Wal-Mart has approached you with the opportunity to develop a one million square foot warehouse for them. In typical Wal-Mart fashion, they have given you a take it or leave it final offer. The key terms are:

Facility Size 1,000,000 ft2 with 26,000,000 usable cubic feet

Lease Term 6 years

Rent $7 per ft2

Operating Expenses Wal-Mart pays all operating expenses, utilities, and property taxes

Renewal Options 7-year extension at $8 per ft2; a second 7-year extension at $9.50 per ft 2; a third 7-year extension at $11.50 per ft.2. All at Wal-Marts choice (i.e. its Wal-Marts option). Wal-Mart pays all operating expenses, utilities, property taxes, and capital expenditures undertaken during all lease renewal periods.

Penalties If the property has not received its Certificate of Occupancy within 9 months, rent falls to $5 per ft.2 during the first 4 years of the lease. If it is not received within 12 months, Wal-Mart is released from all obligations and receives a $3 million penalty payment from the developer.

Property Specifications Must meet all design and quality standards associated with a top-quality bulk distribution facility.

You know the market and feel that the selected location is good and that the warehouse market is in good supply/demand balance. Vacancy rates are 4% - 5% in quality facilities, while net rents in the market are running about $7.50 - $8 per ft2.

You estimate that your development costs to complete (and hence receive your Certificate of Occupancy) this project within 8 months are:

Hard Costs $40 million

Your Development Fee $ 2 million

Interest Costs $ 3 million

Land $16 million

Other Soft Costs $ 9 million

Total $70 million.

You have a $54 million construction loan lined up with a one-year term for a 7% interest rate. You believe that upon completion you can sell the property for a 9% cap rate with Wal-Mart credit as the tenant. Alternatively, you believe you could get a 10-year, 30-year amortization, 6% interest loan for $58 million upon completion (with Wal-Mart as the tenant). Lesser credit tenant quality distribution facilities sell at roughly 10% cap rates.

You have a construction bid for the $40 million hard costs from a mid-sized local contractor that contains a guarantee of hard costs. You also have a contract to purchase the land for $16 million, which you can close with your $16 million of available equity (90% of your firms net equity). Your experience indicates that it should take 30-33 weeks to complete the project and receive your Certificate of Occupancy.

Its decision time. Do you accept their bid or walk away? More importantly, why or why not?