Unusual real estate investment...

[MCN]

Hi all,

 

I’m hoping to receive feedback on the following..

 

I have recently come across a somewhat unusual commercial real estate investment opportunity and was wondering what the curious minds here would make of it, in particular how to analyse it. I say unusual as it is more like an amortising bond or annuity type asset than a traditional piece of real estate.

 

Essentially, the owner is seeking to sell 20 years of future rental payments of a real estate lease but retain the underlying fee/ freehold title of the real estate.

 

As it is so unusual, I can’t be too specific with the details but they are as follows:

 

Asset: 20 years real estate lease payments

Location: Europe

Asking Price: €1.2m

Lease: Year 1 Pre tax net income €100k/yr, 20 year remaining with break option in 10 years, 0-5% annual increases depending on inflation

The land houses critical infrastructure for the tenant, who has recently invested significant sums into the site, so it would seem that the tenant is not planning to leave any time soon.

Tenant: Multinational corporate with multi Billion € balance sheet and BBB+ rating

 

My main issues are-

 

1. How to value this?

There is no residual value after year 20, so I imagine this is a straight forward dcf valuation. And, depending on the annual increase in the lease payments, the asking price seems to discount the cash flows at between 5.5% and 10.2%. However, how to factor in inflation risk?

 

2. There is no collateral if the lease fails or the 10yr break clause is triggered. How to hedge/ insure?

 

3. Liquidity. Non, pretty much locked in for the duration (unless it can be flipped?)

 

Considering that the tenant’s long term bonds currently trade at a yield of 2.77% I’m wondering if this could be considered a cheap bond investment?

 

I don’t like the idea of locking my money up for 20 years at a low yield so will most probably walk away but I am tempted to look into this further for any possibility of flipping to a bond investor. So I am wondering how would they look at something like this?

 

Please feel free to throw rocks at this, all comments appreciated....Thanks!

 

[nkp007]

Sounds like a mess if #2 happens.

[netnet]

Sounds like a mess if #2 happens.

And that is not even the worst case!

 

You have no collateral, you are depending on contract enforcability, the tenant not leaving, the fee holder working for you and no inflation.  Worst case you are litigating against the landlord in year 2. Landlord is uninterested in the upkeep. Tenant gets pissed leaves in year 3 (maybe sues both of you) and the landlord has 0 incentive to get a new tenant. And there is a Euro crisis. (My assumption here, from your description, is that you only have a right to payments, you are in fact not a lease holder.)

 

This is priced for perfection, i.e. no margin of safety. At 300K it is interesting; at 1.2 million not so much.

[sleepydragon]

What if guy who sell you the lease has insider knowledge and know the lease will go bad in a few years? Maybe negotiate a “put” so u can put the lease back to him, but then there is counter party risk. Also you can’t diversify (it will work if you have 10 similar deals like this)

 

[bizaro86]

I would consider buying this if I had leasehold registered on the title and control of the property. I would also want to be sure the property could be leased to someone else for a comparable rent. I would probably want a 10% IRR though.

[michaelj]

Is the LL selling you a leasehold interest or simply assigning you rental payments from the lease?

[bizaro86]

Is the LL selling you a leasehold interest or simply assigning you rental payments from the lease?

 

I agree this is a key question, and one you should evaluate with a RE lawyer in whatever jurisdiction this is in.

[Sunrider]

Set yourself up a little scenario model in excel with inflation rates and some default assumptions on the lease payments. Choose a discount rate, DCF, look at the distribution of values ... pretty straight forward.