In January 2019, Vertical Ventures launched an offering for a 209,300 square foot commercial office and research park located in the transformative Fremont submarket of Silicon Valley.
The offering represented an opportunity to acquire the property in an off-market transaction at a significant discount to replacement cost. The property consisted of modern, functional office/R&D buildings in a market with strong appeal and healthy tenant demand for single-story product with a variety of existing suite sizes. The in-place contract rents were approximately 50% below market rates, presenting an opportunity to create value by increasing contract rental rates as leases expired. By investing minor capital improvements, implementing a professional marketing plan, and retaining experienced brokerage services, Vertical Ventures was confident they would be able to compete with similar assets in the submarket and achieve market rental rates.
Vertical Ventures officially closed on the acquisition in late March 2019 with a smooth ownership and management transition. Throughout the first three quarters of ownership, the project remained 100% leased and Vertical Ventures focused on the capital improvements, which included repainting the exterior to improve the asset’s curb appeal. Additionally, starting in Q3, Vertical Ventures also began placing emphasis on touring activity as there were three upcoming vacancies scheduled for Q1 2020. Two tenants were leaving because they were downsizing significantly and this project was able to accommodate their reduced square footage requirements. The third tenant was acquired by a national group and no longer needed the space.
Slow Leasing Activity
Unfortunately, the Q1 2020 vacates coincided with COVID-19, and although rent collections remained strong throughout Q2 and Q3 of 2020, the leasing activity slowed considerably with many tenants pausing their leasing decisions until there was more clarity on the long-term impact of the pandemic.
Additionally, in Q2 2020, Vertical Ventures encountered another challenge in that the sewer line in one of the buildings failed, requiring a full replacement, which was an unexpected expense. This replacement project was completed during the third quarter at a cost of approximately $300K and caused an inconvenience in the tenant’s space where construction occurred. Fortunately, the tenant was able to utilize the adjacent vacant warehouse space to mitigate the impact to their business.
As of Q3 2020, the property was 64% leased, which was not sufficient to produce positive cash flow. Vertical Ventures communicated to investors that future potential distributions would be dictated by its ability to execute leases on the vacant spaces.
In Q4 2020, the project remained behind plan. It was 51% leased and not producing positive cash flow from operations, which hindered Vertical Ventures’ ability to make distributions as planned (at this juncture, the asset should have been 97% leased per original underwriting and already distributing).
As a result, Vertical Ventures informed investors that it had agreed to terms with a prospective buyer for the property, received a signed letter of intent, and that it was now in the process of negotiating a purchase and sale agreement. The buyer had expressed interest in demolishing the existing buildings and redeveloping the entire site, which was a major departure from Vertical Ventures’ business plan, but demonstrated the initial conviction about the multiple exit strategies associated with this project including its inherent land value.
The sale transaction was officially completed at the end of April 2021.
Vertical Ventures encountered difficult market conditions during the pandemic, which, in combination with leases expiring and tenants vacating, prevented it from fully executing the original business plan. However, all things considered, Vertical Ventures was able to successfully overcome these challenges by finding an alternative way to exit the investment earlier than planned, achieving positive, albeit lower-than-projected returns for investors.
* Net of the most onerous fees charged to clients of CrowdStreet Advisors, LLC, our registered investment advisor subsidiary; an investor’s actual returns on a realized investment may differ.
1 Upon expiration of the contingent liability period (December 2021), the amount held back at sale will be distributed. Inclusive of this holdback distribution, final returns are projected to be 15.2% IRR* and 1.35x EM*.
This report contains explanations of a series of events associated with Vertical Ventures’ Dixon Landing Research Park offering that resulted in an approximate 31%1 (net of fees) absolute return on original equity to investors (including those from the CrowdStreet Marketplace). Certain aspects of the report such as dates of major events and the final outcome are easily verifiable while others, particularly underlying reasons behind the sponsor's business plan execution, are not.
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