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Case Study:
Multi-Phase Restructure
How we reduced Steve's equity required by $2M and boosted his projected profits by $1M+ through deal restructuring.
Disclaimer:
The details and assumptions in this case study have been modified to protect deal confidentiality and are presented for illustrative purposes only.
"I cannot speak highly enough of Proptimal's work on my first commercial real estate development. Their expertise turned a deal that didn't pencil into a promising deal after identifying that the previous deal structure was not done correctly.
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As a result, we are now expecting to make over a million in profits more (yes, you read that right) on this deal. They also spotted fees we missed, saving us from leaving tens of thousands of dollars on the table.
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Finally, Proptimal's ability to facilitate communication with our lender made the entire process much easier than I expected. As a relatively new developer, I learned a lot from working with them. If you are looking for a consultant who can deliver real results, I highly recommend Proptimal!!"
— Steve P, Founding Member at Phlex Properties
Overview
Steve approached us with a 150,000 SF flex/retail mixed-use development project consisting of several free-standing buildings. Phase I included 50,000 SF, primarily flex spaces, while Phase II, comprising the remaining 100,000 SF, focused on retail components. The development costs were estimated at $130 per SF (excluding land), with the land for both phases being purchased upfront and improved during Phase I for a total of $3M.
Steve’s existing financial model was difficult to navigate, and he needed our help to create a clear, user-friendly model that accurately illustrated the deal’s structure and feasibility.
Challenges
When we reviewed Steve’s financial model, we quickly provided a more user-friendly template, but it became clear that the deal had deeper structural issues. Here’s what we found:
1. Land and Site Costs Were Allocated Entirely to Phase I
The total $3M cost for land and site improvements was being charged to the first phase of the project. This created a significant upfront expense that placed undue financial pressure on Phase I.
2. Refinance Proceeds Were Insufficient to Cover the Construction Loan
When the refinance of Phase I was modeled at the end of year 2, the proceeds weren’t enough to fully pay off the construction loan. This shortfall meant that additional equity would have to be injected just to cover the difference and fund the start of Phase II.
3. Front-Loading Less Profitable Flex Spaces
The less profitable flex spaces, which command lower rental rates compared to retail, were being built in Phase I. This further contributed to the refinancing shortfall, as the initial cash flow from Phase I was insufficient to support the overall deal structure.
Lease: $15 PSF NNN rental rate growing by 3% per year. Lease-up and vacancy are not accounted above.
Construction Loan: 70% LTC at 8.00% per annum and 25-year amortization. Construction interest payments are funded by interest reserves included within the project cost.
Refinance Loan: 70% LTV at 7.5% and 25-year amortization.
Cap Rate: $15 PSF at 9.0% cap rate (includes rate inflation) equals to a $167 PSF valuation in Year 0 dollars.
Timing: Phase I refinance and Phase II construction are shown in the same year for illustrative purposes.
Conclusion
The deal was improperly structured. By allocating the large upfront land and site costs and the lower-income flex spaces to Phase I, the project lacked the financial balance needed to sustain itself through the early stages, creating unnecessary risks and funding challenges.
Our Solutions
1. Developed a User-Friendly Financial Model Template
We created a clear and intuitive financial model that simplified the project’s complex structure, showing Steve how the different moving parts of the deal interconnected. This new template made it easier for him to understand the deal dynamics and explore alternative scenarios.
2. Reallocated Phase Sizes for Better Cash Flow
We restructured the project phases, increasing Phase I to 100,000 SF and reducing Phase II to 50,000 SF. This adjustment allowed more cash flow in Phase I to cover the significant upfront land and site improvement costs. To ensure this approach was viable, we validated that the market could absorb the additional 100,000 SF of development in Phase I.
3. Increased Retail Development in Phase I
We advised Steve to develop more retail spaces in Phase I, which boosted the net operating income (NOI) for the first phase. This change significantly improved the project’s cash flow and led to higher refinancing proceeds, resolving the shortfall and eliminating the need for additional equity injections.
Outcome
By increasing the Phase I refinance proceeds, Steve was able to generate excess equity that could be reinvested into Phase II, reducing the total equity requirement from $7.1M to $5.1M. This adjustment boosted the project’s 5-year IRR from 26.2% to 27.8%, significantly improving the deal’s overall profitability.
After a thorough assessment, we determined that the market demand was strong enough to support developing 100,000 SF in Phase I, ensuring the project remained both financially viable and strategically sound.
Steve was thrilled with the new business plan, confident to pitch it, and successfully brought in a co-GP along with several limited partners to fund the project.