should be noted that industrial build-to-core investments typically provide the lowest premium to core pricing of all property types. This is because industrial development generally has less construction risk and shorter
development periods compared to other property types.
Of;ce build to core typically generates the greatest expected premium with the most risk.
As Exhibit 2 shows, the base case underwriting results in a long-term IRR of 8%, which compares favorably to current core unleveraged returns of 5% to
7% (ten-year IRR) for acquiring newer, well-leased
industrial properties. The cost basis after paying for
the partner promote is $104 per square foot versus the
market value of $120, a 13% discount.
We have also calculated and shown different scenarios that re;ect alternative cost, market, and capital
market assumptions. Under the “outperforms” scenario,
where the stabilized value greatly exceeds initial expectations, the “build-and-sell” IRR to the LP increases to
24%, while the long-term IRR increases to only 8.3%.
Many investors ;nd the prospect of a large short-term return very tempting and may decide to sell. On the other
hand, the buyout price of $114 per square foot represents a greater discount to market value than in the base
case, providing a rationale to continue to hold.
The exhibit also shows the impact of a cost and time
overrun scenario, which generates lower returns compared to the base case but similar or greater returns
compared to the acquisition of an existing core asset.
Finally, the exhibit shows a “market correction” scenario, in which lower rents and market values upon
stabilization create a negative IRR upon stabilization.
Under the market downturn scenario, long-term returns, assuming a partner buyout, are still positive
( 4.9%), but they are below a core stabilized warehouse
investment. The more severe the downturn, the more
the build-to-core strategy underperforms. However,
if the acquisition pricing for stabilized core is very
high—more than 30% above replacement costs—
build to core could outperform stabilized core investments even in a market downturn.
Build-to-Core Activity Follows Real Estate Cycle
The NCREIF Fund Index—Open End Diversi;ed Core
Equity (NFI-ODCE) data provide a barometer of how
to track build-to-core trends. The trend in build-to-core
activity, shown in Exhibit 3, mirrors the relationship
between pricing and construction costs shown earlier.
The gross unleveraged value of development and
lease-up properties in the NFI-ODCE hit a record abso-
Exhibit 2: Build-to-Core Project Example
300,000-Square-Foot Industrial Development
Limited Partner (LP)–General Partner (GP) Ownership: 90%/10%
Construction Leverage: 60% (Nonrecourse)
Long-Term Exit Cap Rate 50 bps Higher Than Rate at Stabilization
GP Promote: 30% Over 9% Return, 50% Over 15% Return
Base Project Cost/Time Market
Case Outperforms Overrun Correction
Project IRR if Sold at 14.9% 31.9% 6.0% – 5.9%
LP IRR* if Sold at 13.6% 24.0% 6.0% – 5.9%
LP Basis if Partner Buys $104 $114 $111 $99
Out at Stabilization
($ per Square Foot)
LPTen-YearUnleveraged8.0% 8.3% 6.9% 4.9%
IRR* With Buyout of
Partner Upon Stabilization
Source: LaSalle Investment Management
* Not including advisor fees
much build-to-core investment activity is under way by
institutional core funds. Unlike the NCREIF Property
Index, the NFI-ODCE includes properties in development and lease-up. The 24 funds in this index are core,
long-term holders, although most funds have small allocations to non-core, higher-return strategies, typically
capped at between 10% and 20% of their portfolios. Discussions with several plan sponsors indicate that they
typically limit direct build-to-core programs to less than
10% of their real estate allocations.
While not every development investment by an NFI-ODCE fund is build to core—some are sold soon after
stabilization—most are expected to be strategic, long-term holds, making this information an excellent way