Ron DeGrandis has spent 50 years in the real estate sector analyzing the market and advising business owners on deal structures, valuations and tax credits. His bottom line: Business owners are afraid that owning real estate will tie up capital they might need for other investment opportunities.
“They want to leverage the money into their business and get a higher return,” says DeGrandis, a partner at RSM US LLP.
Still, there are opportunities for savvy dealmakers who take the time to study the real estate market and identify pathways to earn a return on their investment.
“If someone is buying or selling a business, unless you are really into that transaction, you’re not going to know if they’re feeding you a line about what the potential earnings are,” DeGrandis says. “In real estate, it’s pretty evident what is happening. All the transactions tend to be recorded and there is more data to extract. You have to watch the trends and see if you can predict ahead of time where things are going to start moving.”
DeGrandis shares some of his vast expertise on real estate dealmaking in the context of the recent sale of downtown’s Key Center to Frank Sinito and Millennia Cos.
What are some of the variables of a typical real estate deal?
Trying to structure a real estate transaction is all about figuring out how you’re going to pay for it and making sure you budget enough to cover the deal. The capital stack is a classic term used to figure out how much it’s going to cost to buy, build on or come up with uses for a particular piece of property. Then you have to balance that with where the money is coming from.
The best strategy is to start with the bank and get as big a loan as you can, then figure out your gap and fill it in with other funding sources. When we worked on the Key Center deal, it was a $300 million transaction with a bunch of different parts. We got a first mortgage and a mezzanine loan from the same people, which covered about 65 percent of the acquisition. The balance was filled with private equity and the owner’s equity. You have to go out and negotiate a bunch of these different things.
How do you set yourself up to get a good return on a real estate deal?
Go back to the example of Key Center. You have the first mortgage, the second mortgage that will have a higher rate and you have friends and family in there that are looking for a certain return. Then you have the private equity guys that are looking for a 20 percent return. You have to figure out what your weighted cost of capital is. That will give you some idea of how this property has to perform. In the case of Key Center, we’re going to put a lot of money into that property.
It was built in the 90s and there has only been one other office building built since then — Ernst & Young Tower. It needed a redo.
Sinito is putting a high-end Italian restaurant in that space. They’re jackhammering the lobby and redoing the whole thing. He’s looking at an increase in revenue, but first, it’s a decrease in revenue.
When you do all these improvements, it affects your usage. You have to build that in for working capital and then you wind up hopefully getting additional revenue.
You can’t look at the current revenue. You have to go out a few years and compare that to what you’re investing. It’s a financial model. We had to keep adjusting for assumptions and changes. If the interest rate moves a quarter point when you have a lot of fixed leases, it has a big impact on the transaction.
We hadn’t fixed our borrowing yet, so it was floating around until we actually closed the transaction. There are all these moving parts that come into play.
How to reach: RSM US LLP, http://rsmus.com/