This article provides a detailed walkthrough of underwriting a $10 million industrial warehouse property in Texas. It covers key metrics such as price per square foot, cap rates, lease rates, market comparisons, financing challenges, and the importance of lease terms and property condition. The analysis highlights the potential upside and risks involved in such an investment.
In this comprehensive guide, we explore the process of underwriting a $10 million industrial warehouse property located in Texas. The building spans approximately 125,000 square feet across multiple structures and currently generates $1.1 million in gross income but nets only about $380,000. We will break down the key factors to consider when evaluating such a deal, including pricing, income, market comparisons, lease terms, financing, and potential risks and rewards.
The seller is asking $10 million for the property. To evaluate this, the first step is to calculate the price per square foot:
Price per square foot = $10,000,000 / 126,000 = approximately $79 per sq ft.
This price per square foot is a critical metric to compare against the market.
Next, we look at the capitalization rate (cap rate), which is the net operating income (NOI) divided by the purchase price. Currently, the property nets about $380,000, so:
Cap rate = $380,000 / $10,000,000 = 3.8%
This cap rate is considered very low, indicating a poor return based on current income.
The current gross rent is $1.1 million, which translates to a lease rate of about $8.73 per square foot. To assess the investment's potential, it is essential to compare this lease rate to the market.
Market research shows that lease rates for similar industrial properties in Texas range between $11 and $14 per square foot (triple net). Brand new construction can command rates above $200 per square foot, but for this property, which is a C+ to B grade building, a conservative estimate of $11 per square foot is reasonable.
Calculating potential gross income at $11 per square foot:
$11 x 126,000 sq ft = $1,386,000 gross income.
After accounting for vacancy (5%), maintenance (5%), and management (5%) expenses, a conservative net operating income (NOI) estimate is:
$1,386,000 x 85% = approximately $1,178,000 NOI.
Using an 8% market cap rate, the estimated market value based on this NOI is:
$1,178,000 / 0.08 = $14,726,000
This suggests the property could be worth around $14.7 million if rents are increased to market levels and expenses are managed efficiently.
The asking price of $10 million is significantly below the estimated market value of $14.7 million to $17 million (if lease rates increase to $13.50 per square foot). This indicates a substantial upside opportunity.
However, the key to realizing this upside lies in the lease terms. If the current leases are short-term or month-to-month, there is flexibility to increase rents to market rates quickly. Conversely, if tenants are locked into long-term leases (5-10 years) at below-market rents, the potential for rent increases and value appreciation is limited.
To fully understand the investment, it is crucial to review the rent roll, which details each tenant's rent, lease start and end dates, options, and occupied square footage. This information helps assess lease expirations, tenant stability, and the ability to raise rents.
Multiple small tenants can be advantageous, as smaller spaces often command higher rents per square foot and are easier to re-lease.
The building is in decent condition, with no major issues reported with the roof, sprinklers, parking, or HVAC systems. Significant capital expenditures (capex) could negatively impact the investment, so it is important to verify that capex needs are manageable (e.g., around $1 million or less).
One of the biggest hurdles in this deal is financing. Because the current net income is low ($380,000), lenders will base loan amounts on this figure rather than the potential future income.
Typically, this property might qualify for a loan between $3 million and $4 million, which is only 30-40% of the asking price. This means the buyer would need to cover a large portion of the purchase price out of pocket, making it difficult for most investors.
Seller financing could be a solution if the seller is willing to offer favorable terms.
In some cases, investors use hard money or bridge loans to acquire properties with low current income but high upside potential. These loans have higher interest rates (8-12%) and shorter terms (12-24 months) but allow investors to renovate or re-lease properties to increase value before refinancing.
However, for a $10 million property, the cost of hard money loans can be prohibitive unless the upside is significant.
The author shares an example of a smaller property purchased for $1.1 million with an $800,000 hard money loan. By increasing rents from $10 to $16 per square foot triple net, the property's value is expected to rise to $2.2 million, allowing refinancing and cash-out.
This illustrates how hard money loans can work well on smaller deals with clear upside.
The seller's asking price is $10 million, but the author plans to start with a low offer (around $4 million) and potentially go up to $6-7 million, aiming for a cap rate of 5.5-6.5%.
Offering full asking price is generally discouraged, as it can signal undervaluing the asset and reduce negotiation leverage. Instead, offering slightly less than full price is recommended.
This detailed underwriting process helps investors identify opportunities where the current income and price do not reflect the property's true potential, allowing for value creation through lease-up, rent increases, and operational improvements.
Understanding these fundamentals is essential for making informed investment decisions in industrial real estate markets like Texas and beyond.
