Retail · Conversions
Underwriting a Dark Box: The Four Inputs That Decide It
Buying a vacant retail building is a development deal wearing an acquisition’s clothes. Here is what actually moves the return.
A vacant building has no income, so a cap rate on the purchase price is meaningless. What you are actually underwriting is a small development: you buy the shell, spend money to make it leasable, carry it empty while you do, and only then own an income stream. The right measure is yield on total cost against the cap rate you will exit at.
1. Achieved rent
Nothing else comes close. Run the sensitivity on any conversion and rent produces the widest swing in IRR by a distance, typically two to three times the effect of the tenant improvement budget. That is uncomfortable, because rent is also the input you have least control over and the one brokers are most optimistic about. Underwrite the rent you can evidence from signed comparable leases, not from a marketing flyer, then test one dollar below it.
2. Downtime
From closing to rent commencement you are paying taxes, insurance and utilities on an empty building, and earning nothing. Nine months is optimistic for a large box, eighteen is common, and permitting is usually the culprit rather than construction. Every additional month is pure carry with no offsetting revenue, and it compounds because it delays the rent escalations behind it.
3. The capital plan, timed properly
This is where most back-of-envelope work goes wrong. It is not enough to know the roof costs $8 a foot; you need to know the year you write the check. A membrane with six years left is a year-six capital event, and it should sit in that year's cash flow. One that is already past its service life belongs in your basis at closing, because the incoming tenant's letter of intent will require it before they take occupancy. Same dollars, very different returns.
4. The fee stack
Tenant improvement allowance is the one everyone models. The rest add up faster than expected: landlord work to demise and re-face the building, a leasing commission on the full term, plus a tenant representative share if they bring their own broker, origination points on the loan, and a sale commission on the way out. On a typical conversion these total more than the TI allowance itself.
The number to report
Not the IRR. Report the development spread: stabilized yield on total cost minus exit cap rate. That single figure tells you whether you are manufacturing an asset for less than one costs to buy, which is the entire reason to do a conversion rather than buy something stabilized. Under 100 basis points, the deal has no tolerance for a slipped schedule, and schedules slip.
Run it: Vacant Pharmacy Box model, with capital items you place in the year you spend them.
Related notes
How to read this. These are working notes. Figures come from public reporting and from the models on this site, and market conditions change, check anything time-sensitive against the source before you rely on it. Nothing here is investment, tax or legal advice, and no note is a substitute for diligence on a specific property.
Built with the underwriting model on this site. How it compares with the licensed product.