Real Estate Entrepreneurship – Mid-Term Case Study
MID-TERM CASE STUDY
The objective of the MID-TERM CASE STUDY is to analyze two single tenant development and investment opportunities, select one, and provide the rationale for your decision. The opportunities consist of:
1.) Renovation of an inner-city property for long-term use and occupancy by a charter school. The property currently supports a multi-story building comprising approximately 60,300 sq.ft. If you choose to pursue this project, you will acquire the property and completely renovate the existing structure. The charter school has agreed to an 18-year lease and will take occupancy upon completion of renovations.
2.) Development of an approximate 4.5-acre site for a full-service gas station / convenience store. The property currently supports a vacant cinder block building that is in disrepair and obsolete. The gas station / convenience store is part of a national chain, but the property will be leased to a regional franchisee with several other outlets in the region. If you choose to pursue this project, you will acquire the property and deliver a graded site to the tenant. The tenant will build its improvements and occupy the property pursuant to a 20-year lease.
In preparing this Case Study, you will assume an all-equity (i.e., unleveraged) capitalization of the project that you choose – in other words, do not assume that you will use debt financing.
All of the information necessary to complete this assignment is included in this document. It is not necessary to perform. any outside research or interview brokers, developers, or investors.
CHARTER SCHOOL PROJECT
Introduction
The “Hopkins School” has engaged you to locate a site to accommodate a new charter high school in a major northeastern city. You have located a suitable property and negotiated an 18-year lease with the school. The property is located on a primary boulevard and is across the street from a subway terminal and within walking distance of three city bus stations. In addition, it is located on the periphery of a major college with a student body of approximately 15,000. The neighborhood around the college has been transitioning over the past ten years and, although somewhat blighted, is becoming increasingly popular among millennials as both a residential and business address.
Project Summary
Over an expected 12-month time period, you will perform. a complete upgrade and redevelopment of the property from a delinquent Class “C” office building to a fully renovated, state-of-the-art high school facility. You will renovate the building façade and replace HVAC systems, roof, and windows to both improve the energy efficiency of the building and ensure long-term viability of the building as a secondary school. The interior of the building will be reconfigured to support classrooms, offices, meeting rooms, a commercial kitchen and cafeteria, bathrooms, and a gymnasium.
Charter Schools
Charter schools are public schools that do not charge tuition and operate under an agreement between the charter school and the local school district. Students can choose to attend local charter schools in lieu of their district-assigned public school. If there are more students who choose the charter school over the public schools, then a lottery is used to determine which students can enroll. In this locale, charter schools’ success and popularity is increasing with 176 charter schools and more than 128,000 students enrolled in the most recent school year.
Like public schools, charter schools are funded by the local (i.e., state, city, and/or county) government through the collection of state and local taxes. Charter schools receive funding based on the number of enrolled students. In this city, the per pupil revenue rate that charters are provided is nearly $8,000 for general education students and more than $23,000 for special education students. Once a charter is awarded, the school is provided three-to-five years to build-up a student body and demonstrate a successful education model.
Once the initial three-year charter period ends, the school must apply for a charter renewal; renewal periods are five years in duration. During each year of the initial charter period and every fifth year thereafter, the local school board will assess the school’s performance and conduct a full evaluation of the school. Reasons provided in the State Code for failure to renew a school’s charter are summarized as follows:
• A material violation of the terms of the charter that was drafted and submitted to the school board,
• Failure to meet student curriculum standards as set forth in the State Code,
• Failure to exhibit good fiscal management,
• Violation of federal laws from which it is not exempted such as those laws governing children with disabilities,
• Fraud conviction
In the event that a charter is not renewed, the school can appeal to a board of appeals. In extenuating circumstances, if the school board is unable to grant a full five-year renewal because of insufficient data/time for the school to realize its plan, the school board has a one-time option to extend the charter for one-year after which another review is performed to assess the charter for a full five-year renewal.
The Hopkins Charter School
The Hopkins Charter School was opened in 1999 and is one of the oldest charter schools in the state. Hopkins currently operates two charter schools in the city:
• A high school located near the CBD with a current enrollment of 500 students
• A 500-student middle school also located near the CBD.
The schools are located within a mile of one another. The student body between the two schools consists of 99% students of color, 86% low income, and over 15% special education. In the coming Fall semester, Hopkins will open its first charter school outside of the city.
Hopkins has a demonstrated track record of producing high academic results among low-income, urban student populations. Its most recent High School Performance Profile score outpaced all city schools with 71% of 11th graders scoring at or above proficiency in mathematics and 68% of 11th graders scoring at or above proficiency in English.
Hopkins has also had success matriculating graduates into college; 89% of the most recent graduating Class enrolled in college with an average scholarship per graduate of $59,665. Consistently, 85% percent of graduates return to college for their second year. Hopkins was the first charter school in the state to receive a National Title I Distinguished School Award and has been a U.S. News and World Report Best High Schools Bronze Medal winner.
Last year, Hopkins was awarded one of the five new charters issued by the school district, the first new charters awarded in in more than five years. The new Hopkins High School will provide a liberal arts and college preparatory curriculum that is focused on science, technology, engineering and math (“STEM”) disciplines with threads of entrepreneurship and computer programming. Its maximum enrollment is limited to 300 students in the first year and increases to 580 students in year three. Hopkins has a current waiting list for its existing high school of more than 1,000 students.
Project Budget
The project budget is as follows:
Acquisition $ 2,430,000
Transfer Costs and Taxes 48,600
Legal 50,000
Due Diligence 40,000
Survey and Title 28,000
Construction / Renovation 2,700,000
Interior Improvements 4,300,000
Architectural / Engineering 300,000
Leasing Commission 385,000
Developer Fee 135,000
Contingency 125,000
Total Costs $ 10,541,600
Hopkins School Lease
Terms of the Hopkins School lease that you have negotiated are as follows:
Term: 18 years
Rent Schedule ($/sq.ft.)
Year 1 $ 9.00
Years 2-3 12.50
Years 4-8 13.50
Years 9-13 15.00
Years 14-18 16.00
Structure: NNN
Other
In addition to the school lease, the property will also generate income by virtue of several rooftop antennae leases that require annual rents as follows:
Telecomm Co. #1 $ 17,000
Telecomm Co. #2 28,000
You have identified a third company that will pay $35,000 based on a five-year lease.
The existing antennae tenants have been in place for many years, and the property owner has not been able to provide the actual lease documents. The tenants refuse to provide the documents or execute new leases but have consistently paid the rents on time and without any set-off.
Comments
Properties leased to charter schools on the basis of long-term leases trade do not trade very often. However, you are aware that several transactions have occurred in the northeastern United States over the past year. Indicated “cap” rates have ranged from 6.5%-to-7.5%.
GAS / CONVENIENCE STORE PROJECT
Introduction
You have gained control of an approximate 4.5-acre site located in a desirable and well-established suburban submarket that is generally underserved by retail amenities. The submarket is generally affluent and well served by transportation networks. It, and the township in which it is located, are also known for being anti-growth and opposed to new development.
The property currently supports a former grocery store that is approximately 75-to-100 years old and has been vacant for at least 20 years. The building has been owned by family interests that have not resided in the metropolitan area for 25 years and have not attempted to re-lease or maintain the property since the former user vacated. In short, the property is an eyesore, but it sits at the entry to a small but popular downtown area.
Since gaining control of the property, you have secured a 20-year lease with a well know gas station and convenience store operator. The property is zoned and fully entitled for the intended use but has the physical potential to support an additional 10,000 sq.ft. of retail space. The use is not permissible by zoning, but you may be able to convince the township and community that a variance should be granted.
Location / Market
The property is located in a mature, densely populated, high income suburban market, with limited commercial land for development. Demographics are summarized below:
1 Mile 3 Miles 5 Miles
Population 5,934 65,904 142,149
Daytime Population 2,642 28,106 79,376
Median HH Income $96,040 $89,389 $92,873
Project Budget
If you chose to develop the site for only the gas / convenience store, project costs, you need only deliver a graded site. The operator / lessee will build its improvements. The budget will be as follows:
Acquisition $ 3,525,000
Transfer Costs and Taxes 30,000
Legal 50,000
Due Diligence 50,000
Survey and Title 20,000
Demolition and Sitework 250,000
Total Costs $ 3,925,000
Gas Convenience Store Lease
Terms of the gas / convenience store lease that you have negotiated are as follows:
Term: 20 years
Rent Schedule ($/year) $ 275,000
Rent Escalation 10% every 5th Year
Structure: NNN
Comments
Properties leased to gas and convenience stores on the basis of 20-year leases trade often; indicated “cap” rates have typically ranged from 4.5%-to-5.5% over the past year.
MID-TERM CASE STUDY ASSIGNMENT
You have joined a real estate investment and development firm and you have the talent and resources to pursue the opportunities summarized in the case study; you must determine which should be pursued. Your company has created some guidelines but does not yet have a precisely defined investment strategy. Both opportunities seem interesting and potentially capable of generating attractive returns, but you are unsure as to how to proceed until a precise investment strategy is created.
The company president has told you that he or she thinks the following minimum unleveraged guidelines are appropriate:
Internal Rate of Return: 7.0% to 8.0%
Return on Investment: 6.5% to 7.0%
Margin on Cost: 25%
Average Cash-on-Cash Return: 6.5% to 7.0%
The company president has advised that you are free to fully adopt or question and adjust any of these metrics as you see fit. However, if you do so, you must provide specific rationale for your recommendation. In other words, he or she has given you an invitation to suggest adjustments to the company’s investment criteria. You are free to add objectives that are quantifiable or unquantifiable (i.e., qualitative). The company president has not provided any direction as to the nature of his or her desired holding period (i.e., short or long term) and has asked you to also opine on this issue as part of your work on this matter and your opportunity to fully define your recommended investment objectives and strategy.
The company president has asked you to assess the opportunities and prepare a recommendation with supporting analysis. Your assessment should be based on both single and multi-period analysis and should take into consideration the relative costs and risks of each project. Prepare a brief memo with your recommendation and your supporting analysis. In addition to your recommendation regarding project selection, you must articulate a precise investment strategy and demonstrate how your objectives are satisfied by the project’s expected performance.