The very basic concept is if I was leasing from you but wanted you to build me my protottypical building, I would have to pay you a certain amount to give you a return on your investment. If you wanted a return of 10% as opposed to a 3% in the bank or 5% in municipal bonds, as due to the extra risk you need a higher return to compensate. And for example if I owned a drive-thru burger franchise whose total cost of entitlements, permits and construction was $1,000,000. Then you would need me to pay $100,000/year or $8,333/M @2,500 SF that would be $3.33/SF. If however The real cost of building is; land at $30 per SF x 50,000 SF=$1,500,000, construction at $220 x 2,500SF= $550,000, Misc (Legal fees,commissions,architectural) at$50,000 ,totaling $2,100,000. Then you would need to get $210,000 per year, but if no one is willing to pay more than $2.5 per square foot because of the supply of exisitng buidings then your real rate of return on an NNN lease is [($2.5x2,500SFx12months)/$2,100,000]=3.5 rate which would make it comparable to a money market account in return but signficantly higher risk, obviously numbers are hypothetical but show a horrible investement. Your return would increase if costs were lower and rents were higher. The bottomline, think like the most likely tenant who would realistically be interested in your land (for purposes of projected rent costs and if they dont make sense dont buy the land). It makes sense if your return can justify your risk tolerance which in all honesty is subjective on the developer.
Oct 21, 2008