JUST CLOSED | Auburn Retail Center I | Auburn, Washington

Michael Capital is excited to announce that we have closed on an off-market retail strip center in Auburn, Washington for $3,196,000. The property was built in 1985 and has 12,607 square feett of retail space. It sits on top of a 30,854 square foot lot, containing 43 parking stalls. It was fully renovated in 2005 with an estimated 15 years remaining on the roof and HVAC systems. The tenants benefit from being adjacent to Auburn Way North, one of the busiest thoroughfares in Auburn that averages a daily traffic count of 17,000 cars.

The property is located directly across from major retail outlets, including LA Fitness, Rite Aid, Big 5, Office Depot, Lowe’s, Home Improvement, Bank of America, Umpqua Bank, and Starbucks. Three miles from the property lies the Outlet Collection Seattle, which has over 130 stores with anchors like Nordstrom Rack, Bed, Bath and Beyond, and Nike. In addition, there are local schools, medical centers, and grocery stores nearby, including a Walmart Supercenter and Fred Meyer. Downtown Auburn is connected to major highways and interstates (Highway 167, Interstate 5, Interstate 405, Highway 512), in addition to the Sounder commuter rail that connects Tacoma and Seattle, which is  just south of the property. These many travel linkages provide significant traffic to the property.  

The property is 100% occupied by a mix of local and franchise tenants. Four of the six tenants have been long-term renters, all paying a 3.00% annual rent increase with triple net reimbursement (NNN is where the tenant pays a pro rata share of property taxes, insurance, and maintenance costs). All six tenants have performed well over the last 18 months and anticipate renewing their leases. One tenant has expressed opening another business on top of the two spaces they currently rent, if space becomes available. On top, tenants have invested considerable amounts of money retrofitting their interiors. Most notably, CRFT Beers has spent approximately $500,000 on in-the-wall equipment and interior renovations. 

Tenants, Boost Mobile and Cycle Gear, are large national franchises. Boost Mobile is America’s largest and fastest 5G network with 10,000+ independent wireless dealer locations and Walmart stores. Cycle Gear has over 140 stores in 35 states. All the tenants average a rating of 4.2 stars out of 5 on Google reviews, which is a great sign that customers appreciate their business. 

According to CoStar, the leading real estate analytics platform, retail in Auburn has historically performed very well, including the last 18 months. The Auburn submarket has a tight overall retail vacancy with a 2021 Q3 average of 3.00%. In 2020, retail strip centers averaged a vacancy rate of 0.90%, with a year-to-date vacancy rate of 1.40%. In the next five years, the vacancy rate is projected to be 1.46%. This is primarily due to the lack of available retail space and high demand. This has caused rents to surge over the past 12 months, having grown 4.60% year-over-year, and 7.10% year-to-date. The forecasted five year average rent growth is projected to be 4.22%. In addition, the population is expected to increase by 5.77% over the next five years within a three-mile radius of the property, while the U.S. average is 4.50% during the same time period. The median household income is roughly $74,000, with 41,000 employees within a three mile radius. 

Now the financial details regarding the property. Auburn is a very liquid investment market, characterized by high trading, and those trends have largely held true in the past 12 months. The average retail property sales price is $264 per square foot. We are well positioned at a lower-cost basis of $253 per square foot, especially given the property’s prime location in downtown along Auburn Way North and its overall building/tenant quality. The average submarket cap rate is 5.70%, while our pro forma cap rate is 6.25%

The current weighted average rent at the property is $15.07 per square foot. CoStar indicates that the average submarket rent for strip center properties is $20.80. We believe the following lease comparables reflect the potential rents for our property in its current condition. This gives us plenty of room to increase rents at lease expiration dates. 

There are no deferred maintenance items of concern, however we anticipate upgrading several components of the property to maximize value. We anticipate making the following renovations and upgrades: 

• Re-stripping of the parking lot

• Enhancing the landscaping

• Pressure-washing of walkways and exterior of the building

• Cleaning of all windows inside and out, as well as exterior signage 

• Adding awnings to the back exterior doors for each tenant

• Converting all exterior lighting and signage to LED for enhanced visibility and electricity cost savings

• Cleaning of all HVAC systems to maximize efficiency and cleanliness of interior air quality

• Painting the exterior

Now onto the good part. The below table is our income analysis showing the five year net operating income (i.e. cash flows before debt).

Due to the nature of long-term NNN leases, we can better predict cash flows as expenses are reimbursed by the tenants and leases are fixed at longer periods. Based on the current rent schedule and anticipated tenant roll, our projected five year average annual net (after mortgage expense) is $62,364, which equates to an annualized ROI of 7.47% from cash flows. Our initial equity investment was $835,000. Based on the tenant’s lease terms, we are factoring a potential move-out in year three and five at renewal dates. We factor NNN reimbursement of all expenses other than common area repairs and maintenance and replacement reserves.

In addition to property level cash flows, real estate has many tax and inflation protection advantages. Looking at the metrics over a five year period, we anticipate an overall average annual ROI of 31.53%, or $263,248. This does not include a capitalized event, such as a sale or refinance. Let’s break this down so you can understand how we calculated the ROI in addition to the property level cash flows described above.

By factoring in depreciation (using the straight-line method over 39 years for retail) and the market standard 80% assessed value, we can expect an annual depreciation of $65,559. Depreciation allows us to deduct the costs from our taxes, including earned income elsewhere. 

In addition, we can write off the mortgage interest. The average annual interest paid over a five year period is $91,529, thus with the depreciation amount the total annual tax savings is $184,504. At a 41.00% marginal tax bracket, this equates to an annual tax savings of $64,406, or a ROI of 7.71%. It is important to note that marginal tax rates vary depending on personal financial status and should be discussed with your CPA. We can’t forget about debt paydown and the benefits of reducing the overall principal of the loan. At a five year average debt paydown of $45,795, this equates to a 5.48% ROI.

Least predictable but from a conservative and historical lens, we can assume an annual appreciation rate of 2.50% on the overall value of the property. Appreciation is the rise in value of an asset, which occurs overtime due to changes in supply and demand and various other reasons. Based on our equity investment, this overall property value increase equates to an average annual ROI of 10.51%.

In summary, by factoring in all the powers of real estate from property level cash flows, depreciation and tax savings benefits, debt paydown and appreciation, we project an average annual ROI of 31.53%. 

The full underwriting, including the ROI analysis and rent roll, can be viewed here. 

To conclude with our financial analysis, we touch upon the largest expense at the property: mortgage payments. Finding the most attractive lending options is crucial to maximizing cash flow and overall return. With Garrett being in the brokerage industry, we knew that many institutions cut back on their retail lending portfolios, increased rates and lowered proceeds due to the uncertainties from COVID-19. However, given the strong performance in the Auburn retail submarket and the property itself, we knew there would be a lender out there that would offer us our requested terms. 

Over the course of a month we met with nearly 30 lenders and landed with a local credit union based in Spokane, Washington. They expressed significant interest in working with us, since they liked our team and the property/tenant base. They also saw the benefits of retail in Auburn. Here are our finalized terms: 

• 75.00% loan to purchase price ($2,397,000)

• Term - 10 years fixed

• Amortization - 30 years 

• Interest Rate - 4.00%

• Loan Fee - 1.00% (of committed loan amount) 

• No prepayment penalties

• No interest minimums 

Here are our closing costs: 

The majority of lenders we met offered 20 to 25 year amortization schedules. By getting 30 years, we were able to improve our cash-on-cash by lowering the monthly mortgage payments. On top, with no prepayment penalties and no interest minimums, we have a lot of flexibility in the future for potential exit strategies. In addition, the 10 year fixed term provides better predictability of cash flow from fixed mortgage payments. 

In terms of property management, the Michael Capital team will manage the property. Some of the responsibilities include monthly rent collection, asset management of operating expenses and capital expenditures, working with tenants on maintenance requests, facilitating third parties such as landscaping and HVAC inspections, and facilitating renewal agreements or new leases in the case of a vacancy. 

We will continue to update you all on the performance of the property and the continued efforts we make to build our commercial real estate portfolio together.

Hopefully this helped you understand the value of commercial real estate and the many ways it provides return on investment. We are excited to secure our next deal with our investors. 

Please reach out if you have any questions, comments or would like to learn more about what we do at Michael Capital. 

Have a great and successful year end!