Every day, and in every market, there are office deals waiting to be discovered. The challenge for real estate investors is determining which properties will become valuable assets within their portfolios and which will potentially jeopardize their overall investments. Conducting a thorough and thoughtful investment analysis is the key to making informed decisions. In this blog post, we’ll walk through an intriguing office investment opportunity, analyze its potential, and ultimately decide if it represents a portfolio maker or breaker.
Setting Our Investment Objectives
Before we venture into projections and stress tests, it’s crucial to outline our objectives clearly. In this case study, we aim to:
- Forecast the before-tax cash flows over a five-year holding period.
- Calculate the maximum supportable loan amount based on the debt service coverage ratio (DSCR) and loan to value ratio (LTV).
- Determine the gross rent multiplier (GRM).
- Calculate cash on cash return.
- Evaluate the debt service coverage ratio.
- Perform a discounted cash flow analysis to ascertain the levered and unlevered internal rate of return (IRR) and net present value (NPV).
- Stress-test the vacancy rate to understand its impact on cash flow.
- Examine how vacancy rates affect the debt service coverage ratio.
- Consider external deal factors beyond strict financial analysis.
Office Building Investment Scenario
Let’s dive into our prospective investment. The details of our mystery opportunity are as follows:
Property Listing
Address: 1234 Main Street, Our Town, Big State 11111
Size: 10,000 SF · Main Street Office For Sale
Description: Investment or Owner User. Existing, long-term tenants are willing to extend leases for a minimum of five (5) years if the new buyer agrees. The property features a brick building in pristine condition, complete with a private drive leading to a 15-space parking lot. The lot provides direct access to glass executive offices. The main floor consists of 12 offices, public entry on Main Street, an 8,000 SF space housing a boardroom, kitchen facilities, and two bathrooms, as well as a 2,000 SF space with one newly renovated bathroom. The new roof installed in 2010 comes with a warranty through 2025. The building enjoys an excellent west-side location, just two blocks away from a newly-constructed 200-unit condominium, with Castle Centre retail adjacent to it, which is approved for a $5M TIF redevelopment. The property sits on the southeast corner block of Main Street and 1st Street, offering high visibility.
Financial Summary (2016 Actual)
Estimated Income and Expense
Your familiarity with the office space rental market will guide your expectations on potential rents and operational costs for this property. As you know, if the initial analysis indicates further opportunity, you can request the property’s actual income and expenses during your due diligence phase. But for now, we can generate educated estimates for projected rental income and expenses.
Potential Rental Income Analysis
With the assistance of a few phone calls and a review of comparables, we can estimate the rental rates for 2016, 2017, and the points at which existing leases are set to expire. For projected rental income, we will assume that both current tenants will renew their leases at the market rate forecasted for 2018, under the terms of 5-year agreements with annual bumps of 3%.
Estimating based on these assumptions allows us to anticipate potential revenue growth over time and create a more refined financial model for our investment analysis.
Conclusion
Navigating the complexities of small office building investments requires both diligent research and strategic foresight. By outlining clear objectives and employing targeted financial metrics and tests, investors can effectively evaluate the potential of opportunities such as the one detailed in our case study. Whether this office building investment proves to be a profitable addition to an investment portfolio or a risk remains to be seen—what’s crucial is that comprehensive analyses guide the decision-making process.
