I’ve got an idea that could be great for an ongoing series. Given Financial Samurai is an established site with a large community of investment savvy readers from all over the U.S. and the world, why not crowdsource our knowledge to see if we can make better investment decisions!
Real estate is my favorite asset class to build wealth long term because it is simple to understand, tangible, and rides the inflation wave. But buying physical real estate requires a large downpayment, ongoing property taxes, maintenance, tenant headaches, and often takes up a dangerously large percentage of one’s overall net worth.
Given I already have four physical properties, I’d like to diversify and reduce risk by surgically investing smaller amounts of capital in properties with higher rental yields from different parts of the country. San Francisco cap rates (net rental yields), for example, are only in the 2% – 4% range. This is where real estate crowdsourcing platforms come in. You can easily invest smaller amounts in different areas of the country with potentially much higher returns without betting the farm.
By 2Q2017 I will have a relatively large 4% CD in the amount of $340,000 coming due. Before then, I want to get comfortable with real estate crowdsource investing. My goals are: 1) geographic diversification, 2) beating a 4% yield in a low risk way, and 3) investing in commercial real estate given all my properties are residential.
Suburban Philadelphia Class-A Office Conshohocken, PA
Here’s a current offering RealtyShares just e-mailed to me. It’s a Class-A office building with 30,000+ square feet about 14 miles away from Philadelphia. With a target 18% internal rate of return (annual return over 5-year life of investment), I’m salivating like Pavlov’s Dog wanting to invest. But I know nothing about Conshohocken, PA real estate and need help from those of you living in the region and from those who’ve invested in commercial real estate before.
Pros
* Commercial property built in 2000 with a ~30% vacant rate for upside rental income potential.
* $172/square foot potential purchase price.
* Stronger than average demographics (see below).
* RealtyShares investors are entitled to a 10.0% IRR (including return of capital) before the Sponsor (real estate developer) receives adjusted economics. Furthermore, the Sponsor’s position is to be at 16.4% of the required equity for this project, which includes the conversion of its 2% acquisition fee into part of its equity interest. Proceeds above a 10% internal rate of return are to be split 75% to deal-level investors and 25% to the Sponsor, until such investors have earned a 16% annualized internal rate of return. Proceeds above a 16% internal rate of return are to be split 60% to deal-level investors and 40% to the Sponsor. In other words, there’s incentive for the Sponsor to maximize returns.
* Quarterly dividend payment.
* Haverford Properties, the sponsor, has participated in several billion dollars in transactions and currently own five projects that collectively represent more than $300 million in assets under management since 2012.
Cons
* 5 year term. Might be difficult for some people to lock up cash for so long. I’m coming from a position where I locked up cash in a 7-year CD, so 5 years is in the ballpark.
* $10,000 minimum versus $5,000 minimum for other deals. I’d ideally like to invest in two $5,000 deals to test things out, although one good $10,000 deal would make things easier to track and write about.
* Nothing is a guarantee. The 18% IRR is just a target. The sponsor might not be able to fill the vacancies with high quality tenants. We could enter a recession post election. The sponsor might not be able to sell as planned in five years etc. I generally like to cut target IRRs in half, and treat anything higher as gravy. People tend to overpromise, underdeliver all the time when it comes to raising capital.
* Was targeting Midwest and Southern properties, but Conshohocken seems similarly cheap.
* Haverford Properties has only been investing since 2012, although the LinkedIn bio of the co-founder, Charles Houder says he’s been at Haverford Properties since 2010. Perhaps there was no activity the first two years when he first started. At least Charles has been in the real estate investment arena since 2001, working for other firms.
Here is the official overview posted on RealtyShares that comes from Haverford Properties.
Property Summary
375 East Elm Street, (the “Property”) is a multi-tenanted Class-A office building on 2.7-acres in the Conshohocken submarket of Philadelphia, PA. The property was developed in 2000 and currently configured with six separate suites, five of which are expected be occupied at close. Of the approximately 9,000 square feet that will be vacant, it can be broken up into smaller suites or leased as a whole depending on tenant requirements. The tenants are generally characterized as professional type office users and include attorney’s and medical offices among others. Blended average in-place lease term and blended average in-place lease rate are 2.9 years and $23.80 PSF, respectively.
The physical condition of the building is reported to be good and the suites are in leasable condition per the third-party property inspection and the Sponsor’s feedback. The $25 PSF in tenant improvements budgeted for two new leases (6,042 sf assumed after 6 months and 3,021 sf after 15 months) is to most likely go to customizing the spaces and cosmetic upgrades. The $5 PSF budgeted for renewals (70% probability) is to either serve as incentive capital or for moderate upgrades.
Please refer to the Photos tab for pictures of the Property.
Property Details
Year Built
2000
Building Square Footage
30,266 Square Feet
Buildings/Floors
1 Building/2 Stories
Parking
128 Open Asphalt Spaces
Parking Ratio
4.2 spaces per 1,000 square feet
Investment Summary
RealtyShares invites its investors to participate in a common equity investment relating to the acquisition of a 30,266 square foot Class-A office building (the “Property”) located at 375 East Elm Street in downtown Conshohocken, a suburb in the Philadelphia-Camden-Wilmington Metropolitan Statistical Area (“MSA”). Developed in 2000, the Property is located approximately 14-miles northwest of Philadelphia’s Central Business District (“CBD”). Conshohocken is one of Philadephia’s most vibrant and successful sub-markets for suburban office properties, and is supported by excellent residential demographics and strong demand for office inventory (see Investment Highlights below). The 2-story multi-tenanted building is expected to be approximately 30% vacant upon acquisition, presenting the Sponsor with the opportunity to substantially grow revenue by leasing space at market rates and to negotiate market rental rates with existing tenants as their leases come up for renewal; most these tenants are currently paying below market rates.
Haverford Properties (“Haverford” or the “Sponsor”) is acquiring the Property directly from seller at a potentially attractive basis of $172 per square foot. The Property was identified by the Sponsor on an off-market basis and is to relieve the Seller of a negative cash flow situation caused by the recent vacancy of a tenant. The expected new loan facility is to provide for 18-months of interest-only payments (no amortization), which is designed to reduce the initial debt service burden on the Sponsor so that it has sufficient time needed to stabilize the Property.
The Sponsor is a diversified real estate investment and development firm based outside of Philadelphia, Pennsylvania. The Sponsor is involved in all aspects of real estate development and investment, including, but not limited to, acquisition, entitlement and project construction, management, asset management, property management, accounting, and underwriting. As reported by the Sponsor, it has participated in several billion dollars in transactions and currently own five projects that collectively represent more than $300 million in assets under management.
Please note that this investment is scheduled to close in September and is to most likely be debited late August/ early September.
Investment Highlights and Risk Mitigants
Top Office Submarket: Conshohocken is among the top submarkets in the Philadelphia Metropolitan Area (MSA) according to CoStar’s Mid-Year 2016 Report due to its low vacancy and high rental rates. Per CoStar, Conshohocken vacancy and asking rates are 6.6% and $30.47 Per Square Foot (“PSF”), respectively—substantially exceeding metro-wide office market averages of 9.3% and $22.16 PSF. Conshohocken is also the second highest rental rate submarket, behind only the neighboring Main Line submarket (per CoStar). From an underwriting standpoint, the Property is projected to stabilize at 8% vacancy and $27.00 PSF base rent, adjusted for inflation.
Strong Demographic Area Profile: The Property’s surrounding residential base exceeds state and national benchmarks in a variety of key metrics collected by ESRI (a demographic data provider) from U.S. Census data. According to this data, the 48,648 residents living within a 3-mile radius of the Property are generally high earning, well-educated, and employed in white collar labor sectors—aspects which can broadly support a successful office submarket.
The following table compares the demographics in the area with state and country demographics:
3-Mile Radius
Pennsylvania
USA
2016 Median Household Income (1)
$92,400
$53,805
$54,149
2016 Education: Bachelor’s Degree (1)
31.7%
17.9%
18.8%
2016 Education: Graduate/Professional Degree (1)
26.9%
11.7%
11.6%
2016 Unemployment Rate (1)
4.5%
5.9%
5.9%
White Collar Workforce (1)
78.0%
60.4%
60.5%
(1) ESRI
Well-Amenitized, Transit-Oriented Location: The Property potentially benefits from strong, transit-oriented connectivity with two train stations within a half mile and easy access to several major interstates. Downtown Philadelphia is a 45 minute commute by train and 20 minutes by car. The immediate submarket has a large variety of restaurants, cafés, and other neighborhood amenities, cultivating an archetypal live-work-play environment for its office and multifamily properties. To this end, 760 residential apartment units were recently completed adjacent to the Property and two additional developments of 595 Class-A residential apartments are planned.
Newer Construction, High Quality Asset: The Property was developed in 2000 to a Class-A standard. The Property is being purchased (off market) from a small operator who has meticulously managed the physical condition of the asset. The third party Property Condition Report performed in July 2016 found no deferred maintenance issues and no immediate capital expense concerns.
Value-Add Strategy: Near-term rollover should bring the occupancy of the Property to approximately 70%. Along with the $25 PSF budgeted for tenant improvements, the business plan is to leverage the Sponsor’s long standing brokerage relationships to attract tenants to the building at rental rates that are close to market rates, as well as to renew existing tenants (whose rollover is somewhat staggered) at rates also more consistent with those of the market. Underwritten new and renewal rent anticipates $27 per square foot (PSF), compared to $29+ PSF suggested by actual signed lease comparables in the area (see Lease Comparables in Documents tab).
Potentially Attractive Senior Debt: The Sponsor has signed a term sheet with Tompkins VIST Bank for a 10-year loan at 72.5% of cost with a fixed rate of 4.25% for the first 6.5 years. The loan features 18 months of interest-only payments before it begins to amortize on a 25-year schedule, and has no prepayment penalty if the property is sold to a third party. The loan is to be guaranteed by the principals of Haverford.
Favorable Transaction Structure: Deal-level investors (such as RealtyShares 248, LLC) are entitled to a 10.0% IRR (including return of capital) before the Sponsor receives adjusted economics. Furthermore, the Sponsor’s position is to be at 16.4% of the required equity for this project, which includes the conversion of its 2% acquisition fee into part of its equity interest.
Experienced Sponsor and Property Manager: Principals of Haverford have acquired more than $1 billion of real estate assets since 2012. Haverford is to be contracting property management services from Beacon Commercial Real Estate, which has been in business for over 17 years providing lease & sale brokerage and property management services to its clients in the greater Philadelphia area.
Management Biographies
* Don’t see world class institutions like The College of William & Mary and UC Berkeley, but at least both have graduate degrees and a decent amount of real estate investing experience. William & Mary and Cal are my alma maters, so I’m just having a little fun.
Investment Deal / Use Of Proceeds
* Nice to see $356,633 in reserves and $45,000 in working capital. It’s interesting to see that despite a purchase price of $5,200,000, $700,000 more is set aside (13.5%) for various reasons.
Sources Of Funding For The Office Building
* It’s always good to see a Sponsor have skin in the game. However, $267,433 is only 4.5% of the total sources of funding, despite being 16.4% of the equity. From a RealtyShares investor’s point of view, you want the Sponsor to put up even more capital. My preference is for 10% of the capital or greater.
Blue Sky Exit Assumption
* I still can’t believe it will cost a 5% commission in five years to sell a property ($365,339/$7,306,787). That seems outrageous given many of these deals are directly negotiated. Hopefully there is 1-2% upside in terms of commission savings here.
If You Invested $50,000 In This Deal
* If the deal pans out, an impressive 51% of your initial investment will be paid out in quarterly interest payments for the life of the deal. The chart also states that if you invest $50,000, you will end up with profits of $54,098 over a five year period ($104,098 total proceeds after initial capital is returned). That’s a 108% total return if all works out, or 18% annual return. But again, things tend to never work out as planned, which is why I cut my return assumptions in half to be more conservative.
INVEST OR PASS?
I’m itching to invest in my first RealtyShares deal and this commercial property in the suburbs of Philly could be it. But before I do, I’d love to get your feedback, especially if you are a real estate crowdsourcing veteran or live in the PA area. Every potential investment always looks good when you read the marketing material. But as we all know, not every investment turns out great hence the desire to crowdsource knowledge.
This investment is scheduled to close in late August / early September 2016, so I’d like to get my allocation application in before August 21, 2017 because I’ve noticed many of these investment opportunities fill up quickly. There are a lot of deals on RealtyShares that already say “join the waitlist.” Further, as I’m focusing on commercial real estate instead of single or multi-family home properties, supply is even scarcer.
Please feel free to be very critical of this potential investment. It’s always good to know all the potential red flags before deploying any capital. If there are any other investments on the platform that look intriguing, let us know!
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