Introduction:
The valuation of the investment was conducted using the Discounted Cash Flows technique. Multiple scenarios were ran; however, for the purpose of investment decisions, the "most likely case" will be reflected. Due to the nature of the triple net Ground Lease, Potential Gross Income is equivalent to Net Operating Income for each year. We will now examine the valuation of the Chick-Fil-A ground lease investment.
Assumptions:
Assumptions
|
|
Interest Rate on Loan
|
4.875%
|
Loan-to-Value
|
70.00%
|
Amortization Period
|
30 years
|
Discount Point Reduction (1pt)
|
.125% per point
|
“Going-In” Cap Rate
|
5.63%
|
Yr-1 NOI
|
$100,000
|
Purchase Price
|
$1,776,199
|
Acquisition Fees as % of Loan
|
2.00%
|
Holding Period
|
10 years
|
Yr-11 NOI
|
$110,000
|
“Residual” Cap Rate
|
6.03%
|
Selling Costs as % of Sales Price Yr-10
|
3.00%
|
Discount Rate
|
6.00%
|
For all loan assumptions, see the Financing Section of our Blog.
"Going-In" Cap Rate -
Currently, the property is listed at a cap rate of 4.75%. We believe, based on comparable fast food ground leases listed in the area (see table below), we can negotiate the cap rate up to a cheaper and more appealing rate of 5.63%. This represents the mid-point cap rate of the asking cap rate and the average comparable cap rate for the area. By achieving the expected cap rate, we will lower the asking price of $2,106,263 down to $1,776,199, a more reasonable purchase price.
Yr-1 NOI -
Cap Rate Analysis
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|
Comparable
|
Cap Rate
|
Whataburger 1
|
5.00%
|
Whataburger 2
|
8.12%
|
Jack in the Box
|
6.00%
|
Jack in the Box
2
|
6.47%
|
Pizza Hut
|
6.00%
|
Raising Canes
|
7.50%
|
Average Comparable
Cap Rate
|
6.52%
|
Asking Cap Rate
|
4.75%
|
Expected Cap Rate
|
5.63%
|
Yr-1 NOI -
The $100,000 year one net operating income is a result of the rent expense being charged to Chick-Fil-A for the first year of operations of the initial 15-year lease. While the Chick-Fil-A is a franchise store, corporate has signed a corporate guarantee form as part of the lease agreement, securing the NOI and scheduled rent increases for the first 15 years of the lease.
Acquisition Fees -
2% of the loan amount was assumed for the costs incurred with purchasing the property. The 2% takes into consideration the upfront fee for the discount point reduction in monthly payments, and the transfer and legal fees associated with investment in the property.
Holding Period -
The holding period is assumed to be 10 years. At the end of year 10, the ground lease is assumed to be sold and the remaining loan principle and payments will be paid off in a balloon payment with the proceeds from the sale of the property. The property will have guaranteed 5 years remaining on the lease at this time providing a desirable ground lease at the time of the sale.
Yr-11 NOI -
Yr-11 NOI -
In Year 11, the first scheduled rent increase is initiated at 10%, increasing NOI from $100,000 to $110,000. After the initial ten year period, the scheduled rent increase of 10% occur once every 5 years.
"Residual" Cap Rate -
"Residual" Cap Rate -
Given the uncertainty of the future, and for conservative valuation purposes, the Cap Rate at the end of the holding period is assumed to be 0.40% greater than the "Going-In" Cap Rate.
Selling Costs -
3% of the property's sales price in year 10 is assumed to be deducted to pay for the costs incurred for selling the property. Such costs include brokerage fees and legal fees associated with transferring the property.
Discount Rate -
The discount rate of 6% to be used in present value calculations was built up from the combination of a risk free rate and a risk premium. The risk free rate used was the 10 yr treasury yield of 1.92% adjusted up to 2.50% for our anticipation of higher interests rates in the near future. The risk premium is 3.5% and includes risks such as the liquidity premium and default risk on the leases. The discount rate is relatively low due to nature of the triple net lease agreement with a credit worthy tenant.
A 10-year DCF valuation, based on the aforementioned assumptions, was conducted in order to determine the potential return on the Chick-Fil-A ground lease investment and whether it is worth purchasing. The tables below summarize our valuation:
Selling Costs -
3% of the property's sales price in year 10 is assumed to be deducted to pay for the costs incurred for selling the property. Such costs include brokerage fees and legal fees associated with transferring the property.
Discount Rate -
The discount rate of 6% to be used in present value calculations was built up from the combination of a risk free rate and a risk premium. The risk free rate used was the 10 yr treasury yield of 1.92% adjusted up to 2.50% for our anticipation of higher interests rates in the near future. The risk premium is 3.5% and includes risks such as the liquidity premium and default risk on the leases. The discount rate is relatively low due to nature of the triple net lease agreement with a credit worthy tenant.
Discounted Cash Flows Analysis:
A 10-year DCF valuation, based on the aforementioned assumptions, was conducted in order to determine the potential return on the Chick-Fil-A ground lease investment and whether it is worth purchasing. The tables below summarize our valuation:
NPV with Cap Rate Sensitivity Analysis
|
|||
Worst Case (20%)
|
Most Likely Case (60%)
|
Best Case (20%)
|
|
Cap Rate
|
4.75%
|
5.63%
|
6.52%
|
Purchase Price
|
$2,105,263
|
$1,776,199
|
$1,533,742
|
NPV
|
($123,766)
|
$22,616
|
$127,793
|
NPV with Discount Rate Sensitivity Analysis
|
|||
Worst Case (20%)
|
Most Likely Case (60%)
|
Best Case (20%)
|
|
Discount Rate
|
6.50%
|
6.00%
|
5.50%
|
NPV
|
($545)
|
$22,617
|
$46,952
|
"Most Likely
Case" Discounted Cash Flows Model
|
||||||||||||
Year 0
|
Year 1
|
Year 2
|
Year 3
|
Year 4
|
Year 5
|
Year 6
|
Year 7
|
Year 8
|
Year 9
|
Year 10
|
Year 11
|
|
Projected Gross Income
|
$100,000
|
$100,000
|
$100,000
|
$100,000
|
$100,000
|
$100,000
|
$100,000
|
$100,000
|
$100,000
|
$100,000
|
$110,000
|
|
Other Income
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
|
V&C Loss
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
|
EGI
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
110,000
|
|
Operating Expenses
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
|
NOI
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
100,000
|
110,000
|
|
ADS
|
(78,958)
|
(78,958)
|
(78,958)
|
(78,958)
|
(78,958)
|
(78,958)
|
(78,958)
|
(78,958)
|
(78,958)
|
(78,958)
|
(78,958)
|
|
Before Tax Cash Flow
|
($532,860)
|
$21,042
|
$21,042
|
$21,042
|
$21,042
|
$21,042
|
$21,042
|
$21,042
|
$21,042
|
$21,042
|
$21,042
|
$31,042
|
Acquisition Fees
|
($24,867)
|
|||||||||||
PV of Selling Costs
|
($30,559)
|
|||||||||||
Sales Price
|
$1,824,212
|
|||||||||||
Balloon Payment
|
($1,007,526)
|
|||||||||||
Before Tax Sales Revenue
|
$816,686
|
|||||||||||
Most Likely Case
|
|
Leveraged CFs
|
|
Time
|
Cash Flows
|
0
|
($588,285)
|
1
|
$21,042
|
2
|
$21,042
|
3
|
$21,042
|
4
|
$21,042
|
5
|
$21,042
|
6
|
$21,042
|
7
|
$21,042
|
8
|
$21,042
|
9
|
$21,042
|
10
|
$837,728
|
NPV
|
$22,616.87
|
IRR
|
6.46%
|
Best Case
|
|
Leveraged CFs
|
|
Time
|
Cash Flows
|
0
|
($508,224)
|
1
|
$31,820
|
2
|
$31,820
|
3
|
$31,820
|
4
|
$31,820
|
5
|
$31,820
|
6
|
$31,820
|
7
|
$31,820
|
8
|
$31,820
|
9
|
$31,820
|
10
|
$751,419
|
NPV
|
$127,793.27
|
IRR
|
9.00%
|
Worst Case
|
|
Leveraged CFs
|
|
Time
|
Cash Flows
|
0
|
($696,833)
|
1
|
$6,414
|
2
|
$6,414
|
3
|
$6,414
|
4
|
$6,414
|
5
|
$6,414
|
6
|
$6,414
|
7
|
$6,414
|
8
|
$6,414
|
9
|
$6,414
|
10
|
$948,152
|
NPV
|
($123,766.09)
|
IRR
|
3.87%
|
Direct Capitalization Confirms Discounted Cash Flow Valuation:
Comparing a direct capitalization approach with our DCF valuation of the PV for the projected NOI cash flows over the holding period, we confirmed our DCF valuation. The average net difference between the two methods was $36,080. Compared to the DCF method, the direct capitalization approach, overvalued the worst case and most likely case values, but undervalued the best case valuation. The table below illustrates the differences:
Direct Capitalization vs DCF Valuation
|
|||
Worst Case
|
Most Likely Case
|
Best Case
|
|
NOI
|
$100,000
|
$100,000
|
$100,000
|
Cap Rate
|
4.75%
|
5.63%
|
6.52%
|
Value - Capitalization Approach
|
$2,105,263
|
$1,776,199
|
$1,533,742
|
Value - DCF Approach
|
$1,928,696
|
$1,754,639
|
$1,623,630
|
Difference
|
$176,567
|
$21,560
|
($89,888)
|
Average Difference
|
$36,080
|
||
Investment Decision:
Based on the DCF valuation, we have determined the following investment is a valid investment opportunity and worthy of our investment assuming we are able to negotiate the going-in cap rate up to 5.63% for a max purchase price of $1,776,199. Based on our valuation models, we expect to receive a NPV in the range of $14,000-$23,000 and experience an IRR of 6.46%. In addition to the positive NPV, the project provides a comfortable debt coverage ratio of 1.26 and no operating expense ratio because of the terms of the ground lease. 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 holding period, we believe we can turn the property over at a relatively low residual cap rate to a pension fund group in order to achieve a large lump sum and to pay off the remaining loan payments.
Sources:
U.S. Treasury Yields
Comparable Properties
Sources:
U.S. Treasury Yields
Comparable Properties
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