Railroad in 2019 continued to be a stabilized fully leased asset with improvements having been done to the HVAC system, landscaping and mural work. In addition, the existing seller-carry back loan was refinanced using a Citi and a CMBS loan to maximize proceeds and keep interest costs low. In 2020 Railroad should continue to operate as a well-performing stabilized asset and see another annual rent increase. No major improvements are planned for 2020 - a new roof membrane may be needed in the next few years.
The major financing update in 2019 was the refinance of the property from the $1.854 million seller carry-back financing to the $3.25 million 5-year term CMBS loan from Citi. The refinance used the same team that refinance Baywood, so Citi's familiarity with the site, the sponsor (Neal) and the quality of the development helped achieve a competitive rate and proceed amount. Neal also provided a partial-recourse guarantee for the loan.
The original plan was to use Cathay Bank, but Cathay had issues doing the loan because of an environmental testing concern that is not an actual issue that we know of, but something the bank was hung up on.
The building was valued at $5.9 million or $1,311 PSF, which is a great valuation for the property. As a reminder, the property was purchased for $2.654 million with about $1.9 million in development costs (construction costs, design and interest costs) put into the property, with a total basis after the project was completed of $4.58 million.
If we hypothetically sold the building at the end of Dec 2019, we would make $1.42 million in profit on $1.52 million in equity. For a 3-year investment this is a 49% IRR (i.e. 49% return per year) and a 1.93 x equity multiple. These are phenomenal return numbers that are well beyond industry standard.
The $3.25 million in proceeds from the loan were used to payoff the existing seller debt of $1.90 million (including payoff penalty), pay down of a portion of the Yung Intl Line of Credit (used to fund construction) for $500,000, another $470,000 was reserved and used to pay the remaining improvements in Baywood and $350,000 was used to pay off the remainder of the cash balance for Roy's Baywood buyout.
2019 Capital Improvements
In 2019, the most significant capital improvements were a retrofit and modification of the HVAC system, the completion of the landscaping of the surrounding alleys and the painting of a mural to complete the exterior.
Since the tenant had moved in we have had issues with the HVAC system in getting proper heating and cooling throughout the space an excessive system noise and air turbulence. Instead of trying to push the retrofit and repair on the tenant, the decision was made to make significant improvements to the system to solve the issues and retain a strong positive relationship with the tenant. The scope of the contract included new ductwork, the addition of variable control units and work to the existing ductwork. The HVAC capital improvement project cost $50,000 and was completed in December 2019. Since completion the issues have been solved and the tenant is ecstatic with the end result. The original HVAC design was poor and the wrong designer was used in the initial design.
The landscaping project paved and added pavers to the alleys surrounding Railroad and Baywood. Fences and gates were added to create private patio spaces for Railroad as well as an improved outdoor area for Baywood. Landscaping, lighting and improved drainage was installed. The total project budget was $150,000. Unfortunately the duration of the project was unacceptably long due to a subcontractor that did quality work, but didn't have the manpower for the project. The ultimate result is a well landscaped common area, but the project took 4 times longer than it should of. It was delivered on-budget, but only because the subcontractor was made to take a loss and perform some added scope for free.
There are no major improvements planned in 2020. Within the next 2-3 years a new roof membrane may be needed. The tenant, Monomi Park has continued to grow and may at some point need more space. The next phase of this asset will be to add two floors and create a 12,000 to 15,000 SF office building. This will likely not happen until 2022 at the earliest, since the current financing is in place until 2023.