Crain’s: Chicago Spire Offering “Investor Package”
Who said that speculation is dead in the Chicago real estate market?
According to Crain’s, the Chicago Spire in Streeterville is offering a special “investor package” that guarantees to rent out your unit at a 7.5% rate of return for two years.
Sound familiar to some, um, other buildings we’ve chattered about?
From Crain’s:
About 400 of the smallest units are being sold with a promise by Shelbourne to pay buyers 7.5% of their purchase price for two years and then rent out the units. The offer “is of sufficient level to cover mortgage payments, annual real estate taxes and apartment service charges, ensuring the investor does not incur any costs in the first two years,” according to a May 14 press release issued in South Africa.
The program is intended to bolster sales abroad because Mr. Kelleher believes those buyers have the greatest interest in the smallest condos, which start at $750,000 for a 550-square-foot unit, Mr. Grace says. No buyers have complained about the program, which isn’t uncommon outside the United States, he adds.
“People are seeing this project in a different light,” he says. “This particular detail isn’t fazing anyone at all.”
What does this say about sales that they have to offer an “investor package”?
Said one of the Spire’s competitors:
“If we would try to introduce that at our building, oh my god, would our buyers be in an uproar,” says Michael Schramm, a principal with Chicago-based Prism Development Co., which is building the Ritz-Carlton Residences at 664 N. Michigan Ave. “They just wouldn’t accept it.”
On a related note, I heard that the foundation is finished but they don’t want to do anything else until more units are sold. They aren’t working at the site anymore.
1) This thing doesn’t make sense for the local market because it’s too expensive.
2) The premise that it’s a good deal for foreign investors is that they would eventually be able to sell or rent in the local market, but… see above!
(I know, it’s a currency play. But if you think dollars are cheap, then by a T-Bill and not a piece of overpriced property in a building that may never get topped out.)
When are people going to realize that offering this type of investment guarantee is virtually the kiss of death on a development? Why not wait until the market can support the development and do it right?
My question is, who would pay to rent there? I hope the building gets built, but I don’t think it will.
It would be interesting to know how many of the 30% sold have the investor package. The developer should just sell a check of the building to a hotel. I am sure a few boutique brands would love to have that location.
Quick math: 7.5% (per year?) of $750K = $56,250
That is almost $4700 per month that the developer will pay the “landlord”. Since this is guaranteed, the landlord doesn’t need to charge a premium to cover vacancies, so the profitable level of rent may really be around $5000.
Somehow I find it hard to believe that the market rent for these 550sqft studios(?) will be anywhere near $4700.
They must have hired American Invesco for the marketing strategy. Who is going to rent a studio apartment for 4700.00 per month.
I agree with both Daves. This looks like a gimmick to get the building up, I doubt it will work.
I always thought the people who would own here would be the crowd with too much disposable money/wealth who would want to own a unit for the status. This crowd obviously does not apply to renters as they don’t get the ‘prestige’ of ownership.
Few renters, if any, will be able to afford these units. What would the rent be on a studio that is priced for 750k? 4k/month?
I’m voting ‘never gets built.’
Kevin,
I believe your understanding of the return is flawed. It is most likely calculated off the investor’s basis in the deal (which is standard for the re industry). Therefore, the math looks like this:
750K * 20% = 150K (Basis)
150K * 7.5% = 11.25K
11.25/12 = 938
From the Crain’s quote above: “a promise by Shelbourne to pay buyers 7.5% of their purchase price for two years”. So, the developer (Shelbourne) will effectively rent back from investors at $4700/mo for the cheapest 550sqft unit at $750K list.
The foundation and excavation aren’t finished yet, and won’t be until late Fall. They still need to excavate the entire site down 80 feet for the parking garage. I think the only foundations that are complete are the caissons for the main tower.
This isn’t really a comparably product to the Ritz-Carlton, which (1) is a boutique residency with only a handful of units, and (2) is an architectural travesty.
Not sure what it says about the future of the Spire, but employing Invsco tactics definitely gives some pause. I really can’t imagine these studio units renting for anything over $2500 in the open market.
That said, Kelleher is going in with 30% private equity to get things started, so the project is much, much less leveraged than most Chicago highrises: this is why he can proceed in such a speculative fashion, because financing is much easier to secure with that much equity (most highrises usually need 50-75% presales before a bank will consider giving a loan for construction). So he also has a much lower sales target to get to a point where he can complete construction and pay the construction debt, meaning he’ll also have alot more time to be patient in fully selling out his product, which won’t even be complete until 2011 when the market picture will probably be different than now (better/worse, I don’t know).
Point being, I don’t think the usual adages about the Chicago real estate market can be applied to this project.
Matt,
The article says unambiguously that the developer will pay 7.5% of purchase price over two years.
For everyone’s, the internal rate of return on real estate will depend heavily on the amount financed and projections of future rent increases and commensurate appreciation in value. The rate of return is basically a comparison of net present values of cash flows and is therefore also dependent upon the timeline of analysis; it’s a little more complicated than a straight percentage calculation.
Here’s a handy calculator to illustrate the interplay between the various factors:
http://www.fincalc.com/INV_04.asp?id=18341
Playing around, one could see how optimistic projects could imply a 7.5% IRR for these properties, but it seems unlikely and probably is closer to 3%. Foreign investors, of course, could potentially bank on future currency fluctuations and make it big if they time the sale right. But I bet a lot of foreign investors will get supremely burned, too.
A financing game/gimmick doesn’t change the fundamentals in the real estate. It is grossly overpriced. I hope it gets built, but I highly doubt it at that price point. There simply can’t be enough dumb foreign buyers out there…since they already got burned in Florida! At this price point it simply will not be built, period. $5K per month for a 550 s.f. studio is beyond laughable. Basically, the developer is saying overpay for the unit and I will refund $5K per month for 24 months back to you (and might just try to rent your place too). This is an investment game/gimmick that makes it LOOK LIKE you can get a safe return of 7.5% possibly beyond year two, but come on, that isn’t going to happen, period. Cool building, price point is off, so why not just fix the price point and get these things sold? P.S. The foreign buyers are trying to dump their units in Florida too…
Preview is my friend:
“For everyone’s reference”
and
“optimistic projections”
…
David (the first one) – the “currency play” would simply be put into a bad investment. As another poster stated, and I have stated previously too, why not just keep the currency play and the purchase decision separate?
John,
No argument from me there, but the ‘currency play’ explains why foreigners are at least interested in U.S. assets at the moment – just because our insider knowledge suggests they might just hold the (nearly) liquid cash rather than tie it up in real estate doesn’t mean it’s an irrelevant factor to bring up as a consideration in determining if U.S. real estate is a worthwhile investment for a foreigner…
Guess I should have read the full article!?!
Since we got technical here, I’d like to ask Shelbourne if they are promising a levered or unlevered “return” of 7.5%.
Word on the street is they’re out of money and have stopped construction. I hope they continue and throw another bunch of condos on the market. More falling prices 🙂
“a levered or unlevered “return” of 7.5%”
C’omn, get serious. A levered “return” of 7.5% is meaningless–if they (somehow) got 100% financing, then Shelbourne wouldn’t have to pay anything. Wouldn’t Shelbourne then have a significant incentive to make sure they get 100% financing? And the investors would want to pledge other assets in order to pay cash (at least for 2 years, then a mortgage would be okay).
The author of the article just got sloppy with the terminology and made a statement (“…offering to rent out the high-priced units at a guaranteed 7.5% return for two years”) that is at best misleading, but that I would say is just wrong.
This looks like a stealth price cut to me. Basically cutting price by 15% and trying to cover some of the cost with the 2 year’s worth of rent. By saying its for “investors” they are trying not to piss off the actual buyers that already signed up. Maybe those contracts have favored nations clauses?
anon….. good luck getting 100% financing on an investment condo.
anyway, if you run a simple IRR calc on this deal, it would look like this:
750K price
-150K equity (20%)
7.9K cash flow yr1*
7.9K cash flow yr2*
150K return of equity**
IRR: 5.3%
*Assumes buyer only pays mortgage (600K mortgage balance, 7% interest rate, 30 yr amortization).
**Assumes no appreciation in price, and sale at end of yr 2.
“good luck getting 100% financing on an investment condo”
See “if they (somehow) got 100% financing”. I acknowledged that.
Your numbers are still wrong; you use (1) an amortizing loan, (2) no appreciation and (3) no RoE for the (NB: SMALL) principal payments.
anon,
i said “a simple irr calc”…
1) using a amortizing loan is far more realistic in this capital environment. again, good luck securing your 100%, interest only financing on one of these.
2) frankly, i would have modeled depreciation to be realistic but like i said… “a simple IRR calc”. modeling no appreciation is just conservative, not wrong.
3) nice try, but the roe on the principal payments in the first two years of an amortizing loan is absolutely trivial, so please excuse me for not carry out the irr calc to hundred-thousandths.
judging from your financial acumen and wreckless assumptions, i’m guessing you’re an acquisitions analyst for either atherton-newport or burnham pacific?
Up to this point, I’ve accepted the fact that based on supply and demand, prices will fall. However, I’ve been a bit less sold on the dramatic drops that everyone has been predicting on this site. After seeing this, one of the most significant and exciting projects in years stoop to such gimmicks, I have nothing but fear and apprehension.
“acquisitions analyst for either atherton-newport or burnham pacific”
Nah, I work for the Trump organization.
moving to chicago – Real estate price drops are slow and painful. Give it time. People have been talking about the huge price drops in Miami and started calling a bottom, but that is silly, they still have a long way to go. So does Chicago just not as much on a % of peak price basis.
‘Nah, I work for the Trump organization.’ I want to say that explains a lot, but I’m not sure.
This is a good time for foreign investment into the US real estate (the ‘currency play’). It’s a lot of risk, but the potential for return is there. The currency is down and the real estate is down. However, Spire prices and this bogus rental deal wouldn’t be my first choice as a foreign investor.
There’s a small, small market for luxury apartment rentals. I wonder, for example, where Christian Bale or Heath Ledger stayed during the filming of Dark Knight. There might be a few other select reasons to rent a luxury unit. But, make no mistake, this deal is bogus.
According to the Trib, the penthouse has been sold.
http://www.chicagobreakingnews.com/2008/09/spires-penthouse-sells-for-tall-price.html
Expensive airspace..