Retail Strip Mall Development

[Gene H.]

Hello - wanted to get some basic input on estimated costs for retail strip mall development costs with the following preliminary details:

-Area: Seattle / Tacoma area, suburb with ~35k traffic counts past the lot

-Land Size: 1.3 acres

-Building sq ft: ~12,000

-# of tenants/spaces: 6-8

-Land shape: Sligltly sloped

What I'd like help with is to understand the major costs associated with such a development. I'm new to this but from my research and from speaking with people, I was able to come up with the following estimate:

Land Acquisition: 1,260,000

Site Improvements: 200,000 (i've heard that site improvements for raw/undeveloped land will cost you around 100k-150k per acre - not sure if this is accurate)

A&E Fees: 150,000 - 200,000 (6% of total project cost)

Building Permits: 50,000 (not sure if i'm close to being accurate)

Construction Costs: 1,800,000 (150 sq ft) for a fully built out multi tenant building / 1,200,000 (100 sq ft) for non built out multi tenant building

Total Cost: 2.9 million / 3.5 million (fully built out)

Am I on the right track in assessing costs here? Are there any major ommissions from a cost perspective?

Would appreciate any input. Thank you very much!

[Joel Owens]

Are you trying to be a merchant developer to immediately sell after filling up or are you going to be a buy and hold developer doing construction to permanent loan and building more to hold? 

If you build to sell off then some developers do not care as much about tenant quality. They fill it up fast with mainly local tenants and are sloppy with negotiating the leases in the developers favor. When you go to sell what is in the lease makes a ton of  difference for what you can sell for and what financing the buyer can get.

If you can land all national tenants then the stabilized cap rate value tends to be lower and your sale price higher. When you have a mix of national and local tenants cap rate tends to go higher and highest tends to be all local tenants.

A buy and hold developer tends to do more long term construction with higher quality roof, building,parking lot, selection of tenants and how they flow optimally for the center etc. The leases are generally very clean in favor of the landlord also since the developer was holding long term and getting the cash flow they negotiated more carefully and took their time.

You need to add in TI (tenant improvement costs) and leasing commissions for the leases.

Most important is to nail down rent per sq ft you can achieve conservatively in the market. Using conservative rent per sq ft figure in your all in cap rate to cost for expected cash flow. Generally you want a 9.5 to 10 cap for break even and sell 6 to 7.5 cap depending on tenant mix for most markets. As the size of the center goes up to 7,8,10 million etc. the exit cap rate needs to rise and less buyers in the market for larger properties and when putting down larger amounts of cash they want better yield.

So for example a center in the mid 5 million range might get a 7.1 cap and then a 3 million new center might go for a 6.5 cap as more buyers compete to buy the asset. These are just examples and every market is different. Another consideration is when you are building strip centers the lenders consider it speculative development so usually want 50 to 60% pre-leased before funding. They want to know worst case scenario if the other 40 to 50% doesn't get leased up right away you are almost at a break even point servicing the debt.

Is the site already zoned commercial for retail strips?? If not you need to get zoning approval and then also site plan approval from the city or county planners depending on where the property is located. Some areas have a very long entitlement process and tenants from LOI to Lease execution stage take awhile to commit to a site. So generally I see developers lock up a peace of land on PSA contract for 1 year before closing on the land. The developer wants to know that before they go and spend this upfront due diligence costs that they will have adequate time to make the project work otherwise they spent the money for nothing.

If you are just building 1 larger building single tenant the financing tends to be different. The tenant signs a forward commitment before closing on the land and the lender knows it's a done deal with non-refundable earnest money from the tenant versus a spec build. If you do builds for franchisees instead of national tenants you have to be very careful as things can go wrong mid build out and then you have a half built building trying to land another tenant again. Make sure for ground up there is enough cap rate spread for the work involved. You would not want for example to be at a cap rate to cost of 7 to 8 trying to sell at a 6 cap. What if the market changes and sell cap is 6.5 cap now? If cap rate to cost is 9 to 10 and you have to sell for 7 you still have good yield there. Ground up development should have the greatest yield, followed by existing value add properties, then stabilized the least yield ( more turn key ). There are exceptions but generally this is what you see.