A Good Walk (Un)Spoiled

Fellow Missourian Mark Twain may have thought the game of golf represented "a good walk spoiled." But he never had the opportunity to play Country Creek, one of Fiducia Properties' most recent listings.

Our firm is representing Country Creek Golf Course in the disposition of nine of its 54 holes in the larger Country Creek/Hoots Hollow complex. The almost 86 acre tract is located equidistant from  the Cass County communities of Pleasant Hill, Harrisonville, Peculiar, Raymore, and Lake Winnebago.

The offering consists of what is essentially the front nine of "The Quarry." Features include zoysia fairways, a 10-acre lake, an irrigation system, and 18 lots approved by Cass Co. for duplex development.

Country Creek will still continue to operate the remainder of its 45 holes, so a successful purchaser will not be able to operate its own fee-based golf course. However, the tract is ideally suited for additional residential development or for an individual home site. In both of these cases some or all of the golf holes could remain for use as a residential amenity or for a private golf course.

Contact us today at 816-862-8005 to learn more about this valuable asset. Or, visit fidprops.com and download an offering memorandum.

11 Cap Dollar General Portfolio

Sperry Van Ness|Fiducia Properties is pleased to announce that our Dollar General portfolio in Southeast Missouri is now being offered at an attractive 11% Capitalization Rate. This attractive yield was made possible because the price was dropped by over $100,000 to $2,295,000 and the NOI was increased by $3,500 annually due to recently-received % rent checks.

Please click here to download the full offering memorandum.

Wal-Mart to open first "Express Store" Tomorrow

Wal-Mart Stores, Inc. has identified gaps in its business model and is taking aggressive steps to fill them. Tomorrow the giant retailer opens its first "Wal-Mart Express" store in Gentry, Ark., a commnunity within a stone's throw of company headquarters in Bentonville.

The Wal-Mart Express concept features an approximately 15,000 s.f. store which sells between 11-13,000 items. It seems the concept will be deployed primarily in markets which are too sparse to support a traditional Supercenter. Other Express stores are planned for markets such as Chicago in which building a Supercenter might be impractical. A key objective for Wal-Mart appears to be regaining market share lost to retailers such as Dollar General and Family Dollar. Besides the store in Gentry, other near-term openings are scheduled for various locations in Arkansas and North Carolina.

No word yet on whether these real estate assets will be company-owned or leased to investors.

(Read USA Today Article)

Thanks to fellow Sperry Van Ness advisor Bo Barron for tweeting this article last week.

Value Investing and Commercial Real Estate

Several months ago I proffered a question for reader contemplation. It went something like this: "Can the concept of value investing in securities be applied to commercial real estate investment properties?" If you recall, that question emerged for me after reading Michael Lewis's book The Big Short. Lewis highlighted how value investing was one strategy that brought certain individuals to "short" the sub-prime mortgage market and make several billion dollars along the way.

In our last post I asked you to provide me with some feedback on the above question. I waited and waited through blizzards and wind chills and finally tornados to conclude that you weren't going to respond. Perhaps I'm pulling the plug on the dialogue a little too quickly, but I figured four months was enough time for my seven followers to weigh in. But alas, you haven't. So now you'll have to endure (if you're still reading) me answering my own question, which is obviously why I asked it to begin with.

Commercial real estate investment properties, particularly net-leased investments, are typically evaluated on what is essentially an income approach. Buyers of these assets typically evaluate capitalization rates when comparing one asset to another. Sometimes investors will look at the underlying demographics or other specific market factors as a way of putting the investment under a three-dimensional lense. But most investors will fixate on the cap rate or cash-on-cash return or IRR which still by-and-large relegates the real estate to the one-dimensional world of paper investments.

There are undoubtedly many concepts that could be applied to the question of value investing in commercial real estate. I've come up with three that I think are worth mentioning. These include:

1. Cost Per Square Foot
2. Residual Value
3. Adaptability

This list should not be considered exhaustive and as we'll see these three factors are very interrelated. Some can be quantified; some cannot. We'll look at them in order.

Cost Per Square Foot
Perhaps no other metric gets at the "book value" of real estate than the cost per square foot (PSF) of the asset. This is probably the only factor of the three that can be objectively known and quantified. It can be measured against other assets. It may and usually has some reflection to the underlying land value of the improvements which should have some correlation to market factors such as traffic counts and demographics. It may reflect the building's age but does not have to. It may only reflect the rental rate of the lease governing the property. Too often when evaluating net leased investments, we find extremely high costs per square which are solely attributable to the income approach. These costs may have no correlation to the building's true value and are only reliable as long as the tenant continues to pay the corresponding rent. Investors should use extreme caution when paying exorbitant costs per square foot. They would be wise to evaluate how closely the underlying lease rates track with market rents in the area. If they are double or triple the market, the investment's value may not hold during its useful life. This leads us to our second factor--Residual Value.

Residual Value
The residual value of a real estate investment is simply the asset's value once the original tenant is no longer occupying the space. Once the tenant, be it Walgreen's or Dollar General or whomever, vacates the space due to relocation, closure, lease expiration, etc. questions surface such as What is this building worth to another owner/user? Or, For what amount of rent can I re-tenant this asset? These questions are predicated on the asset's residual value, which may or may not have any correlation to the property's original lease rate and acquisition price. Investors would do well to look into the future to project the asset's residual value in the event the tenant eventually vacates the property. This may seem insignificant when there are 20 years left on the lease, but any long term play should account for the eventual certainty that the property will one day be vacant. While the residual value does not have to be the same or more than the present day acquisition price, great care should be taken to ensure the residual value is not 1/3 or 1/2 of the original acquisition price. This can occur when the property's current rental rate is way out of whack with the market.

Adaptability
The final concept we'll look at is what I call Adaptability. The question we want answered here is what to do with the asset once it becomes vacant?  A popular issue within the worlds of Architecture and City Planning is that of Adaptive Reuse. Adaptive reuse contemplates how an older building which was utilized for one purpose during its early life can be modified to house a completely different use during its later life. When we think of adaptive reuse we think of warehouses turning to lofts or massive train stations being converted to museums, shopping centers, or office buildings.

Our concept of adaptability with investment properties is similar to this larger concept of adaptive reuse. How simple will it be for your asset to house another similar retail tenant if your first tenant leaves? Are there peculiarities or idiosyncrasies with the building that would preclude 90% of other would-be tenants? If so that might be a red flag. Adaptability obviously carries with it both physical and financial components. Many buildings might be vanilla boxes capable of housing other retailers, office users, etc., but they may not financially accommodate many users. The financial component points us back to our concepts of Cost Per Square Foot and Residual Value.

Perhaps the best illustration I can think of that brings these topical issues to reality is to look at the case of a single tenant property leased to Starbucks.  I had a Starbucks deal cross my desk this morning. I'm sure it's a fine property but the asking price was well over $1.5 Million while the size was only about 1,850 square feet on one acre. The investment's NOI was over $120,000.  The resulting cost per square foot was over $854 while the tenant's rental rate was almost $66 per square foot. While Starbucks is a great tenant, this deal does not fare well when evaluated against our three criteria. Its cost per square foot is some three-to-twenty times higher than that of properties leased to other credit tenants. Further, it is doubtful a Starbucks residual value would ever come anywhere close to that of a local market when the rental rate is $66 PSF. And if these two issues were not enough, adaptability comes into question. Restaurant properties rarely can be used for anything besides restaurants. Starbucks might contain even more specialized features than a typical restaurant (think limited seating) which suggests it would miserably fail the adaptability test. Perhaps one could get comfortable with these issues if we were talking a 30 year lease, but this deal's lease had only 6.5 guaranteed years remaining. Any purchaser there might be asking our questions much sooner than he or she should have to.

Hopefully we've given you a few things to think about. Perhaps you've thought of something we haven't. If so, we'd appreciate a comment. But this time we're not going to wait on you for four months....

Value Investing

I just finished reading The Big Short, the book by Michael Lewis which chronicles the demise of the sub-prime mortgage market. In this book, Lewis highlights a few brilliant souls who correctly analyzed the flawed fundamentals in this market and then proceeded to profit handsomely from its crash by selling it short.

One of the investors Lewis features in this book is Dr. Michael Burry, a neurologist turned money-manager who started a firm called Scion capital. Scion eventually made several hundred million dollars by purchasing so-called credit default swaps on sub-prime mortgages. The credit default swaps Burry purchased on mortgage bonds were essentially insurance policies payable upon the default of these bonds. As history has shown us, these bonds failed en masse, and Burry and others became all the richer for it.

Lewis tells us Dr. Michael Burry was influenced heavily by the late Benjamin Graham and a protégé of sorts of Graham's—Warren Buffet. Burry bought in to Graham's philosophy of "value investing," which is essentially a quest to identify stocks of companies which trade below their asset or book values. Presumably it was Burry's passion for value investing that led him to correctly foresee the sub-prime bust.

As I read about Michael Burry and his approach to value investing, I wondered how such a philosophy for picking stocks could be applied to the commercial real estate investment market. Do certain characteristics of a real estate investment suggest it is a poor value and while others suggest it is a good value? Is there a scenario in which a property's "book value" could be higher than its current market value?

If there are fundamentals which could give us some insight into true "value," can they be quantified? Or, are they simply seat-of-the-pants, instinctive, and nebulous sort of criteria that may vary from investor to investor? I may be wrong, but my sense is that most investors don't stop too long to ponder the differences in "value" among certain net leased commercial real estate investments.

What are your thoughts? Give me some feedback in the "Comments" section by providing ways in which you might identify the intrinsic or book value of a commercial real estate investment.

I look forward to your responses!

Available: Southeast Missouri Dollar General Portfolio

Sperry Van Ness | Fiducia Properties is pleased to announce the availability of a six-store Dollar General portfolio in Southeast Missouri. These assets are outstanding retail investment properties and are the subjects of modified gross leases with Dollar General (DG).

The stores are located in the St. Francois County communities of Bismarck, Bonne Terre, Desloge and Farmington and the Stoddard and Bollinger County communities of Marble Hill and Advance, respectively.

The entire six-store package is offered at an attractive $2,400,000 which provides the successful investor with an outstanding 10.4% capitalization rate. In addition to the attractive cap rate, the portfolio asking price amounts to a paltry cost of less than $48 PSF.  Other features include outstanding store sales and staggering numbers returned by percentage rent clauses in the lease. Although being offered as a porftolio, the six stores may also be acquired individually for a small basis point premium.

Please contact us toll free at 888-879-2083 for additional information, or follow this link ( http://docs.svn.com/Southeast Missouri DG Portfolio ) to acquire an offering memorandum on this excellent opportunity.

The Curious Case of Sherwin-Williams

Sherwin-Williams stores have long been considered desirable real estate investments--and for good reason. The company has been around since the conclusion of the Civil War. Since then, it has grown to become one of the largest chemical, paint and coatings companies in the world. Besides its longevity, Sherwin-Williams’ debt is rated "A" (recently upgraded from "A-") by Standard and Poors (S & P). As a real estate investment, Sherwin-Williams retail properties possess many attractive qualities. They are viewed as very stable assets and are generally available at attractive price points--many under $1 Million. Further, the stores are typically located in stable markets at strong locations.

Despite these positives, Sherwin-Williams stores, as a real estate investment commodity, are somewhat difficult to quantify. If currently shopping for a Sherwin-Williams store to add as a last minute stocking stuffer, one might find offering capitalization rates in a range of anywhere from 6% to 10%. This wide range creates somewhat of a schizophrenic trading environment if trying to accurately value a Sherwin-Williams asset. It then becomes somewhat difficult for buyers and sellers to agree upon fair prices and capitalization rates for the investments.

"The stores have a very high lease renewal rate," said one investor, justifying the lower cap rates observed in the marketplace. "I've been told that Sherwin-Williams renews something like 97-98% of store leases," he said. Another factor that seems to drive Sherwin-Williams cap rates lower is the overall scarcity of product. The company does not operate as many stores as many retailers so the universe of potentially available properties is somewhat smaller. Beyond this factor, relatively few of the stores in existence ever come to the market.

While these factors might explain the low end of the cap rate spectrum, they do little to explain the higher end. After all, the lease renewal rates of the stores, very favorable S & P rating, and product scarcity should keep the cap rates of Sherwin-Williams stores down in the 6-8% range. But what explains those stores offered at 8%+?

"I think the (cap rate) diversity can be explained by looking at the wide range of real estate choices found among Sherwin-Williams properties," said another Sherwin-Williams investor. Indeed, this may explain much. It is estimated that approximately 2/3 of the business done in a typical Sherwin-Williams is from contractor sales. Consequently, some Sherwin-Williams stores may not be located at "Main and Main." Since for many Sherwin-Williams is a destination, in some cases the company's stores may thrive in convenient but not necessarily first tier locations. Some of these stores may be located in even what would be considered quasi-industrial locations, rather than trophy retail locations. Whereas retailers such as Walgreen's, Wal-Mart, etc. have no room for error in their real estate decision-making, Sherwin-Williams may in fact be able to survive and thrive with some sub-standard locations due to their reliance on contractor and other non-impulse customers. Such locations, however, may end up being penalized in the net lease marketplace from investors unwilling to buy what they would consider to be inferior locations at low cap rates.

Other factors that might balance out the favorable investor sentiment for Sherwin-Williams properties are the shorter-term and double-net nature of the company's leases. Typically the base term on the company's leases are 10 years and typically the landlord with have modest responsibilities with grounds maintenance, roof, and structural. These factors undoubtedly scare off some investors which might pay lower cap rates otherwise. It has undoubtedly kept many institutional investors away from the product.

Although difficult to pigeon hole as an investment commodity, Sherwin-Williams stores still provide an excellent investment choice for the smaller commercial real estate investor. Many can be purchased at excellent costs per square foot and at reasonable capitalization rates. Although one must evaluate the real-estate specific characteristics of each offering carefully, the eventual Sherwin-Williams investor should be rewarded with a long-term, stable tenant for years to come.