135,000 square foot Cold store / distribution center in north east. advice needed
I’ve had a business deal that has pivoted in the 11th hour and need some advice on lease valuation. 

I have a long term customer/friend that is at end of career and in the later stages of life (upper 70’s). 

He has a business in the food space that is currently leasing production space and offsite cold storage. The premises are far too small for his operation and is causing problems to the growth and operations. (Business 1). I do not own any equity in business 1 but my business supplies business 1 with raw material. I know business 1 intimately including financials. There is an option on the table to buy out business 1 in 3 years or sooner if owner dies. 

We have a 50/50 partnership in a different business in the food manufacturing space (business 2). This business is not currently manufacturing but is formed and active pending construction of new premises. No financing yet. I already have a 3 year buyout and operating agreement on business 2.

Partner and I are very close to closing on land and financing for a 50/50 partnership in a real estate holding company (business 3). Part of the closing will be an option for me to buy out business 1 at a fair rate in the next 3 years, which will also buy out his 50% of business 3

Business 3 is a 135k sf chilled food manufacturing, office, dock space, and frozen cold storage on 13 acres. Land and Construction costs are estimated at $16m. Partner has built and sold the same business before and is knowledgeable in fit and construction of this purpose built building. Terms of the loan are 20 year amortization with floating libor 1 month + 350. Maturity 10 years which the bank has vocalized will be pushed to 20 if the relationship is strong. 30% of the build is a 20y sba at approx 3%. Owners are putting in 20% equity. We can also swap the floating for a 5 yr or 8yr fixed for a setup fee and breakage fee. 

I have extensive knowledge of the business and a network that I can call on in the coldstore construction if partner dies during construction. 

Business 1 will operate approx 75% of the facility and business 2 approx 25%. 

The questions I have are as follows:

1.	I need to make sure business 3 is protected and profitable assuming I do not take the option of buying business 1. My operating agreement obligates me to buying out business 3 within 3 years of signing, or sooner if partner dies. A specialized realtor advises leases of new builds in this space and area are 14-15 / sf blended with 10+ years in term. What payback metrics do you like to see strictly as a real estate deal? What return would YOU need to see to be taking 16m in debt, 20% down with the bank terms above. I assume this will be a NNN lease.

2.	do you see any major issues if the business operates 2 separate, independent tenants sharing one office, dock space and coldstore assuming property has been constructed for 2 tenants

3.	my current company that I am a higher up in (no equity) is a large entity in frozen food sales and distribution. They will most likely help out if business 1 fails. I am confident We can find a business to fill the space with our network. 

Happy to find and take professional opinion and advice as well with bona fide credentials thru DM.
[{"id": "gupt5e6", "text": "A lot to follow here. My knowledge of your businesses is limited to the frozen food aisle  so lets completely strip the operations from the real estate:\n\n1. What is the short/long term space need for business #1. Would they be your first choice for a tenant if you had vacant space at a property today? 70 is not that old in may cases.\n2. Is the property under construction for business#2 accumulative  or  competitive to the planned property in business #3?\n\nI'd consider underwriting each property with a couple of lease scenarios to determine what their value will look like in 3-5 years to a financial buyer or lender. Cold storage is it's own specialty, I think grouped with industrial,  you'll want to find some unbiased (uninvolved) opinion on the current capitalization rate that they are trading at in your area. The large brokers (CBRE/JLL/etc) probably have teams that focus on this who may publish market reports.", "replies": [{"id": "gupvy03", "text": "Hi\n\nIn answer to your question\n\n1.\tThe company would probably not be my first choice if it was completely arms length and I had no option to buy, but since I do it would most definitely be my first choice. The company needs this space to be efficient, drive profits and \n\n2.\tBusiness 2 will be the second tenant in the space, taking the other 25% of the building. The market in this space is sound and is a very good complementary business to business 1, utilizing the same customers and relationships for a different product category. There are also cost efficiencies and business defense strategies in offering the products of business 1 and 2 in the same delivered trucks to customers. \n\nI\u2019ve currently engaged a National brokerage that specializes in this asset for a valuation, but would want to know what a real estate investor would want for a return, assuming both businesses are credit worthy.", "replies": [{"id": "gv74xu1", "text": "Depends. If the investor was making an equity contribution in the development project a mid-teen's IRR seems like the floor, however keep in mind this would necessitate an exit from the property, likely through a sale. What you may be asking is the expected return on the purchase by an investor of the property once stabilized. That will be a function of the lease you sign with business 1&amp;2, their respective underlying financials, and a comparison of these to market rates. The brokerage can help with some lease and sale comps for similar assets which should point you in the right direction for a near-term sale.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gupxwzm", "text": "The right yield depends a lot on the credit quality of the tenants, the nature of their contracts, the facilities themselves and the operating history of the owner. \n\nI would guess that the tenants are unrated and not especially large.\n\nIn general, cold storage isn't like an office building where tenants pay some NNN amount for 20 years with 2% escalators -- the contracts I've seen are more often a function of pallet volume, shipments, how much stuff has to be moved around, etc. Essentially, the rent is commonly variable, although if you own/are related to all of these businesses, you can make it say whatever you want.\n\n16m sounds really really cheap. Modern cold storage facilities have all kinds of high-tech shit in them to track and move pallets. If you're just talking about an ordinary warehouse that's been turned into a freezer, like Americold runs, there are a lot of those out there and they tend to be disfavored by tenants. Again, you kind of own/run the tenants so you're really just monetizing the credit quality of those businesses and you don't really care what the alternate-use value is, but it speaks to the risk and return. Same thing with operating history - people don't want all of their product to melt/spoil, and they don't necessarily trust some guy who just built a warehouse yesterday, but since you can just make Business 1 and Business 2 sign contracts, you don't really care about that -- but if you ever have to remarket the property, it will matter.\n\nBig picture: \n\n1) this is really a set of affiliate transactions designed to monetize the credit of businesses that you/your partners already own - obviously you could hire some other cold storage warehouse but you're choosing to build instead of rent; so it's sort of doubling down on business 1 and business 2 instead of a true operational real estate play, and if it goes badly, you're not going to be able to find new unaffiliated tenants - the bank will take your warehouse. \n\n2) large cold storage businesses produce equity returns in the high single digits (it is a complex, capital intensive business) when at scale (many warehouses, many contracts) with high-quality tenants (rated, multi-billion dollar businesses); to deal with some affiliated unrated businesses in a one-off build run by some guy, I'd want to earn at least a 12-15%+ IRR, depending on tenant financials. You should also probably compare this project to simply renting space in a cold storage facility from a provider in the market - both in terms of cost as well as level of service and ease of management (after all, you own B1 and B2 and care about whether or not all of their ice cream melts even if you're paying rent to yourself).", "replies": [{"id": "gupzyvg", "text": "Thanks for input. \nYou are correct in everything you are saying. \n\nIt is not true coldstorage a la Americold or lineage, which would be twice the cost to build with all the bells and whistles. \n\nThis is a chilled food operation with onsite coldstorage. Someone may repack bulk seafood here into smaller packs, or debone fresh chicken and blast freeze it. That type of operation\n\nThose types of operations don\u2019t need the bells and whistles in automated palletized coldstorage with movable racks etc. \n\nNoted on the 12-15% irr. Appreciate you throwing a figure out and your insight on the operation.", "replies": [], "depth": 2}], "depth": 1}, {"id": "guq0xh9", "text": "Is the financing on Business 3 recourse or non-recourse?\n\nIs your partner obligated to take out a form of \"key man\" life/disability insurance? One of my tenants was obligated to do so for a USDA-backed \\~$5M loan, although idk if your partner would qualify for such insurance.\n\nWhat happens to Business 1 (partner main ops) if partner dies/incapacitated and you do not acquire that business? Is management in place to keep it operating 10+ years? *I would want a bank guarantee of the lease (letter of credit).* This will come at a cost to him so he probably won't want to do it. But this is the biggest component in my opinion to \"business 3 is protected and profitable\".\n\nIs Business 2 (new food mfg) dependent on Business 1 in any way, would it survive independently?\n\nRe: Two tenants, I don't have operating experience there but I would request of the architect that they build in maximum flexibility to adjust the facility split in the future. For example Business 1 shrinks while Business 2 grows, and you'd like to reallocate the facility toward 50:50, can that easily be done? Obviously speak with local planning to ensure facility can get two operating permits.\n\n*Personally* I would like to see a cash-on-cash return of around 15% to take on this debt, commit such significant capital etc. However this is about triple the value of my largest build-to-suit so I don't know if there is rate compression etc. I'd suspect it really depends on the bankability of the Business 1 lease which we can't comment on. You also have a startup taking 25% of the space, which we should assume will fail in &lt;5 years, from a real estate perspective. \n\nJust a few thoughts. I hope you have engaged a sophisticated real estate law practice to assist you with all of this.", "replies": [{"id": "guqfjv9", "text": "Not just for himself. Everyone should have their own counsel or it can get real ugly real quick", "replies": [], "depth": 2}], "depth": 1}, {"id": "guqdfql", "text": "Some accounting/tax considerations:\n\n1. Self-rental rules. Rental profit is active income while rental losses are passive losses. Are business 1 and business 2 taxed as partnerships, S Corps, or C Corps? Real estate (i.e. business 3) should always be pass through, never in a C Corp.\n2. How do you allocate rent for shared space? Do the businesses share staff? Are you going to have a new business, business 4, hire the shared staff, rent the shared office and bill back to business 1 and 2?\n3. Is Business 3 funding the cold storage buildout? I think once you have the building shell (including office space shell) then the tenants should be responsible for buildout costs. Business 3 can provide some TI allowance, but you need to look at how that amortizes over the lease term, how that affects your IRR (since you're looking to protect business 3) and how the TI themselves affects general marketability of the space to other tenants. Given the size and track record of business 1 and 2, rent credit in lieu of actual cash reimbursement from business 3 to tenants may be preferable if business 3 can service the debt over that time period. I wouldn't credit TI allowance against CAM charges in a NNN lease.", "replies": [], "depth": 1}, {"id": "gvc44xu", "text": "Cold storage is one of the hottest niches in CRE right now. 30 year Industral rep here", "replies": [], "depth": 1}]