Executive Summary

Potential Investment:

In April of 2012, our company ran across a potential ground-lease investment just south of downtown Houston. The property intially caught our eye because a brand new Chick-Fil-A was being built upon the land, with Chick-Fil-A bearing all of the costs associated with land improvements and leaving us with no operating expenses and no risk of collection loss for the length of the 15 year lease.  Looking to add less risk to our portfolio of property investments, we began our due diligence to determine the investment potential of the Chick-Fil-A ground lease.

Market Analysis:

The property benefits from the heavily populated south Houston area. With Chick-Fil-A as the tenant, the investment both benefits and suffers from a fast food heavy location because of the potential for customers but also more competition. A major strength is the location along a busy freeway entering downtown Houston, so drivers who go to work, people entering or passing by Houston are all potential customers. A significant density of the target market, which comprises of low-medium income households with an average annual income of $31,888 - $46,759, is located with a half mile of the property. A large customer base for our tenant is comprised of George Sanchez High School students, which is across the road and Houston Community College and University of Houston students, which are in close proximity. The asking price of this property per square foot is $487.67, which is cheaper compared to the comparable properties that we have listed. A major benefit of this property is that it is a ground lease and  Chick-Fil-A  will pay all the expenses related to the construction of their building.

Financials:

Going into the investment, we knew right away, the asking price of roughly $2.1 million was overvalued for the market.  We believed a more appropriate cap rate was closer to 5.5% which would lower the purchase price into a more reasonable and rewarding purchase price of about $1.75 million  In order to take on the investment, it was determined 70% loan-to-value financing would be necessary. The terms of the loan would consist of a 4.875% interest rate and a  30 year amortization period. With the lending terms determined, our firm valued the investment using the Discounted Cash Flows method and confirmed this value with the direct capitalization approach.  Our DCF model revealed a large sensitivity to the cap rate and gave us a clear picture as to what we needed the cap rate to be going-in in order to be a profitable investment. Our company strategy allows us to take on projects with a lower than normal discount rate than most real estate investors such as this one where we have a required rate of return of about 6%. Upon completing a DCF, we determined the property to be a positive NPV investment ranging between $14,000 and $23,000. In addition, the IRR on the investment would be roughly 6.46%.

Investment Decision:

Based on the DCF valuation, we have determined the following investment is a valid investment opportunity and worthy of our investment at a minimum going-in cap rate of 5.63% for a max purchase price of $1,776,199. Considering the credit worthiness of Chick-Fil-A, and the terms of the lease, we believe the riskiness of the investment to be relatively low over the course of the holding period. In addition, we believe the property will require a low level of involvement on our behalf over the course of the holding period, thereby allowing us to be more efficient in our other investments and prepared to enter new investments. We plan to take advantage of the steady cash flow stream the investment will supply in order to offset our more risky investments.  At the end of the 10-year holding period, we believe we can turn the property over at a relatively low residual cap rate to a pension fund in order to achieve a large lump sum and to pay off the remaining loan payments.