Case Study of Non-Institutional Cash-on-Cash Returns
National Economy
As of the third quarter of 2018, the U.S. economy grew at an annual rate of 3.4%. This was a decline from the 4.2% experienced in the second quarter of 2018. However, it was above the 2.2% in the first quarter 2018. Side note: As of the second quarter of 2018, the Bureau of Economic Analysis (BEA) reports that Texas had the fastest growth in GDP with an annual rate of 6.0%.
The labor market continues to experience rising wages, which has been slow to follow the expansion. As a result, the consumer confidence increased to an 18-year high in October 2018 at 137.9. It was 135.3 in September.
The International Monetary Fund projects the national GDP to grow by 2.7% in 2019, which is a slight reduction from the 2.9% in 2018. The reason provided was that the U.S. and China trade wars could reduce the growth of both countries.
Employment
The Bureau of Labor Statistics (BLS) reported that the U.S. job market remained strong with the unemployment rate at 3.7% in October 2018. This was a decline from one year prior, which had an unemployment rate of 4.1%. These unemployment rates are the lowest since December 1969, according to Situs RERC. The BLS reported that payroll employment increased by 304,000 in January, and the unemployment rate moved up to 4.0%.
Financial Markets
The stock market experienced a large amount of volatility towards the end of 2018 where all the gains for the year were lost in two days, November 19 and 20. The Fed has raised the federal funds rate by 25 basis points eight times since December 2016.
The commercial real estate developers and investors may be adversely impacted by higher cost of debt if the Fed continues to raise rates.
Through all of this, and on a national institutional level, commercial real estate (CRE) remains a stable asset as shown by the returns compared to that of other investment vehicles.
Dallas-Fort Worth Industrial
According to the Texas Labor Market Review, December 2018, the Dallas/Fort Worth/Arlington MSA total employment for the region was 3,733,500 as of November 2018, which is up by 96,900 over the prior year. The Dallas/Fort Worth/Arlington MSA unemployment rate was 3.2 percent.
The Dallas-Fort Worth industrial market continues to perform well as the metro has grown tremendously in jobs and population. There continues to be a significant amount of industrial supply delivered.
Industrial Case Study
The property is an 87% occupied, by 4 tenants, office warehouse. The building is 52,613 square feet and was built in 2001. The property sits on 3.75 acres of land. The average remaining lease term of all the leases was 2.0 years. The building has 20’clear heights, approximately 48% office, and a 102-feet truck court with a combination of dock high doors and truck doors. The NOI was reported to be $310,202.
This property is within a well established industrial park within the DFW metro area. The property sold in 2017 for $3,850,000, or $73.18 per square foot. This results in a capitalization rate of 8.05%. We note that the property was just below stabilized occupancy. We have added a lease up cost of $24,740 to the sale price as any reasonable buyer would not pay a full market price for a building below stabilized occupancy as there is a cost with leasing the property.
No financing was reported. However, this doesn’t mean that financing didn’t exist. If we apply market financing at the time of sale, we can acquire a leveraged (or cash-on-cash) rate of return for this non-institutional industrial property.
We use a loan term of 25 years for the amortization schedule, an interest rate of 4.75%, and 30% down payment. This breaks down into a down payment of $1,162,422 and borrowing $2,712,318, with the annual debt service of $185,561.
The debt service of $185,561 is deducted from the Net Operating Income of $310,202, which provides a cash flow of $124,644 annually. The $124,644/$1,162,406 down payment equals a 10.72% cash-on-cash return.
Of course my mind wonders how this compares to the surveys of institutional investors. The yield that those investors were achieving at the time of this transaction was 8.1%, while their capitalization rates were 6.40-6.80%. This is a spread of about 1.50%. The spread on the property being analyzed is 2.70%. Theoretically, the spread accounts for the growth in the value and income of the property.
Overall, it appears that the non-institutional property is trading at a higher return requirement as expected. This can be due to a number of factors related to length and durability of the income (ie. the ability of the tenant(s) to pay the rent, in good and bad times).