Generally speaking, when you need financing, you pay interest or equity upside in the future in exchange for capital today. If you are able to achieve some kind of Adam Neumann-esque hat-trick and get paid to borrow money, you are more or less a genius. Enter CrowdStreet, a crowdfunding platform that has made geniuses of the otherwise mediocre. Yield-starved main street investors facing mediocre bond and equity yields will find their investing loins aflame when they see the headline 15% IRR / 2.5x equity multiple offered by Allen Morris in the Atlanta Star Metals Office. In fact the majority of Sponsor returns come from investor fees, and that this deal is fairly low reward and fairly high risk for investors. Let’s dive in!
Star Metals Office has been thoughtfully designed to be a Class A+ creative office tower to take advantage of its proximity to Midtown while also appealing to the technology, advertising, media and information sectors that are more drawn to creative office buildings. To kick-off the Project, the Sponsor has executed a 56,000 square foot pre-lease with Spaces (26% of Office SF), a leading co-working group owned by Regus (IWG) that exemplifies the entrepreneurial and creative spirit of the Project. The Sponsor intends to keep this leasing momentum going in a market that has seen recent corporate expansion or relocation from companies including Blackrock, Starbucks, Honeywell, Square, Norfolk Southern, Anthem, Salesforce, ThyssenKrupp, Google and Zillow. The Project is projected to deliver over a 7.4% return on cost providing an opportunity to achieve double digit annual cash on cash returns with moderate leverage. Projected rents could decline by ~20% and still achieve a comparable return on cost to purchasing a stabilized asset based on current market pricing. Star Metals Office is part of the Sponsor’s larger Star Metals District which will have over 1,600 people who live and work there on a daily basis and over 45,000 hotel guests annually. By combining a complementary mix of uses in a pedestrian friendly environment, each Star Metals project will have an inherent competitive advantage over other new developments.
These fundamentals seem great: Class A office buildings require large, price-insensitive corporations and Salesforce has a real penchant for real estate.
Comparables provided by the sponsor:
The comps that the sponsor provides are extremely questionable at best. First, these comparables are asking prices for “Under Construction” buildings, rather than existing rental prices for existing buildings. Additionally, while the Atlanta market does in fact just barely support $42 per square foot annual rents, they are for areas of midtown Atlanta that look like this ($42-$50/sq ft):
not like this ($32/sq ft)
In fact, the sponsor seems to be assuming $50/sq feet, and gets us to 15% IRRs.
In this insanely positive case of very stupid renters, interest expense still eats more tan 50% of project’s operating income, leaving just $5m of operating income from $11.8m pre-interest operating income. This wouldn’t be such a bad thing, but let’s see what happens when price per square foot gets cut even just a little bit, to a still-aggressive “Upside” case of $42/sq ft:
Uh oh — net operating income has fallen to $3.4m from $5m.
On a post-fee basis, investor returns for $43/sq feet are now only 40% over 7 years, equating to roughly 5% annualized returns. What’s worse, the Sponsor’s returns are still quite high: while investors have a 1.4x equity multiple over 7 years, the Sponsor, from fees, is still earning a 2.4x equity multiple. Unadjusted for the investor-to-sponsor wealth transfer, you both would’ve earned a 1.7x equity multiple.
It gets worse: what happens when we using existing rental comps for the actual Atlanta market? I.e., rental rates we know the market will support that we can be confident in? This is where things get really interesting:
Holy crap, the “guaranteed case” scenario only has us doing $900k of operating income net of interest expense.
Sponsors, on the other hand, are still made whole, primarily through fees collected from investors. Sponsors will literally earn nearly as much money from fees (~$600k/year) than the property generates in net operating income.
In summary, the “base case” for this deal is truly awful: I estimate that regular investors will see a *negative* 15% IRR, losing 60% of your investment in 7 years as the most realistic outcome, and seeing a 40% total return over 7 years in a very very positive upside case where never-before-seen prices per square foot in that part of town are achieved. *facepalm*
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.