CASE STUDY: WATERLOO PLAZA

A group of investors have formed a general partnership to invest in real estate. They want to add real estate to
their investment portfolios for their later years. Although additional income in the near future is not of great
concern, any investment they consider must “stand on its own” once the acquisition is made and must show a
good long-term return.
Rather than limiting themselves to the residential rental market or the passive investment market by acting
independently, the group has decided to form a syndicate in order to have sufficient equity to enter what they
feel is the more creative and higher yielding commercial investment market.
The maximum equity investment for the four partners is $1,000,000 each. Each member of the group earns
taxable income paying a marginal tax rate of 48% and would appreciate any tax advantages that the potential
investment offers. However, this factor is not their primary investment concern. The investors are considering
holding the property for five years, with a sale at the end of the fifth year. Closing costs on investments at time
of sales are assumed to be 4%. They are looking for a return on their investment of j 1 = 9.5%.
The Investment
The investors are considering Waterloo Plaza, a three-year old commercial building in a medium-sized
suburban community of approximately 120,000 people called Midtown. The Trans-Canada Highway runs
outside of Midtown, allowing Midtown to serve a large catchment area. Waterloo Plaza is located along
Richards Street, the main commercial strip, which provides east and westbound access to the property.
Secondary access is provided from 5th Avenue, which runs along the rear of the property.
Waterloo Plaza offers a mix of retail tenants and a stand-alone restaurant pad. The main building
comprises 17,500 square feet and is anchored by a liquor store at the western end (corner unit). Of the
remaining four retail units, three are leased to a pawn shop, a small pharmacy, and a barber shop. The eastern
corner unit (end cap) was recently vacated. A noodle restaurant occupies the 4,200 square feet stand-alone
building.
At a meeting with the listing agent, the investors learned that the developer of the property was selling to
free up equity for an office development nearby. Since being completed, Waterloo Plaza has been fully leased,
until recently when a three-year lease expired and the tenant vacated. There is strong interest in the 5,000
square foot vacant unit from a doctor and related integrated rehabilitation facility.
The investment is available at a price of $7,000,000.

The Market
Midtown has seen slow continual growth over the past eight years, with the energy and mining sectors
providing steady employment. Other strong sectors are the agricultural industry, post-secondary education
facilities, and a budding high-tech sector. The availability of a wide range of post-secondary learning
institutions and strong employment opportunities has made Midtown an attractive hub for young people and
families. Overall, Midtown is a balanced community and an attractive place for investors.
In terms of new development, a number of multi-family and single-family projects have recently
completed and are underway. Last month, the premier announced the approval of an expansion of the regional
hospital and a new assisted living facility adjacent to the hospital. Not only will these projects provide jobs
while under construction, but also the completed facilities will be able to provide improved service to the
growing community of Midtown and surrounding municipalities. A new office building is being planned in the
business district and a new, larger high school broke ground in the spring.
Retail vacancy for good quality premises with exposure, such as the subject offers, is at a low of 3.7%.
Market rents for newer retail space with good exposure and access is $28.00 per square foot for interior retail
units (non-corner) and $32.00 per square foot for prime end cap (corner) units.
Interest in retail investments is moderate, with sales supporting a market capitalization rate of 7%. In
consideration of current market expectations and in discussion with a number of local and institutional buyers
who would be interested in acquiring a property similar to the subject, it is appropriate to add a risk premium

© UBC Real Estate Division 2021

of 0.5% to the market overall capitalization rate in determining the reversion value for the subject property.
Closing costs on investments at time of sales are assumed to be 4%.
The Property
The site has frontage of 370 feet along Richards Street and a depth of 200 feet, for an overall area of
approximately 1.7 acres. It is zoned C-2A, a general commercial zoning that permits a wide range of retail,
office, food service, and medical uses. All the existing tenants are permitted as per the zoning bylaw.
A paved parking area for 120 cars is provided along the front of the building, including accessible parking stalls.
An additional 35 employee stalls are situated along the rear and side. The total number of stalls slightly exceeds the
zoning requirements. Bus service is provided along Richards Street. The site is attractively landscaped.
The improvements are of steel frame construction with concrete block exterior walls. The roof is tar and
gravel with a 35-year warranty in place. The units have 11-foot clear ceiling heights and attractive glazing
allowing good exposure. Each unit has separate signage above their units that is clearly visible from Richards
Street. Heating and air conditioning are provided by roof-top units. Each unit is finished with t-bar ceiling with
acoustic tiles, recessed lighting, painted dry-walled interior walls, washrooms, and rear loading. The units have
good soundproofing of shared walls. Tenants have individual finishings as per their business model, all of
which are in keeping with a well-managed retail complex of a high standard. The stand-alone restaurant
building was completed one year ago and is finished as a mid-range restaurant with a (seasonal) outdoor patio.
Lease Data
The following chart details the leases in place.
Retai Tenant Area Initial Rent Steps CAM & Property Subsequent
l Unit (sq. ft.) Rent Taxes Terms
# Lease Dates & Term per sq.
ft.
1 Liquor Store 5,200 $35.00 Jan-21 $37.00 Part-gross ($4.50 2 x 5-year
per sq. ft. CAM options to renew
  Jan 2018 to Dec 2027     Jan-24 $38.50 included in base;
remainder pro-
  term: 10 years     Jan-26 $40.00 rata CAM charged
to tenant as
recoveries)
2 Pawn Shop 4,200 $27.50 Jan-23 $29.00 Triple net Market
  Jan 2018 to Dec 2027            
  term: 10 years            
3 Small Pharmacy 2,000 $28.00 Jan-21 $29.00 Triple net Assume 5-year
option to renew
  June 2018 to May 2023           @ market will be
exercised
  term: 5 years          
4 Barber Shop 1,100 $24.50 Apr-21 $27.00 Triple net Pre-exercised 3-
year option to
  Apr 2018 - Mar 2025           renew @
$29.00. No
  term: 7 years           leasing
commission due
or free rent.
5 Vacant Corner Unit 5,000         Discussions
underway – see
note below
               
6 Noodle Restaurant 4,200 $32.00 Jan-24 $33.00 Triple net Market
  Jan 2020 - Dec 2029     Jan-27 $34.00    
  term: 10 years            
  Gross Leasable Area 21,700          
(GLA)

Note: There is strong interest in the 5,000 square foot vacant unit from a doctor and related integrated
rehabilitation facility. The investors are confident that a lease can be secured in the first few months, with build

© UBC Real Estate Division 2021

out of the space to follow. The tenant is proposed to be in occupancy by July 1 for a 10-year term. Market rent
for prime corner retail of this size is $32.00 per square foot for new tenants. Market leasing commissions and
other tenant inducements will apply.
Assume that when a tenant renews or signs at market rent, the market rent in place at the start of the lease
will be the lease rate for the whole term (no rent steps).
Operating Expenses and Property Taxes
There are both recoverable and non-recoverable expenses related to the management and operation of the
property.
1. Common Area Maintenance charges (CAM) – all CAM charges are recoverable. For simplicity, we
have included management fees in the CAM amounts. All tenants pay their pro rata share of CAM
charges, although the liquor store has some already included in their base rent. An annual inflation
rate of 2% applies after the base year. The 2021 CAM charges are calculated at $125,000.
2. Property Taxes – all property taxes are charged back to the tenants on a pro rata basis. An annual
inflation rate of 2% applies to the property taxes after the base year. The 2021 property taxes are
expected to be $115,000.
3. Structural Repairs – an annual allowance for structural repairs is traditionally entered into a forecasted
statement of operations to provide for extraordinary capital expenditures that cannot be passed on to
the tenants for various reasons. Due to the newer age of the improvements and good condition of the
overall property, 2% of the effective gross income will be applied.
4. Leasing-Related Costs – these are costs incurred by the landlord related to leasing commissions, fees
associated with tenant relocations, improvements to premises, and inducements relating to both new
and renewing tenants. These expenses are not recoverable. Commissions payable to the leasing agent
for new leases only have been included at 5% of base rent for Year 1 with 3% for the remaining years
of the initial lease term. Leasing commissions are payable at the commencement of the lease. Market
research shows that rather than tenant improvement allowances, landlords are giving free net rental
periods to retail tenants. Typically, five months of free net rent is given to new retail tenants, and two
months of free net rent is given renewals of five years or more. Rent-free periods occur at the
beginning of the lease. With respect to tenant improvements, tenants are responsible for building out
their own interiors at their cost.
Financing
The syndicate has arranged financing for 60% of the purchase price of $7,000,000. They have secured
financing at a competitive rate of 3.75% per annum, compounded semi-annually, with a 20-year amortization,
a 5-year term, and monthly payments. Monthly payments are rounded up to the next higher dollar. The
remainder of the purchase price will be in the form of equity. The bank requires a minimum debt coverage
ratio of 1.2.
Apportionment
For tax purposes, the building to land ratio will be apportioned 70:30. This proportion will remain the same
upon sale.

© UBC Real Estate Division 2021

 CASE SUMMARY SHEET
EFFECTIVE DATE FOR VALUATION: January 1, 2021

PURCHASE PRICE: $7,000,000

Improvements $4,900,000
Land $2,100,000

LONG-TERM FINANCING
Loan Value 60% of purchase price
Amortization Period 20 years
Term 5 years
Interest Rate (j2) 3.75%
Payments Monthly, rounded up to the next higher dollar
Minimum DCR 1.2
There are no prepayment penalties on the loan.

RENTAL INCOME PER ANNUM (Base Year - 2021)

Market rents increase at 2% per annum.

EXPENSES (Base Year - 2021)

Property Taxes $115,000
CAM Costs $125,000

ALLOWANCES
Vacancy and Collection Allowance 3.7%
Structural Allowance 2.0% of effective gross income

COMMISSION PAYABLE AND TENANT INDUCEMENTS

Commission - New Tenants Only Commission of 5% of the base rent in Year 1, 3% per annum thereafter over
the term of the lease.
Tenant Improvements Responsibility of the tenants
Free Rent - New Tenants 5 months’ net rent free at beginning of lease

Free Rent - Renewing Tenants 2 months’ net rent free at beginning of lease

REQUIRED RATE OF RETURN (AFTER-TAX) ON EQUITY: 9.5%

MARGINAL INCOME TAX RATE: 48%

The investors will qualify for tax on one-half of any capital gains.

CAPITAL COST ALLOWANCE: 4% (Class 1)

The investors will take the maximum possible CCA.

MARKET OVERALL CAPITALIZATION RATE: 7%

REVERSION RATE: In consideration of current market expectations and in discussion with a number of local and
institutional purchasers who would be interested in acquiring a property similar to the subject, it is appropriate to add a risk
premium of 0.5% to the market overall capitalization rate in determining the reversion value for the subject property.

CLOSING COSTS: A 4% commission of gross sale price is paid on sale.

© UBC Real Estate Division 2021