Peter, As the search for a property began, I had a few goals I wanted to accomplish with the property I would be purchasing: 1) Be located in a very

Transcription

1 Peter, As the search for a property began, I had a few goals I wanted to accomplish with the property I would be purchasing: 1) Be located in a very walkable neighborhood. 2) Have historical character, yet not at its full potential so I may add value through rehab / change of use. 3) Provide my overall portfolio a hedge against inflation while still providing a solid return on investment. 4) Have enough units to which I can live in one and have the other units cover my living costs. 5) Provide me a real life education in real estate development that I can utilize for future, larger deals. I believe I found a property that can accomplish all this and more. Todd Hanchett FIN 517 October 28 th, 2013

2 Best of Both Worlds (or Neighborhoods) Noble Square 1440 N. Ashland Located Smack Dab Between the Two Neighborhoods of Noble Square and Wicker Park WalkScore of 89, TransitScore of 74, BikeScore of 82 Rail: Blue Line 0.3 mi Bus: 9 Ashland 0.1 mi and 56 Milwaukee 0.2 mi Incomes Above $150,000 Increased from 12% to 19% of the Population b/w 2010 and Today Median Income of $70,159, an Increase of 11% b/w 2010 and Today 56% of the population between 25 and 44 Restaurants, Coffee, Bars, Groceries, Parks, and Schools all within 0.2 Miles There seems to be a movement of artists and young professionals that have been priced out of the more eastern side of Chicago toward the West, Wicker Park and Noble Square are benefiting from this migration According to Marcus & Millichap, for the Chicago area, rents have been rising roughly 4%/yr while vacancy has been falling to under 4%. Also, Chicago is expected to add 44,000 additional jobs in 2013 A small fraction of the surrounding amenities are represented on the map to the right ( A Pin is 1440 N. Ashland) (Sources WalkScore.com and HomeTurf) Wicker Park 384 Restaurants, Bars, and Coffee Shops 5 Bus and 1 Subway Line Pass Through Lower than Average Crime 8 th Most Walkable Chicago Neighborhood WalkScore of 94, TransitScore of 74, and BikeScore of 86 (Source WalkScore.com) 639 Restaurants, Bars, and Coffee Shops Less Violent Crime than Average 21 st Most Walkable Chicago Neighborhood WalkScore of 91, TransitScore of 73, and BikeScore of 87 (Source WalkScore.com)

3 Retail 1 Bedroom 2 Bedroom 3 Bedroom Comparable Rents Current Situation Comparables Distance Bed/Bath Sq Ft Rent/Month Rent/SqFt Adjustments Walk Score 0.1 mi 3/ $1,900 $ mi 3/ $2,300 $ mi 2/ $1,800 $ mi 2/1? $1,650?? 0.2 mi 1/1? $1,300?? 0.1 mi 1/1? $1,395?? 0.2 mi - 1,100 $1,650 $ mi - 1,540 $3,850 $2.50 -$50 Laundry in unit. Very comparable to post rehab -$100 Add'l Bath. Worse location. Net wash -$200 Official 2nd bed. -$200 Larger. Equivalent WalkScore -$200 Official 2nd Bed. Worse WalkScore -$50 Laundry in unit. -$100 Top Floor -$50 12' Ceiings Worse Location. -$250 Larger +$0.50 Sq/Ft Worse Location -$0.50 Sq/Ft Better Location Before I started to run the numbers for a rehab situation, I wanted to see if the property was attractive as is. Almost a baseline worst-case scenario. As the property is currently set-up, it seems to be an attractive situation. If I can get 3R rented, my ROE is more than 11%, DCR is 1.44 and rents would have to fall, or vacancy rise to, almost 22% before BTCF would be $0. And if I choose to live in 3R, the rents from the other rented units would cover my debt payment, expenses, plus over $4k/year extra. When compared to the other units available in the area, 1440 N. Ashland s units rent for significantly below market. This is due to the difference in quality of finishes between the units. Although the units are clean, they lack upgraded features and excitement that young professions nowadays seek. The 3R unit is recently rehabbed and is being offered closer to market rates (still not rented though) Mixed Use / Multi-Family Property. Total of 5,310 Sq/Ft and a FAR of 3.00 (3 stories). Has roughly $50,000 in Green capital expenditures including solar panels and wind turbines. Also includes a back-up battery generator. Currently has 5 apartments, 1 Live/Work space, laundry machines provided in the basement and part of the basement is rented to a photo studio. All units have separate utility meters, and current owners recently installed a new roof. Unit # Sq Ft Bed/Bath Rent/Month Rent/Yr Lease Exp. Basement 350 Commercial $500 $6,000 Month to Month Live/Work $1,400 $16,800 May 1st R $900 $10,800 Month to Month 2F $1,250 $15,000 Jan 31st R Den $850 $10,200 June 15th F $1,445 $17,340 August 1st R Den $1,300 $15,600 Vacant Total $7,645 $91,740 Expenses Taxes $11,364 Insurance $2,400 Water $3,000 Electric $960 Management* $4,587 Reserve* $4,587 Total $26,898 *Wasn't Included in Seller's Estimate NOI $64,842 Offer $875,000 Cap 7.41% Debt (80%) $700,000 Equity (20%) $175,000 PMT (5% int) ($45,093) BTCF $19,749 With me Living in 3R NOI $49,242 BTCF $4,149

4 Retail Conversion (Just Retail Convert) Rehab? Full Rehab (Includes Retail) The current 1 st floor is set-up for a live/work tenant. The two major problems I see with this is that type of tenant doesn t create a exciting sidewalk atmosphere, and the tenant pays about $1.17 Sq/Ft verse the conservative $2.00 Sq/Ft (based on comparables on previous slide) that this space could get if transferred to full retail (café, unique retail store, etc.) Walkout the front door and the potential of this beautiful tree lined street is not being taken advantage of. Based on what s available on the website Loopnet.com, there s not a whole lot of vacancy for retail in the area. Not only could an excellent space pull in an excellent tenant, but that tenant would then create a great third-place that people would gather. Thus increasing the value of the above apartments and surround areas. Below is the financial impact of converting the current live/work space to an excellent retail space. Total Sq/Ft Cost per Sq/Ft Source Retail Conversion $170, $ Contractor Retail Conversion Total Sq/Ft Price/SqFt Current Rent 1st Floor $16, $14.00 Basement $6, $17.14 Total $22,800 Potential Rent New "3rd Place" $35, $22.74 Plus Ex. $75 Per Apartment $4,500 Total $39,750 Add'l NOI from Conversion $16,950 Return on Conversion Cost 10% Add'l Value to Building (7% Cap) $242,143 Add'l Equity From Conversion $72,143 By just rehabbing the retail place, I can increase NOI by almost $17k (assuming no increase in operating expenses), an annual return on my rehab investment of 10%. This increase in NOI increases the value of the property by $242k (assuming 7% cap rate), and, after subtracting out my rehab budget, increase my equity by $72k. The current rents are significantly below the going rates in the surrounding area mostly because of the difference in quality. Once a quality rehab is completed, I believe rents could be at the going market rates. The picture of the stairwell below, although run down and in need of some love-and-care, illustrate what this building has to offer over a new build development. The character and charm of an old-school building. The old-school charm will be mixed with quality modern features young professionals expect. When figuring the budget for renovating, I backed into the amount by figuring what the increase in rent would be if the apartment was brought up to top quality. I then divided by 10% for my required return on rehab investment. I then backed out the cost of the retail conversion and what remained is what I can spend to bring the units up to HGTV quality. I included a large slush fund because I m sure something will come up that is unexpected. From the improvements made, I can expect to increase rents by over $33k and increase the value of the property, assuming a 7% cap rate, by almost $481k. Cost per Construction Total Sq/Ft Sq/Ft Source Retail Remodel $170, $ Contractor Apartment Remodel Cost/Unit Units Total Cost Homewyse Kitchen Current Potential Fridge $1,500 4 $6,000 Units Rooms Annual Annual Stove $1,500 4 $6,000 Sink $1,000 4 $4,000 Basement - $6,000 $6,000 Countertops $4,000 4 $16,000 Retail - $16,800 $28,800 Microwave $400 4 $1,600 1R 1 $10,800 $13,800 Dishwasher $900 4 $3,600 Floor $1,200 4 $4,800 2F 3 $15,000 $21,600 Cabinets $7,000 4 $28,000 2R 1+Den $10,200 $15,600 Backsplash $1,200 4 $4,800 3F 3 $17,340 $22,800 Bathroom 3R 1+Den $15,600 $16,800 Toilet $600 4 $2,400 $91,740 $125,400 Cabinets $800 4 $3,200 Sink $400 4 $1,600 Increase in Rent $33,660 Shower $2,500 4 $10,000 Budget at 10% Return $336,600 Floor $500 4 $2,000 Budget for Retail Conv $170,000 Other Rooms & Slush $18,150 4 $72,600 Total $41,650 $166,600 Budget for Apartments $166,600 Average Cost Per Budget/Apart (Ex. 3R) $41,650 Sq/Ft $49.00 Value 7% Cap $480,857 Equity Created $144,257

5 So, is this a good investment? My goal would be to purchase the building for around $875,000, significantly under the $987,500 list price. Why do I feel I can achieve such a discount? In the marketing materials the realtor advertises a 7.5% cap rate. This seem to be a touch strong for the current quality of the building, but not too far out of line. If I adjust their operating expenses to reflect reality and divide by 7.5% I get a value of $900k. Another factor is a comparable building right down the street recently sold for $882,000. Also, from what I can find, the current owner purchased the property in 2009 out of foreclosure for $490k. This means that he s sitting on a significant profit and may be open to negotiates as he now has a desire to sell the property. As shown in the Sensitivity Analysis chart, as long as I can acquire the property below $950k, there s a good chance I ll achieve a return greater than 10%. If I can acquire at $875k, my IRR is greater than 14%. I plan to pay cash to rehab the property and then recap the property at the end of year 1 to cash out some equity. As it ll take till the end of Year 1 to rehab I figured I ll sell at the end of Year 4 as that ll be long enough to have 3 full years of rehabbed, higher rents, yet short enough to hopefully not be affected by the next real estate bust. Roughly 52% of the discounted value comes IRR from the CF obtained from the sale, so 14.27% confidence in the future cap rate and rents is DCR critical in the decision whether to move forward 1.36 with this investment. Given Chicago s growing employment numbers and historically stable cap rate, I feel we can be confident in the predictions and make this investment. Although I would like to purchase the property for below $800k to get a projected 20+% return to maintain a margin-of-safety, given the safety inherent in the Chicago real estate market I feel this investment meets all the goals I outlined on the cover page and then some. Year 1 Year 2 Year 3 Year 4 Equity Dividend (ROE) -3% 4% 6% 7% (BTCF/Yr0 CF) NOI/(Debt+Yr0 CF) 3% 7% 7% 8% Year 1 Year 2 Year 3 Year 4 Sensitivity Analysis Purchase Price IRR $775, % $800, % $825, % $850, % $875, % $900, % $925, % $950, % $975, % $1,000, % Shown below, I utilized a very conservative 40% vacancy in the first year to reflect the remodeling of units as renters leases expire. Terminal vacancy and rent growth rate are both taken from the Marcus & Millichap report. Projected Vacancy 40.0% 10.0% 3.6% 3.6% (3.6% from Marcus & Millichap Report) Rent Rate Growth 4% 4% 4% 4% (Per Marcus & Millichap Report) Expense Growth 3% 3% 3% 3% Year 0 Recap Yr 1 Value $875,000 $1,135,567 Reno Investment $336,600 $0 LTV 80% 80% Debt $700,000 $908,453 Equity $175,000 $227,113 Interest Rate 5% 5% Term 30 Yr 30 Yr Debt Service Payment ($45,093) ($58,521) Sale Yr 4 $1,424,157 Purchase + Reno $ $1,211,600 Depreciation $163,505 Taxable Amount $376,063 Taxes (28%) ($105,298) Debt Owed ($866,152) CF From Sale $452,708 Year 0 Year 1 Year 2 Year 3 Year 4 Potential Revenue - $91,740 $125,400 $130,416 $135,633 Vacancy - ($36,696) ($12,540) ($4,695) ($4,883) Other Income - $0 $0 $0 $0 Expected Revenue - $55,044 $112,860 $125,721 $130,750 Taxes - ($11,364) ($15,534) ($15,534) ($15,534) Insurance - ($2,400) ($2,472) ($2,546) ($2,623) Water - ($3,000) ($3,090) ($3,183) ($3,278) Electric - ($960) ($989) ($1,018) ($1,049) Management - ($2,752) ($5,643) ($6,286) ($6,537) Maintenance (Reserve) - ($2,752) ($5,643) ($6,286) ($6,537) Operating Expense - ($23,228) ($33,370) ($34,853) ($35,558) NOI - $31,816 $79,490 $90,868 $95,192 Debt Service - ($45,093) ($58,521) ($58,521) ($58,521) BTCF - ($13,277) $20,968 $32,347 $36,670 NOI - $31,816 $79,490 $90,868 $95,192 Interest - ($34,765) ($45,118) ($44,433) ($43,712) Depreciation - ($40,876) ($40,876) ($40,876) ($40,876) Taxable Income - ($43,826) ($6,505) $5,559 $10,603 Taxes Credit (Owed) - $15,339 $2,277 ($1,946) ($3,711) Cumulative Tax Credit $15,339 $17,616 $15,670 $11,959 BTCF - ($13,277) $20,968 $32,347 $36,670 Taxes Paid - $0 $0 $0 $11,959 ATCF - ($13,277) $20,968 $32,347 $48,629 CF from Recap or Sale $218,781 $452,708 Cash Flows ($511,600) $205,504 $20,968 $32,347 $501,337 Value (@7% Cap Rate) $1,135,567 $1,298,115 $1,359,880 $1,424,157