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Sam: I'm here with my friend, all the way back from high school, Marc Morin. Marc thanks for helping me out with this project.

Marc: Happy to be here Sam. Thanks for inviting me on.

Sam: Yeah, absolutely. I kind of mentioned to you in an email, it's actually a building my great-grandfather used to own back when he owned a department store in Ottawa in 1911. They built it and, yeah I just kind of came across this building and found out it was for sale. I thought "Oh that's kind of interesting I'm kind of curious how much it would be worth right now." I mean our family sold it like a century ago, so...

Marc: Would have been nice to hang on to these things eh?

Sam: Yeah, yeah. Although there were a lot of kids. I think by the time it trickled down to me.

Marc: Yeah, easier for kids today - there's one.

Sam: Yeah, exactly. Essentially, the building is 100% occupied by Scotia Bank. It's 65,000 sq ft in downtown Ottawa, but Scotia Bank is moving out of the top few floors in December of this year, so December 2025 and then the bottom floors they have the ability to leave in October 2028.

So there's going to be some lease turnover. I modeled out a bit of it, but I thought maybe we could go through it, and you could tell me what I'm missing. But I guess maybe first, do you have any kind of thoughts on what the highest and best use for a property in downtown Ottawa on Sparks Street is?

Marc: Well I think by and large people are still concerned about office although, probably the busiest sector of the market asset class wise has been office, and it's primarily because so many groups are looking to get out of owning office buildings.

Manual Life has sold all their office assets. You've got ProREIT has gotten out of the market. It's opened up. You know we've seen a shift from private ownership and institutional back towards syndicators – people looking to put deals together where it starts to make sense. It's started to make sense again. We've seen cap rates increase, so it's been far more attractive for private owners to invest through syndication. So for a property on Sparks Street however, I think that you've got a different group opens up and that's the NCC who's got a stated mandate to own as much of that parliamentary precinct as they can and they've you know sometimes it seems seemingly unlimited funds to do that, but they do have a strategic mandate to own and control as much as they can in that parliamentary precinct. You saw that with the old Chapters building that Chapters had vacated at Rideau and Sussex as an example. From a brokerage standpoint I would want to be positioning this building to them.

Sam: Right, Okay, ideally selling the property to the NCC but then being prepared to kind of bridge those two leasing gaps and fill the space – be prepared for that kind of repositioning potentially of the property if we need to.

Marc: That's kind of the two. I should also say that I don't have any familiarity with the ownership and the history of this building and the brokerage, I'm completely unrelated. So everything I say is off-the-cuff and you know there may be some other great opportunities that I'm not aware of here, so I'll just give that as a caveat before we start.

Sam: Absolutely. Well I mean you definitely know more about the Ottawa market than me, so this is all helpful.

We have these two vacancies coming up, so in the software here I've kind of created two sets of leasing rules. One for the retail space downstairs. It's kind of an interesting building where it fronts onto both Queen Street and Sparks Street. If you're on Queen Street, it looks like a six-story building and from Spark Street it's a five-story building, so you kind of have two levels of retail and then kind of offices upstairs. Based off of different leasing reports, it looks like retail might be maybe 16 months to lease property at the moment. That's kind of your running average and on a gross lease about $36 per sqft is kind of the current market and I just put in a kind of placeholder TI allowance of $10 per square foot and assume 2% step base rent. How does that all sound?

Marc: Underwriting it at $36 for new rent is...if you can make it work on that basis I think that's a good thing.

Sam: Okay, we're being safe by putting in 36 then.

Marc: I'd say that's a very safe number.

Sam: Okay, great and then in terms of the office upstairs I have 9 months to lease at $34 per sq ft gross with no TI allowance.

Marc: Unless the space, depending on what is how it's built out I think that carpet and paint, you know, you assume $10 that you're probably going to need depending on how long Scotia's been there, you're going to need to at least replace the carpet right, and so I think you're going to have to build something there, and you know you might get a better deal if there's something you can walk into as is. But that's a pretty fair price for certainly this location. But something like this you're talking about de-risking it right. You're taking on the risk. You're turning it around. So what's perfection pricing in five or six years from now once you've done all the hard work to get this done.

Sam: Exit cap rate, I mean I remember a professor of mine said "Oh if you want any deal to look good just make sure your exit cap rate is lower than your"

Marc: you're going in cap.

Sam: Yeah, then everything looks good.

Marc: The rule has generally been you know as you're underwriting your exit you would increase your cap rate by a point on the exit just to show some caution in it. But you're going to, in that time, you're assuming if you're holding it maybe less than six years but if you're going to hold it for a reasonable amount of time you're going to assume that you're ratcheting up your rents across the board and you're going to make up for that delta in your growth.

Sam: Right, okay, so what would be a nice safe cap rate to put in, that you know, it doesn't look like we're gaming it?

Marc: Go with 7.5

Sam: 7.5?

Marc: Yeah like I said, you're talking about really stabilizing this asset for a long term and at that point, the reality is you're doing five-year leases. You're going to need to do 10. If you want to sell it in six years, you're going to need to do 10-year leases right. A five-year lease won't really cut it right.

Sam: Okay, that's good to know.

Marc: If you are looking to stabilize and exit within the next six years.

Sam: I mean that's a really interesting point that you're making. Like an important point. So I'm going to change the office leasing parameters to 10 years. So we're going to go looking for 10 years, but we're going to increase tenant improvement allowance to $25 per sqft.

Marc: The reality is $25 is a good number, but that assumes the space is in pretty good shape and there's not too much to do. They can do a lot through systems furniture, let's say. And the cost to the landlord is going to be really you know we're bringing base building up. We're going to give you carpet. We're going to give you new paint and maybe there's some capital work we're doing on our end as the owner, but you're going to do a minimal build out. You're not building up much for $25 per sqft. You're really just doing aesthetic improvements and perhaps you're running a tenant doing a leasing program on furniture systems - systems furniture and walls and things like that. Where they can ostensibly take the furniture with them when they leave the building and that's probably a better way to look at doing this today.

Sam: Well thanks a lot Marc. It's really helpful. I'm going to play around a little bit more with the numbers and I'll let you know what I come up with, but thanks for all your help and advice.

Marc: Yeah, it's great seeing you Sam. Thanks I'm not sure if it was help or advice, but it was at least another perspective. So it was great to see you. Happy to help. I love the program, the software you're using and look forward to digging into that more as well on my own.

Sam: So it looks like in six years our NOI is going to be just over $2.3 million. And we can make some adjustments for the occupancy. And using Mark's exit cap rate of 7.5% and making some adjustments for transaction costs, we're going to be left with a net realizable reversionary value of $26.3 million.

If you have a property you'd like to model out with me feel free to contact me through either the Return Suite website or LinkedIn, I'd love to hear from you.