Hypothetical Example

Bulk Purchase of Condominium Dry Boat Storage Racks
Copyright 2008 Alaqua Professional Group

Background
The International Advantage
Example
The Scenario
The Win-Win Solution
Results Case A
Results Case B

Background
Many US dry storage marinas have been set up in the condominium ownership format. The original objectives of this type of ownership were:

• To help the Boat Owner (end user) find convenient and safe boat storage, to avoid "skyrocketing" rental rates, and to capture market appreciation.
• To provide the Developer with a profitable business opportunity and an exit strategy upon turnover to the condominium owners' association.
• To help the Community utilize scarce waterfront property efficiently and meet the growing needs of the public
  
• Theoretically to provide a Win-Win-Win solution.

The US dry rack storage and wet slip condominium markets have fallen on hard times due to several factors:

• Following the residential condominium cycle (the US real estate bubble) more and more developers were chasing fewer and fewer waterfront properties. and paying higher and higher prices for existing properties that would be converted or redeveloped;
  
• The US mortgage market collapse and resultant extreme tightening of credit markets have severely limited the ability of developers to finance marina projects and have almost eliminated the availability of any financing for end user purchase of condominium marina units. Home equity loans, which were the primary source of financing, have disappeared along with the equity itself as home prices plummet. The few banks that were beginning to lend on racks have pulled back; wet slips are somewhat less affected than dry racks.
  
• Because of the morass of government regulations and multiple layers of regulators, it typically takes two to five years of expensive and frustrating effort to obtain permits to redevelop existing marinas and it is nearly impossible to build a new marina. (to comply with neighborhood, municipal, county, state, and federal agencies on issues ranging from parking, aesthetics, traffic, noise, visual, building code, environmental)
  
• Because redevelopment of existing waterfront properties is "the only game in town" developers paid extremely high prices for existing facilities that were then mostly demolished and effectively reduced to very expensive vacant land
  
• In order to justify land cost and produce profit, the price of individual condominium units was pushed upward and onward to the end user (Boat Owner).
  
• The relationship between boat value, slip price, and rent got "way out of whack" with slip prices that could exceed the value of the boat to be stored, thus effectively doubling the cost of entry to "recreational" boating; and market rental rates did not "skyrocket" although there has been a substantial upward trend.
  
• To justify the higher slip prices, many developers declared that they were going after the "high-end" market and forgot about the fact that in most US markets, about 80% of the boats are less than 26' in length -- the demand pyramid narrows dramatically as boat length goes up.
  
• Operating expenses are escalating rapidly, particularly fuel cost and insurance cost, to the point where these considerations are changing the patterns of boat usage and are causing some to drop out of boating and others to decide not to enter.
  
• and ... "the rest is history" -- yet to be made.

The International Advantage
The US dollar has been battered against other world currencies in recent years, reaching near-historic lows against the Euro, British Pound, Canadian Dollar, etc. Yet world insecurity has caused much "flight capital" to flow into the US markets, particularly into real estate products. Is this more bad news, or is there a light glimmering at the end of this tunnel?

US investors are all caught in the same whirlpool together; but you as a non-US citizen or business entity can be the catalyst to create the Win-Win Solution — due to the current exchange rate imbalance that acts in your favor. Leveraged by the favorable exchange rate, you can buy a block of slips (limiting your risk exposure) at a much deeper discount than can a US entity. You can gain interim income from rental and can dispose of units (singly or in multiples) when exchange rates become favorable for selling, and you may gain market value appreciation as US market conditions return to a more normal equilibrium.

Example
The following hypothetical example illustrates how the bulk purchase of dry storage boat condominium units can create a win-win solution for seemingly disparate participants. The concept creates a sound business model with positive cash flow and economic return on investment. While results would be enhanced by market value appreciation, the concept does not depend on it and is not proffered as a speculative or investment scheme.

The assumptions regarding prices, rents, etc are based on solid market data and experience in today's market conditions in the southeastern US region, but are widely applicable to other markets.

You can read more about the hypothetical situation below in The Scenario or review the underlying assumptions of the hypothetical example by jumping to The Win-Win Solution.

The Scenario
Consider a typical dry storage condominium marina containing 200 racks, of which 50 racks (25%) have been sold. The facility was completed in 2006 (at the top of the bubble). Demand has dried up despite diligent (and expensive) marketing efforts and good management by an experienced developer. After initial demand was met as 25 pre-construction contracts were closed and 3 more sales were closed in 2006, only 3 sales were closed in 2007 and none in 2008 -- this is realistic and typical.

The developer's pro forma financial projections were based on a two-year sellout period after completion of construction -- which was entirely in tune with market conditions in 2003 when he bought the property; it took two years to obtain permits and approvals and another year to complete construction (including survival during the very active 2004-2005 hurricane seasons).

Now after two full years of marketing, the project is only 25% sold -- the developer's hopes for personal profit have evaporated, he is financially embarrassed because for the first time in his career he is in danger of losing money -- a lot -- for his equity investment partners (whom he will certainly lose as future investors if his project fails), and with no sales, the developer has been forced to negotiate with the bank for extensions and adjustments to the project loan and the project is perilously close to foreclosure.

The developer has been moderately successful in renting racks at slightly below market rental rates. Demand for rental is not strong but there are many recreational boat owners who are facing financial challenges of their own and they are looking at value-oriented alternatives that might improve their situation. They would very likely be interested in a slightly below market rent in an almost new dry storage facility; or better yet, a "rent-to-buy" agreement where rent paid now would be applied toward purchase of the unit when the boat owner's situation has stabilized.

The developer's remaining 150 units are definitely available for sale or rent, but retail sales are not happening and rental income will not be sufficient to support the project that was financed based on lofty sales figures. Even if he offered dramatic discounts on retail sales it is unlikely that the absorption rate would increase rapidly enough to save the project.

He would gladly sell the whole project in bulk to a "bottom feeder" but because of the US credit crunch, no bank is likely underwrite the risk and no investor is likely to risk the entire amount in cash.

In addition neither bank nor investor would control the entire property -- 50 units are no longer part of the developer's property -- they have been sold and deeded to up to 50 individual unit buyers -- even though they are integral to the operation and the physical structure of the dry storage facility -- and they are voting members of the condominium association. This is a "fractured condominium", a frequently encountered situation in the residential condominium industry, and it can be handled successfully.

The probability of buying back 50 units at prices reasonable enough to regain project feasibility is nil. The probability of negotiating or litigating dissolution of the condominium documents is also about nil and would be very costly. The only reasonable solution requires compromise and a catalyst. The developer must accept necessary reduction in sale price from retail down to wholesale levels; the existing unit owners must cooperate and encourage both sales and rentals of the remaining racks. The catalyst must provide cash into the project but must receive leverage in return that allows purchase of the units at prices where project feasibility (i.e., loan payments and minimal equity distributions can be made).

The Win-Win Solution
Let's assume you are an entity doing business in the Euro currency and that the current exchange rate is EUR 0.64 against USD 1.00 (or USD 1.56 against EUR 1.00). As the USD begins to strengthen, the exchange rate is assumed to increase at 10% per year, and it will reach 0.94 by the end of a 5-year investment holding period.

You purchase a block of 20 dry slips, average length 35 feet, for a total of 700 linear feet of rentable and re-saleable storage. The developer's pro forma price was USD 4,000 per linear foot; the most recent sale (2007) was at USD 3,000 per linear foot and you negotiate a bulk sale price of USD 2,000. The average price per rack is USD 70,000 and the total purchase price for 20 units is USD 1,400,000.

Real estate commission on sale is 8% (USD 112,000) and closing costs are assumed to be 1% (USD 14,000). Therefore, total cash required for closing is USD 1,526,000 (EUR 976,640).

APG Management will manage the rental of your units and represent your interest in the condominium association. You will receive monthly financial accounting of the rental income and expense. Marketing costs will be included in the monthly management fee of 8%. Assume that a rental rate of $17.00 per foot of rack per month is the current market rate and that rental rates will increase by 10% per year. Annual average vacancy rate is expected to be 5%.

Your other operating expenses will be limited to the monthly dues to the condominium association, which cover your pro rata share of marina operating, maintenance, and insurance; and real estate taxes on your units that you pay directly to the county. The condominium association fee is assumed to be $5.00 per foot per month, or $175 per month per unit. Real estate taxes are estimated based on a tax rate (millage) of $20.00 per one thousand dollars of assessed (taxable) value. Both of these expenses are assumed to increase by 10% per year.

Market value appreciation is estimated to be 10% per year. Market absorption is expected to be up to 4 unit sales per year; with sales offered at your direction depending on your assessment of exchange rates, market conditions and other factors relating to your business operations. Real estate commission on sale of units will be 8%.
The underlying assumptions and first year income and expense estimates are in the following table:

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APG Product Hypothetical Example: Condominium Dry Racks for Boat Storage