It's a space I am increasingly fond of lately and wanted to get an idea of profitability here. For example, I own a pretty good piece of land. On one side there is a Wendy's on the other is a McDonald's, so the location is pretty good for another restaurant chain. I am just trying to understand the true development costs of these assets. I got some relationships with some fast food chains that are interested. The question is how much money can be made in the development and sale of these type of assets. Since they are NNN with strong credits and long leases, they are essentially treated like bonds by the investment community. They are selling for several hundred to nearly a thousand dollars per square foot. So is it easily possible to construct lets say a Taco Bell or another strong chain for an 8 cap and sell for a 6 cap or are the margins not that high for developers? It doesn't even have to be fast food, could be a bank branch, etc.
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We do BTS, not exclusively but we have a land bank in a very high land constrained area of the country. This is for industrial.
The BTS play is basically a land play which is high risk, high reward. The developers margin is made in two way: cost to build vs price to sell, which unless you're in Podunk USA should have a favorable margin; and what you got into the land at and its carry (this is where you make the most money).
All your risk in BTS come down to land carry and construction costs. Generally construction costs vary but not wildly, land value varies wildly.
I'm not quite sure the question you're trying to ask but I'm happy to answer anything you might have. You can also just ground lease the building to a potential tenant if you don't have the cash or don't want to carry the construction risk although you'll end up limiting your return.
I guess what I am basically trying to understand is the development cost involved here. For example, a McDonald's trades for 3.5%-4% cap. Is it possible to develop one for a 7% cap? A lot of these asset's values are based on the credits, however, there seems to be nothing special about the buildings. When they sell they trade for several hundred per square foot even if they are in tertiary markets.
Are the margins really that high? You mentioned land carry cost being an issue, but do you mean simply things like property tax or are you referring to time value of money? Also development of these smaller BTS properties can't take too long.
You mention that you mainly do industrial. Do you have a pretty sizable spread between development yield and selling cap rate?
That's the value a build-to-suit developer or merchant builder brings. Ability to develop & construct an asset at a favorable basis in the current market. That, or in your case, a relationship with a national credit retailer that wants a new location.
I sincerely doubt anyone here is going to be able to give you a specific answer as to how to determine the cost to construct a McDonald's. I don't even think it's a question that can be answered, because the answer will always be specific to the individual deal.
That said, a former coworker now works for a development group that is a merchant builder of student housing. The group is a division of a national contractor, and most of the guys on his team have construction backgrounds, so they know what it costs to build. His rule of thumb is that if he can develop a project at a cost basis 200 bps wider than the cap. rates where comparable stabilized assets are trading, that project gets a green light.
Cool. Yea, I know its impossible to determine cost because it depends on market, I was just making sure that there are sizable spreads that exist for developers. These small NNN retail assets trade for millions even in podunk areas. The cost to build them would be extremely cheap, so just making sure my eyes weren't deceiving me.
I talked to an experienced retail developer about this recently. Land is out of control, so that is where you will get squeezed - in between the cost of the land and the rents that your tenant will be interested in.
What are the NNN rent rates in the area? What is the going cap rate? Ask a builder how much he thinks it will cost to deliver the fast food chains requirements. Is there a spread?
I think it all depends on lining up the tenant and buying the land. If you're site is at a prime location where everyone knows that a NNN user is really going to want it, the land will be expensive, the spread is going to be tighter and your profit is going to be lower. If you find a sticky situation that's going to take some expertise or a good relationship with a user, you will likely be able to buy the land cheaper and increase your profit...
My two cents would be that quality tenants that push the take out cap rate down understand the value of their leases and this pushes the rents down or the incentives up. Make sure the rents you are looking at are based on the tenant and not general no-name retail rents.
Def plenty of money in the space though, especially if the deals are in a deal size sweet spot between what individuals can afford and what big players need to justify getting into it.
I've been wondering about this too, but it seems like it's hard to find good info about how build-to-suit deals work. Let me see if I've got this correct:
Buy a piece of the land in a suitable retail area for as cheap as possible
Contact national retailers to see if they would be interested in a build-to-suit deal
Allow the retailer to hire a builder to build the property
Make money from the ground lease, and keep all improvements on the land, including the building, once the ground lease expires?
If this is incorrect, please let me know. Also, does anyone know about any resources I could use to study this more in depth?
Bro, I've googled it before... Lol. I was almost correct.
Almost.
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