In February 2018, Vertical Ventures launched an offering for an 89,147 square foot, Class A, two-building office campus located in the Redwood Shores submarket of Redwood City, California.
The offering represented an opportunity to acquire the property in an off-market transaction at a significant discount to replacement cost. As of January 1, 2018, the property had been 86% leased and in-place rents were an average of 18% below market rates. 54% was leased to a strong anchor tenant, with the lease expiring in December 2026. Vertical Ventures believed that the local market had an unmet demand for office space and capitalizing on this high demand, over the two-year hold period Vertical Ventures intended to increase occupancy levels to 95% and bring lease terms to market rates (as leases expired).
More specifically, the business plan included three primary goals: (1) to improve and aggressively market the currently-vacant suite (12,687 RSF) and lease it as soon as possible, ideally to a biotech tenant, (2) to work directly with one of the major tenants and their partial sub-tenant to extend both leases on a direct basis for long-term occupancies, and (3) once the rent roll was stabilized and value-add business plan completed, to market the asset for disposition and exit the property within two years.
Slow Leasing & Unexpected Sewer Replacement Work
Leasing velocity in the local Redwood Shores submarket remained slow during the first year of ownership, with the property continuing to have 86% occupancy.
Additionally, Vertical Ventures encountered an unexpected issue with one of the sewer lines serving the 1201 building. The scope of work proved to be complex as it required cutting through some of the structural slab, which impacted the occupancy of the anchor tenant, forcing it to completely move out for a few months. Vertical Ventures agreed to provide the tenant rent relief until the sewer replacement work was completed in late April 2019, which of course had a detrimental impact on the annual gross income and NOI for 2019.
Given the unfortunate sequence of events, Vertical Ventures decided to proactively replace the sewer line in the 1235 building as well to avoid any similar major disruptions to tenants’ operations.
Marketing for Sale
In Q3 2019, Vertical Ventures announced that it had executed over 20,000 square feet of leasing over the past quarter and the property’s occupancy had increased to 94%. One of the deals was with a life science company, which achieved rent well above underwritten projections. Given the recent leasing success, Vertical Ventures decided to put the building on the market for sale, targeting selecting a buyer in Q4 2019, with closing some time in Q1 2020.
However, Vertical Ventures did not achieve desired pricing during the marketing process and instead decided to focus on refinancing the property—in fact, preliminary terms had already been received from a few prospective lenders.
Additionally, by the end of Q4 2019, the sewer replacement work in the 1235 building was completed and tenant improvement works were underway for a 12,000 square foot tenant that was signed in Q3 2019, with the completion scheduled for the middle of Q2 2020.
In early 2020, as a result of the COVID-19 pandemic, the refinancing efforts were put on hold due to the lack of attractive debt opportunities caused by the general shutdown of the lending market.
In Q2 2020, Vertical Ventures informed investors that the property continued to perform well without any request from tenants for rent abatement. With the debt and sales market still quiet, Vertical Ventures was continuing to actively explore options for a cash-out refinance as well as a potential outright sale of the asset in early 2021, subject to market conditions. After suspending distributions in both Q4 2019 and Q1 2020, Vertical Ventures reinstated distributions in Q2 2020, which then continued until the time of disposition. Ultimately, Vertical Ventures decided it was in the best interest of investors to sell the asset and the transaction was officially completed at the end of April 2021.
Vertical Ventures encountered less favorable than anticipated submarket conditions, unexpected capital improvement expenses, as well as the global pandemic, all of which contributed to Vertical Ventures holding the asset longer than originally anticipated. Although the investment achieved lower-than-projected returns for investors, taking all things into consideration, Vertical Ventures was pleased with the ultimate outcome of this project.
* 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 (January 2022), the amount held back at sale will be distributed. Inclusive of this holdback distribution, final returns are projected to be 15.5% IRR*and 1.55x EM*.
This report contains explanations of a series of events associated with Vertical Ventures’ The Pointe at Redwood Shores offering that resulted in an approximate 48%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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