Acceptable IRR for a Redevelopment of a Shopping Center.
I am running a couple scenarios for a shopping center in our portfolio, which would require a demolition and re-development of a large portion of one our shopping centers for a credit (grocery store) tenant. We would most likely need to finance most or maybe all of the ~10 million cost to deliver the space. Given where we are at in the market cycle, increasing construction costs, what would an acceptable IRR be in your expert opinions? The space we would be re-developing has been vacant for almost 3 years now. Since we are eating all the CAM/RET costs now, I'm wondering if If I should show that revenue as all upside in my model, since our alternative right now is $0.
[{"id": "gue5r8a", "text": "In my opinion, the idea of target IRR is really based on each individual investor, their cost of capital, and what their fund requirements are, if they have one. Without that information, off the cuff I would say 20%+ IRR given the amount of risk here. The one benefit here is the credit tenant. Do you have a signed lease or pre lease for them?", "replies": [{"id": "gue6x8s", "text": "Not yet, we are trying to determine which rents we would need to support such the expensive buildout to negotiate. We won't spend anything until the lease is signed. When you say 20% IRR - are you talking project IRR? I'm trying to figure out how to model equity IRR if we finance 100%.", "replies": [{"id": "gue8d3v", "text": "If you finance 100% then your return is infinite.", "replies": [{"id": "guedgoy", "text": "I think what they mean is 100% of the redevelopment cost, not the existing asset cost.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "guegrqf", "text": "Agreed with this. Any redevelopment, core or not, should be projecting at least mid-high teens. for a redevelopment that requires existing demo I'd look for higher returns in the low 20's. \n\nIf you have guaranteed tenancy and guaranteed leasing, the IRR could be lower. I'd say at absolute bare minimum you'd go 15% IRR if you're guaranteed an anchor tenant lease and you're confident in your development. This is at absolute bare minimum however.", "replies": [], "depth": 2}], "depth": 1}, {"id": "gue6vwx", "text": "Hard to give deal-specific estimates without proper analysis ...with THAT said...people never want to hear that. \n\nSo, rule of thumb, Core is around 8-12%; Value-Add 12-18%; Opportunistic 18%+\n\nLevered returns before tax. Of course, the variation among a cohort can be substantial depending on lots of factors. But I would use that to anchor your opinion.", "replies": [{"id": "gue78eo", "text": "Thanks!", "replies": [{"id": "gue891y", "text": "No problem! Have fun with the analysis\n\nFYI - source is various industry reports, CAIA material, 10 yrs in institutional PERE, another 10 in broader commercial. All the best!", "replies": [], "depth": 3}], "depth": 2}, {"id": "gue7owz", "text": "Assuming capital event upon stabilization. Either refinance with take out/permanent loan or a sale at market cap.", "replies": [], "depth": 2}, {"id": "guegw97", "text": "Development projects by definition are going to be anywhere between value-add to opportunistic. Those numbers are only deal specific for acquisitions of existing.", "replies": [], "depth": 2}, {"id": "gueka4e", "text": "I work for a multinational developer. In no world would we ever build a project of any kind at 8-12%. Absolute bare minimum is 15% and we REALLY have to want to do the deal for that.\n\nI assume you\u2019re talking from a straight acquisitions standpoint and not development.", "replies": [{"id": "guem0zu", "text": "Yup, kinda.  By definition, a development deal would not be considered a Core risk/return .  When segmenting into Core, Value-Add and Opportunistic...development is going to be categorized as opportunistic investment.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gueixtl", "text": "15-20% IRR, based on your conservative/realistic exit cap rate projection. Also talk with architects/ development project managers to be sure of the cost estimate for the project. Also, bear in mind the exit cap is generally improved when you have a supermarket anchor tenant.\nWhen you figure out the costs for construction, as well as your financing terms and exit cap rate, be sure you solve for your desired IRR range by controlling the ERV (expected rent you'd get from the anchor). Figure it out, try to make a deal with the tenant at an acceptable rent and you're good.\nBe sure to get a good bonus afterward.\n\nAlso, by IRR I mean leveraged IRR at a 50-60% LTC. But it really depends on your opportunity cost /comparable transactions. Ask for the IRR of value-adds or measure with the IRR of your internal transactions. If you get a lease signed your IRR would be with a limited downside.", "replies": [{"id": "gueohl1", "text": "Awesome! Thanks for the thoughtful reply. Given our current cash situation I'm not sure we could put down more then 20% (As it stands today) Is this out a realm of possibility in this market ?. We already have a 55% LTV on the property itself, but this demo/redevelopment would require additional funding.", "replies": [{"id": "guerflo", "text": "Who is providing this funding? I have to imagine that a straight up construction loan on  a shopping center redevelopment where you're only putting up 20% of the equity is going to be exorbitantly expensive. Are you attempting to refinance the existing asset and roll the Capex costs into the loan?", "replies": [{"id": "gui59x7", "text": "Essentially Yes - We are refinancing the property, and this would be additional \"good news funding\" we don't anticipate a cash infusion from refinancing with our current valuation (post-pandemic). So we would need additional funds to cover the extensive LL Work for this deal.", "replies": [], "depth": 4}], "depth": 3}, {"id": "guezygf", "text": "Tenant matters a lot on this. You might be able to secure it with less than 20% if you have a good credit tenant. CTL is the name of this financing type.", "replies": [], "depth": 3}, {"id": "gugtj8y", "text": "You\u2019ve got debt on it and you want to demo a portion of the improved building with a new loan?", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}]