Commercial Investment Real Estate March/April 2019 | Page 23

Cost Markup Model Market Value necessary for the successful operation of the subject property. A retail store is linked primarily to customers who reside adjacent to or near the retail store; these customers are called the residential base. In addition, the retail establishment can serve the needs of customers who work near the property but do not reside nearby. These customers are a part of the daytime population in the sub- ject property’s trade area. Employees and distribution centers are two other linkages necessary for retail operation. In the past, employees were con- sidered ever-present resources, readily available at all points in the geographic area. But, depending on location, prospective employees may not have the required skills. Additionally, dis- tribution centers used to be viewed as relatively insignificant because transportation costs for the products were considered a minor item. However, today’s rising cost of gasoline and increased travel times due to traffic congestion increase the retail store’s procurement costs. Political and Legal Analysis Real estate business decisions are integrated into the political and legal analysis, which can give rise to gaps between supply and demand and also can eradicate gaps. When a gap is identified in the market and competitive analysis process, the analysis might indicate support for the proposed development or acquisition. However, political and legal considerations and/or site limita- tions may increase the risk of achieving a successful development. Political considerations and societal issues are so pervasive that no feasibility can be evaluated and no decisions be made outside the context of them. Legal Issues. Zoning jurisdictions provide necessary compre- hensive plans for current and future permitted land use. Zoning then determines the use of a particular site. There also may be opportunities to pursue changes or get zoning variances. Building codes determine the type of building, allowable sig- nage, and parking lot requirements for the site. Licensing require- ments can restrict the type of use for a site, such as requiring special license for the sale of alcohol. Financial Analysis The results of the first three areas of the strategic analysis ulti- mately lead to the financial analysis, which determines the finan- cial feasibility. Financial feasibility answers the question, “Is the return and/or profit sufficient to attract the capital needed to develop the project?” Further financial analysis compares the alternatives of selling the project upon completion or holding it as a long-term investment. The two benchmarks used to measure financial feasibility are cost markup feasibility and rent constant feasibility. If the invest- ment/development is a go-decision, the analyst then can use net present value to compare the alternatives of selling the project upon completion or holding the property as a long-term investment. Front- and back-door approaches are applied to both the cost markup feasibility and rent constant feasibility benchmarks. The CIREMAGAZINE.COM Profit – Cost of Sale – Total Project Cost Cost Market Value = Profit – Cost of Sale – Total Project Cost Total Project Cost Markup Model Profit Total Project Cost = Cost Markup = Cost Markup = Profit Rent Constant Spread 1st Year NOI Total Project Cost = Cost Rent Constant Rent Constant Spread Cost Rent Constant 1st Year NOI – Net Value Rent Constant = Cost Rent Constant Total Project Cost Rent Constant Spread 1st Year NOI = Net Value Cost Rent Constant Rent Constant (Market Value - Cost of Sale) – Net Value Rent Constant 1st Year NOI Rent Constant Spread = Net Value front-door approach determines the minimum rents needed to (Market Value - Cost of Sale) Rent Constant achieve the investor/developer’s benchmark threshold at a given project cost. The back-door approach determines the maximum project cost the investor/developer can incur to achieve the bench- mark threshold at given rents. CCIM Strategic Analysis Cost Markup. The cost markup is the Model relationship between profit and project cost expressed as a percent. Profit is the dif- ference between net market Market value and and project cost. Net market CCIM value Strategic Analysis Model Competitive value is the market minus the cost of sale. Cost markup Analysis is calculated by dividing profit by project cost. (See the Cost Market and Markup Model.) Competitive The rent constant is the relationship between the market rent Feasibility Analysis Analysis • Goals and Objectives constant and the cost rent constant. The market rent constant Location and Financial • Alternatives Analysis Analysis by dividing the projected first year Site is calculated net operating • Decision Criteria income by the net market value of Decision the asset (similar to the calcu- Analysis • Feasibility Go/No-Go and value Objectives lation Financial of a cap rate). Net • Goals market is the market value and minus Location • Alternatives Site by Analysis the cost Analysis of sale. The cost rent constant is calculated dividing • Decision Criteria Political and income by the total project the projected first-year • net operating Go/No-Go Decision Legal Analysis cost. The rent constant benchmark is the spread between the net market rent constant and the project cost rent constant. The and difference between the cost Political rent constant and the market value Legal Analysis rent constant represents the margin for risk and the profit for the investor/developer. These models, combined with the Excel-based CCIM Finan- cial Feasibility Workbook, allow for a detailed analysis from total Rent Constan project cost to all factors to consider in a go/no-go decision NOI or a go-decision with specific modifications. Total Project Cost Rent Constan = Cost Rent Constant Catherine Simpson Olson is senior editor of Commercial NOI Investment Real Estate magazine. Contact her at [email protected]. 1st Year NOI Total Project Cost Editor’s note: This article was adapted from the course Market “Feasibil- Value – Cost of Sale = Cost Rent Constant ity Analysis for Commercial Real Estate.” In additional to the CCIM = Net Value Rent Constant 1st Year NOI Strategic Analysis Model, the course provides an Excel spread- sheet for in-depth analysis using a real-world case study. more Market For Value – Cost of Sale information, visit www.ccim.com/education. = Net Value Rent Constant March | April 2019 21