See a case study involving a simple retail acquisition of a neighborhood retail center.
- [Instructor] Alright, welcome back. In this lecture we're going to look at a simple neighborhood retail example. Essentially we're going to look at a strip mall. So, it's something along the lines of just a neighborhood corner retail. It might be in a corner of a street where there's several small retail locations with a few tenants. But we're going to buy it fully leased. This is totally an income play. Might be common for a private investor that can't really look at the larger deals that are fairly exclusively reserved for institutional investors with billions of dollars to play.
This one is a small little place and we're looking at eight units of various sizes with slightly different uses in terms of tenants. They'll range from 1250 to 4000 square feet. And the rents will range from a buck, 50 all the way to three dollars a square feet. More detail on economics. The total purchase price is 4.4 million. We're going to look at hold for at least five years. No rehab, single investor. Let's just see what that might look like.
Okay so, here are our eight tenants in this strip mall. Let's say we got a Pizza Hut, a nail saloon, a GNC store, a comics book store, a boutique store, a bakery, a T-mobile store and a Subway. And here is the mix, the boutique store is taking up the biggest space. It's paying a buck, 50 and everyone else is paying sort of a range of prices for the units here.
And based on the square footage and the rents we have sort of the base monthly rent here and the annual rent for each of the units. We may assume 3% annual bumps and that they're all fully leased. This is a fully leased purchase. We're buying it all outright. Assuming 10% operating expenses and 15% vacancy going forward. As sort of an overall vacancy rate for the entire portfolio. Now all of these are single tenants.
And for simplicity, we're going to say just the all-in purchase price including closing and everything else is 4.4 million and that there's no renovations, nothing else really that needs to be spent at the beginning. So, other than the purchase price and we're looking at just pure hold. There is really no lease-up. But the way the mall is built we need to put in that lease, one here. And because it's 100% leased, it doesn't really matter, that won't affect anything.
So based on these numbers and these rents. What we're looking at is really a yield return, right? This is a cash flow type of investment for the investor. So, what would it look like in this case? Well based on these assumptions we're going to see about a 9% IRR. About a million in profits. And a 1.5 multiple over the course of about five years. Which is actually pretty good for something where you don't have to do anything.
This might be a little bit high in today's market. Where fully leased, net leased projects especially the ones that have, sort of better tenants are going to go lower. But these ones there is some neighbor mom and pop type deals. You have few tenants that are national brands. The Pizza Hut, the GNC, T-mobile and Subways. So about half of the tenants have good credits. And not likely to default and shut down.
But the other half are a little bit more risky. So for these types of strip mall type of projects then they might have to trade a little bit higher, right? So if these were in a nicer market and the brands are all like very well recognized brands. You have a Starbucks or things like that. This will trade much lower. It might trade around the four or five percent cap rate. And your IRR is going to be something similar to that.
But you know for something like this. It may trade a little bit higher just because the tenant makes, is not as good, so the cap rate is going to be a little bit higher. Which means the overall expected return will be a little bit higher as well as taking on sort of a tenant credit risk for this investor. So, here the key drivers are going to be obviously the rents and your cost spaces when you're going in, right? There's really no other major parts other than operating expenses which for something like this, there is not much in terms of operating expenses.
And maybe very little if it's fully triple net you're going to have the tenants pay pretty much for everything else, right? But we'll put in a little contingency here of 10%. Just for that. And if the market is very good, where there is very little turn over your vacancy might be lower than that. So you could actually potentially get better. Now if the investor here is looking at say very long term. 10 years, right? Looking at it for 10 years.
And they think that in 10 years this area is going to be just popping. Then maybe they think that the cap rate when they exit is going to be lower, maybe they think they can sell it at 6%. This is going to be a, more of a premium market later on. Well if that's the case and they hold it for 10 years and they think they can exit at 6% cap rate. Well look at what happens to their returns now, right? Their going to look at a 17% IRR.
While these types of place tend to be income place for the really really long term investors who are willing to kind of hold for much longer horizons and if they're thinking about a bet in the market that where they're at right now, it maybe sort of in the path of growth. But the growth hasn't quite reached that area yet. But they think they'll get there, eventually. If they're right then that's where they may experience this what's called a cap rate compression at that time.
And they're going to get a premium on the same income that they paid less for, right? On a per dollar basis. They might have paid a nine cap going in but then when they get out they might pay a six cap. In which case then that gives them sort of a lot of upside potential in that scenario. But usually you're not going to see these kinds of opportunities, especially in the current market cycle where everything has been on an upswing for quite a bit. And things have been trading at a ready very low cap rates.
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