive deposit ($250,000’ish), fast but reasonable due diligence period (7-14 days), full release of deposit after contingencies and closing a couple of days after (he was going to buy for cash). He generously offered to compensate me for any advice or guidance I could provide in helping him secure the deal. After thanking him for the offer, I told him involving me in any way, shape or form as a broker is going to significantly reduce his chances of getting the deal. [I can get into the reasons for this in another post maybe but I will say the reasons are not personal but simply prudent business decision making and logic on the part of the listing agents.] I then informed the buyer that he should be prepared for the price of the property to be bid up well over $1,000,000. Essentially, expect the deal you think you see in front of you to become a totally different deal quite soon. My logic for the immediate $50,000 premium in his offer? Simple, guarantee you are the best offer immediately and pray like crazy that the seller signs something binding with you before the $1,000,000 offers start flying in and demote your offer to single-sided scratch paper.
Throughout the remainder of the day I had about 15 more conversations about the deal with various colleagues both inside out outside of my office. A couple of people were really taken aback by the fact that I was so resolute in my judgment that the property was totally underpriced. Claims that “these guys know what they are doing” and “these guys do a lot of retail deals” were made here and there. Both statements are true by the way; however, the fact remains that $768,000 for this property was far below its true value. The next business day (Monday), I spoke with a friend who had spoken to one of the listing agents and he proceeded to tell me the listing agent told him they got 9 offers for the property within the first several hours of sending out the initial email offering. If that is not a sign that a property is underpriced, I don’t know what is. Quite frankly, 2 offers in the first day would sound that alarm.
Here is my quick, simple, back-of-the napkin underwriting approach to arriving at my conclusion: Something tells me the property was priced where it was because the agents believed that a 5.00% CAP rate was, and is perceived in the market, as being extremely aggressive and is an absolute psychological floor in value. I totally disagree with this assumption. Here is why:
· $77 per building SF is very cheap for a leased freestanding building in a market anchored center in Southern California;
· $17.63 per land square does not strike me as inflated were this to be just raw land (I’m pretty sure you could get $15-$18 per land square foot for this parcel if it were raw land right now with relative ease);
· You should not have to worry (hopefully)about loss of net income in the next couple years, meaning when the space is recaptured in 4 years the market should be better than it is now;
· If the current base rental rate of $0.33 PSF / month were assumed to be quadrupled upon rollover with minimal capital needed to get there (TI’s, LC’s and carry), the future rent of $1.33 PSF / month seems fairly conservative even if you had to lease the building today.
If my NOI in 4 years is conservatively at $160,000 and I think the property may be worth somewhere between $1,800,000 and $2,000,000 in the future and I only needed to spend $300,000 to get there (which I think is high in this case), there is about $500,000 minimum profit in the deal. I personally think the rent attainable in the building will be much higher than $1.33 PSF at time of rollover and that further capital investment in the property will prove to generate additional positive return on costs and therefore more profit. Simply put, at a purchase price of $768,000, the deal is a total no-brainer. A quick check of one key fundamental figure further reinforces my belief that someone will pay way more for this property:
· My future value of $2,000,000 represents a value of just $200 per building SF. This figure strikes me as very low for a repositioned deal, especially 4 years from now. I can’t imagine this property not being worth at least $300 PSF in the near future. Even if it takes a few years after repositioning for the value to get there, the $100 per building SF growth in value represents $1,000,000 more in value.
· At a $3,000,000 future value and a $768,000 purchase price, an investor could invest an additional $1,500,000 in the deal ($150 PSF) for remodeling, TI’s, LC’s, etc. (a figure which is super high and darn near the total cost to rebuild the building from the ground up) and still have a cost basis $700,000 below market value.
Here is my final super-simple (maybe illogical, but I actually believe it is valid) line of thinking:
Vacant land has a lower CAP rate than 5% right? Yes, the return is negative due to carry costs. Why not look at this as a land deal with a free building and $38K of net income for the next 4 years? Would you pay lower than a 5% CAP for that (remember, your land basis is a very reasonable $17.63 PSF)? Maybe you would, maybe you wouldn’t but I can guarantee you I could find several someones that would. CAP rate isn’t everything.
So getting to the point, you probably want to know if I was right or not. Last I heard several days ago (it has been a little over 6 weeks since the property went on the market) the price had been bid up to somewhere between $1,200,000 to $1,400,000. Was the super low pricing a strategy by the listing agents to generate a ton of interest in the property? Who knows, only they can say for sure. Strategy or not, the offering generated a ton of interest and what I assume were a ton of offers. Even if the pricing was intentional, I just don’t agree with it operationally. Sure, pricing super low will generate lots of interest, generate lots of offers and ultimately push the price up through competitive bidding. That’s fine. What doesn’t make sense to me is why you would want to intentionally create an onslaught of work and interaction and loss of time spent with a bunch of people that you already know are not going to end up being the eventual buyer of the property? It just seems like it makes more sense to price it right and target who you believe to be the most probable buyer through presentation of the value proposition to that target buyer at the actual market price. That would be much more efficient, no? Another risk: pissing off a ton of potential buyers. The buyer I mentioned above (who obviously stopped chasing the deal as the price was bid up) told me he is super pissed at how the process was handled by the agents. I assured him that they didn’t do anything wrong or unethical, but they did set themselves up for failure in the area of managing buyer expectations. A final critical drawback to pricing the property so significantly below actual market value is one of credibility. To many, you look like you don’t know what you are doing – never a good appearance to project when advising others in large financial decisions.
If you are interested in seeing the marketing package for the property, you can download it here.
