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SL Green's Mysterious Cap Rate Calculations, And Budding Israeli VoIP Operators-cum-Midtown Real Estate Investors
Today, SL Green announced a preliminary sale transaction (subject to assumable financing, an out wider than VaR exclusion loopholes) which is supposed to herald the coming of the new mid-town CRE renaissance. An ebullient SL Green CEO Marc Holliday had this to say: "This is a first, but significant step
towards the sale of interests in 485 Lexington Avenue. If ultimately
approved, the transaction would demonstrate that the Midtown Manhattan
office market continues to stand as one of the world's top locations
and that investor interest is once again on the rise." Zero Hedge is waiting with baited breath for the Holliday mirage to dissipate, while in the meantime Class A office space in 767 Fifth Avenue can be sublet for $60/sq foot.
But back to the story. The building in question is 485 Lexington, in which SLG sold a 49.5% interest which presumably translates into an implied valuation of $504.2 million. According to Bloomberg, Dan Fasulo, managing director at Real Capital Analytics couldn't find enough superlatives to describe the deal:
The deal may be a “a real wake-up call” for investors expecting further declines in Manhattan office prices, said Dan Fasulo, managing director of Real Capital Analytics. New York office values have fallen 30 percent to 50 percent since peaking in late 2007, according to FirstService Williams, a New York- based brokerage.
“The fact remains that significant demand exists for well- leased, well-located Manhattan property,” Fasulo said in an e- mail. “There is only a finite amount of supply available at current market pricing.”
Yet despite Fasulo's exuberance, Zero Hedge has some questions about the transaction. In the SLG press release, the REIT announced the transaction had an implied cap rate of 6.25%. However, a cursory look at SL Green's 10-K highlights the total revenue generated by any given of the company's office properties. And according to the below table, 485 Lexington generated an annualized rent of $48.7 million in 2008.
Now Zero Hedge's math may be rusty, but the cap rate on a property that generated $48.7 million in rent and subsequently sold for a $504.2 million valuation, indicates a cap rate of 10%, just a little off from the presented 6.25%, and roughly 2% in the wrong direction from this property being indicated to be the CRE renaissance case study that Messrs Holliday and Fasulo would like it to be. Alternatively, 6.25% cap rate on a $504.2 million property is $31.5 million. Did 485 Lexington, whose key tenants are Citi and Travellers, somehow lose 30% of its rent-based cash flow in 6 months? Which begs the question: how many other REITs are seeing comparable 30%+ decline in rents from existing core, anchor tennants in the span of less than six months.
If that is indeed the case, Zero Hedge applauds the sale of 485 Lex to a hapless buyer group led by Israeli-based Optibase. Considering that Optibase's describes itself in its "About" section as "a pioneer and market leader in advanced video over IP solutions,
specializing in video encoding, decoding and streaming for government
and law-enforcement agencies, military bases, Telco operators,
enterprise organizations and the world's leading broadcast service
providers," one would be hard-pressed to blame the VoIP company in making a massive miscalculation in its first half a billion dollar, Midtown office property purchase: after all everyone needs to diversify, even if one needs to upgrade from an abacus to a calculator first.
That all being said, if Zero Hedge is making any fatal error in said cap rate calculation, we would be happy to acknowledge our stupidity, and thus solicit reader commentary as to how a 10% property can mysteriously be sold as a 6.25% cap rated office building. In addition we will reciprocate by diversifying, and purchasing a 6.25% office building in Tel Aviv as soon as our balance sheet allows, or as soon as Wachovia is willing to finance a West Bank project at comparable terms as the SL Green deal.
And here is some additional color on the WBCMT 2007 C30 ($315MM) and MSC 2007-HQ11 ($135MM) deals. Hopefully Optibase is aware the deals are watchlisted, with the WB deal designated at 1.04x DSCR at 99.6% occupancy at March. One can hope Optibase gets a nice rebound in the market prior to 2016/17 when Travelers' and Citi's leases expire. Also, you can likely kiss your Nortel rent revenue (floor 18) goodbye and DSCR<1 hello.
And just in case there is any confusion, here is a snapshot of the reputable VoIP Optibase, unfettered by a $20MM+ market cap. Is it a coincidence that Optibase's entire cash contribution to the transaction was limited to the entire company's market cap?
Is this some evil joke SL Green is trying to pull? Who made how much money on this transaction that is supposed to herald in the golden age of the midtown CRE boom?
h/t Bankster and Ed
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CRE seems to be the popular asset class being flogged these days. I see something different - so I sold all my Goldman stock this morning (bought ~6 weeks ago) and bought December puts on VNQ.
Could it be the difference between net operating income / cap rate = value versus revenue / cap rate. Not sure if their information shows revenue or net operating income.
Can't be bothered to look for this, but it s/b somewhere. $48.7/.0625 = $779mm. A 35% chop in "valuation?"
10% cap is closer to market. Either that's the actual rate, or they discounted the future income and used the 6.25%. Stupid to be buying any CRE unless you price in 50% occupancy for three to five years.
Isn't there a divergence on CRE values between REITS and CMBS equal to almost 25%?
Hmmm, which do i believe? Speed ball fueled equity rally or something resembling price discovery (CMBS).
TD, nothing i enjoy more than watching you stir a pot.
Net Operating Income is used when determining cap rate not revenue, so NOI of $31.5 million may not be that far off the mark for a building with $48 million in revenue. This building probably would have been a 4% cap in 2007 so 6.25 isn't great for the market, of course it will be 8-9% by next year
- REIT Analyst
Frankly, I'm surprised it's still as low as 6.25%. I think that 9% is the low-end projection for next year.
i concur
The Rich says"
good articles;
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exactly, subtract a 5% management fee, RE taxes, utilities and CAM and you could easily be at $31m when subtracred from the adjusted rent.
I also agree on the 8-9%, underwriting is being done at 7.5% right now and I think mentally we all think 8% is a good deal if you have a good tenant roll. Personally though I think class A space will still be highly sought after and command a historically large spread over class B and C properties.
Yup
Just more of the same, poor analysis by ZH turned into a "shocking discovery".
How he could profess to having any clue as to what he is talking about in CRE and then proceed to write that length of a post on something we saw instantly as error is stunning. But after seeing him do it time and again, its becoming less surprising.
But the good news is the devoted will continue to believe the BS. I keep expecting to one day to see a Zero Hedge weekly showing up next to the checkout line at the local supermarket with a picture of a boy who was born part human, part bat.
"picture of a boy who was born part human, part bat"
You mean Tim Giethner? I mean, come on, look at those ears...
The cap rate is based on Net Operating Income (NOI)/Price so you need to subtract the operating expenses from the $48.7M in rent. I would guess somewhere around $20M. You would also then need to add back operating cost recoveries to get to the NOI number.
$20 mm in opex is normal? maybe, if you operate the Bellagio fountains in the atrium, have a gold plated facade that needs polishing every day and operate a shift of 10,000 illegal romanians vacuuming and polishing everything (and I mean EVERYTHING) that is not nailed down.
"a gold plated facade that needs polishing every day"
I just can't resist. Tried, but gave in...
X4 Labs to Create Solid Gold Male Enhancement Devicehttp://albany.bizjournals.com/albany/prnewswire/press_releases/national/...
No, adjusted rents are $41m then you have a 5% management fee, 1% in utility and maintenance costs and then probably $5m in RE taxes and you could easily have $10m in net operating expenses. Unless the rent numbers are tripple net then the 6.25% number is right. Remember that 2 years ago REITs where paying as low a 3.5%-4.5% for class A buildings in the K street corridor in DC. 6.25 seems a bit low in this environment but with the cheap financing CRE reits have had and they ridiculous prices they have paid in the past 6.5% doesnt phase me. I personally would be buying at an 8% if you can find it, but I think that is doubtfull.
That fatazz Fasulo will be eating his words in 12 - 18 months.
Maybe dumb-dumb Fasulo but in any rational business model there is a direct correlation between income and expenses. Many businesses are making less revenue because consumers are spending less.
Reader comment on ZH mathmatical abilities requires completion of the ZH mathmatical question at the end of the comment box. Beware of the computer hunting robots.
In economics, hope and faith coexist with great scientific pretension. - John Kenneth Galbraith
It would seem as though some folks are electing to operate a business premised upon economic models rather than what has been referred to as sound business precepts.
ya'll forget that Madoff money had to get laundered somehow
The laundry only counts if you can extract your property at the end of the cycle.
At least this is the operating belief of those that supply the primary source of revenue for the great global money laundry circle that has been providing well in excess of 2 trillion in global liquidity each year. The failure to be able to extract their earnings -fees will cause a a far greater crisis than what has been experienced here to fore.
“The fact remains that significant demand exists for well- leased, well-located Manhattan property,” Fasulo said in an e- mail. “There is only a finite amount of supply available at current market pricing.
1. Get Manhattan Office Space
2. Steal underpants
3. ?
4. Profit
Pete
here's the take from the guys who arranged the deal
http://www.carltongroup.com/WebPR/2009_7/7.htm
Carlton represented international investors from Israel and Nigeria
So those emails from Nigeria were true!
I actually looked at this deal. CW had the listing and the NOI was reported to be approx. $31.5 million in the CIM. As a number of commentators have already noted, TD your math is off because you are using gross rental revenue as opposed to net effective. You need to deduct your non-recoverable expenses from your $48.7 million to arrive at a net effective NOI.
I'll guess it is actually a U.S. gov't sponsored indirect funding of a high-profile CRE deal in a desperate attempt to create a fundamentals-free, hopetastic CRE rally.
I'll also guess it is an Israeli "defense contractor" just cooperating & dropping a little pay-to-play chump change to score some political capital or a much bigger defense deal. Just a "fun" guess... that the economics are a moot point... for this particular deal.
Interesting.
If so I would look to see if there is a licensing agreement going into effect in Singapore in the near future.
You are right, and you will see much more of this as CRE implodes. The U.S. government is going to call in its chips for this disaster. There will be many "deals" which are for see-throughs and are done just to keep panic at bay. People should really examine the San Francisco commercial real estate market more closely. This is the most corrupt area in the U.S., probably the world.
But I still don't think Yellen will be Chair. I think it will be Geithner. It's his reward. For financiers, it's like an appointment to the Supreme Court.
Wasn't there a recent deal at 250 Montgomery that raised some questions as to weather the total haircut was the 60% as advertised or closer to 80% or more?
I actually looked at this deal. CW had the listing and the NOI was reported to be approx. $31.5 million in the CIM. As a number of commentators have already noted, TD your math is off because you are using gross rental revenue as opposed to net effective. You need to deduct your non-recoverable expenses from your $48.7 million to arrive at a net effective NOI.
cant analyze this deal without valuing the off market terms on the assumable financing. disingenuous of the company to tout the 6.25% cap as representative of what was paid. implied cap was surely much higher.
There isn't enough info here for a proper valuation with no idea on expenses, but at minimum you would use Net Effective Rent for a calculation: 45.14*921,000=$41,574,000/504,000,000=8.25%
http://www.televisionbroadcast.com/article/84852
As of June 30, 2009, Optibase had cash, cash equivalents, and other financial investments, net, of $38 million, and shareholder equity of $37 million, compared with $28.8 million, and $38 million as of March 31, 2009.
hmmmm
same poster....pretty high leveraged deal
Must be a bit more to the story on who exactly is buying this thing. Another company with the same terrible name?
There isn't enough info here for a proper valuation with no idea on expenses, but at minimum you would use Net Effective Rent for a calculation: $45.14*921,000=$41,574,000/$504,000,000=8.25%
this deal is a joke...no way, any investor, neophyte, or not, is going to buy an office building based on a 6.25 cap rate of in this environment...just ain't happening.
either there are major rent bumps built into the lease terms, all with high quality credit tenants, or a lot of space is leased way below market (doubt either one).
therefore, in my opinion, it can only be a bunch of smoke getting blown up our collective skirts...costar website shows the deal terms as optibase coming to the party with 20.79 mill for 49.5% of the deal. plus they assume 5.67% interest only loan on $450 million, due in 2017 (sweet deal..that part).. further, optibase supposedly will loan $20 million to sl green, using green's 49.5% remaining share as collateral..final analysis, sl green keeps 1% of the deal. i am not a math whiz, but 20.79, plus 450 million, plus even another 20 million (if green walks away), plus sl green 1% does not add up to the headline number....
sounds like someone from the cbo, or one of the bac/citi eggheads dreamt these numbers up..definitely not a gs boy....they can count. only too well.
So based on an assumption that Optibase is assuming 49.5% of the total debt on the building we can assume 900 million in debt on a building with $60 million in NOI, which is 6.66% coverage.
The loan is at 5.67% interest only so their is a net return of 1% per annum on the building now.
Apart from it being a very slim margin before the building starts running cash negative, (only one small tenant needs to stop paying), if they really did sell at 6.25% on a building yielding 60 million net then that values the building at 960 million with $900 million in debt on it. Any cap rate above 6.66% puts the loan underwater. If the market cap rate is really 8% then the building value is $750 million or a 17% write down on the loan today (and that's assuming no tenant losses or rent reductions).
Hard to see rents rising in the near term so optibase is basing its underwriting on cap rates falling! And SL Green is looking at still holding half a building that in the very best of circumstances has no value and more likely is already underwater and probably going to sink further
10% cap is closer to market. Either that's the actual rate, or they discounted the future income and used the 6.25%. Stupid to be buying any CRE unless you price in 50% occupancy for three to five years...but is that with theThe Rich says"
good articles;
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to clarify what others have said. the 48.7m is gross income. portfolio-wide, their 2008 gross income is 1.116b and their operating expenses and taxes (and ground lease rent) comes to 388m, roughly 35%. knock 35% off the 48.7m and you get 31.5m, or 6.25% of 504m.
anybody care to name the last tech company that successfully moved into real estate investment?
There's a dirty little secret to Manhattan real estate. The incentives, such as a few months free rent, or whatever, is signed on a seperate document, which of course is not shown to the Bank with the leases.
That's "bated" breath, not "baited."
i make that mistake on purpose every time and time how long before i get the obligatory correction.
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"i make that mistake on purpose every time and time how long before i get the obligatory correction."
Just trying to help, dude, because I love you.
Lissen, TD loves bate and switch.
Bernanke said everything was okay the whole way down. How could he not be correct in his assumptions this time?
http://www.youtube.com/watch_popup?v=HQ79Pt2GNJo
What if, just a thought, "someone" new that the dollar was on the way to major devaluation over the next couple of years and is looking for somewhere to convert a large anount into something tangible. Many are saying massive inflation is coming and, on a dollar basis, this deal may seem cheap in a few years...
The crazy thing here, whether the cap rate is the company's 6.25% or some higher number, is that this company's equity, levered approximately 12x, is trading at a sub 5% cap rate. At yesterday's high the number was closer to 4.5%. Hello Mr. public equity buyer!
SL Green Transaction:
As others have pointed out, cap rates are based off of NOI, not off of rental income.
However, the key point of this story is how little this deal does for SL Green. A sale of a 49.5% interest, based on a $504 million valuation for a property with $450 million of debt, means SL Green will clear, at best, LESS THAN $27 million.
This property is highly leveraged, assuming that the implied sale price makes sense.
Plus, what other benefits does the Israeli buyer get ? Is this a straight equity deal; or is it preferred equity (meaning is the buyer's new capital senior to, or have preference over, SL Green's remaining "equity").
In reality, it looks like a minor "sale" of the building by SL Green where they get to retain the management and leasing (fee income) and have a hope certificate for any equity upside.
Nothing to pop the stock, that's for sure, and the lack of full disclosure regarding the transaction details (a transaction that ultimately may not close) is a bit suspect.
Here is another nugget on the transaction:
After the transaction closes, Optibase Ltd. and Gilmor USA plan to provide the seller with a $20 million loan, which is secured by SL Green's pledge to sell the remaining 49.5% interest in the building. SL Green would retain a 1% interest in the property.
-----
This deal seems almost like a call option on Manhattan real estate for the buyer. Hopes the market recovers by the time the loan comes due.
"James Kuhn, president of Newmark Knight Frank, noted that the strengthening stock market and improving employment outlook are encouraging more buyers to consider purchasing buildings in places like New York City. Yet, he said, there was no way this deal could have worked without having the existing financing in place because lenders are still not financing major real estate purchases"
http://www.crainsnewyork.com/apps/pbcs.dll/article?AID=/20090810/FREE/90...
The malaise is about to set in..
Yeah, midtown real-estate really holding up:
http://therealdeal.com/newyork/articles/fitch-warns-midtown-loans-to-def...
you dumb fuck....cap rates are associated with NOI, not gross revenues...stop wasting our time
you see that YE 2008 NOI was $31M for an implied cap on 504 of closer to 6% as stated by the RCA guy. Still a stupid purchase
FWIW The Henley Group paid $60 a square foot for office space in 767 Fifth Ave in 1986. The Henley Group was spun off on Allied Signal after that company's takeover of Bendix. They very briefly had three headquarters, this one, LaJolla, CA and Hampton, NH. http://tinyurl.com/kvb9g6
When they moved out they subleased the space to Fletcher Asset Management for significantly less than $60.
May I ask how one would go about getting the information necessary to sublease space in 767 fifth ave for $60/ft....?
I do not understand your question.
CR on CRE cap rates today ...
http://www.calculatedriskblog.com/2009/08/cbre-retail-cap-rates-increase-sharply.html
But again... I am believing this deal is about green shoots marketing, with the profit-and-loss-agnostic government pulling the levers behind the scenes to influence the overall market... with the economics of this particular deal being ... moot.
cap rates are based off the net operating income, not the net rent. you have to deduct operating expenses from income, then divide by the cap rate.
To clear up the "Durden mirage", the net operating income (NOI) {NOT GROSS RENTAL REVENUE} as indicated in the Bloomberg data sheet is around $31 million. After applying a 6.25 cap (31m/.0625) to that NOI, the valuation is appropriately identified as around a half a billion (= $496 million).