JoePreis.com

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