Commercial Real Estate Asset Investment Process
In order to purchase one commercial real estate (CRE) asset, we may look at dozens or even a hundred commercial investment properties. To accommodate this level of effort, we have a very thorough and well defined commercial real estate investment process that is designed to maximize investor returns while minimizing the risk taken to achieve them.
In this article, we provide an overview of that process.
Why Deal Flow Matters
Often, we encourage our investors to imagine our real estate investing process as a funnel. In this analogy, we need to pour a high number of deals into the top of the funnel so that we can analyze them and eliminate the ones that don’t meet our risk criteria and/or return requirements. Through this analysis process, only the best deals emerge from the bottom of the funnel. Those are the transactions that we want to pursue.
But, in order to maximize our chance of seeing the best investment properties, we need to look at a lot of them. To do this, we rely on an extensive network of owners, real estate brokers, lenders, appraisers, leasing agents, lawyers, and property managers to refer investment opportunities to us. As part of our investment strategy, we work hard to maintain these relationships and they have proven to be a valuable source of deal flow over the years.
However, we don’t stop there. We also employ a team of individuals whose sole job is to seek out potential real estate investment opportunities. They are constantly driving markets, calling owners, and combing through public records to identify properties that meet our investment and cash flow criteria.
What is the Initial Screen?
Due to the high number of commercial property acquisition opportunities that we look at, we have developed an initial screening process to quickly filter out the deals that don’t meet our investment criteria. Specifically, we look for things like:
- Property Type: Is the property a grocery store anchored retail shopping center or a single tenant asset with a triple net lease? This is our preferred property type. Anything else (like office buildings, multifamily, or industrial properties) will be a quick pass.
- Market: Is the property located in a fast growing commercial real estate market with favorable supply and demand characteristics?
- Demographics: Is the local population in their prime spending or household formation years?
- Income: Do income levels in the surrounding community support the property’s intended use?
- Credit Analysis: Do existing property tenants have strong financial statements? Are they on long term commercial leases?
- Property Fundamentals: Is the property in good condition with minimal deferred maintenance?
- Purchase Price: Does the property’s cap rate compare favorably to similar properties? Does it allow us to achieve our desired rate of return?
If the property passes the initial screen, it moves into the preliminary underwriting stage.
What Happens in Preliminary Underwriting?
The goal of the preliminary underwriting stage is to take a closer look at every aspect of the property and its financial statements. Key activities in this stage include:
- Offering Memo Review: The Offering Memorandum is a marketing document produced by the listing broker and it is designed to portray the rental property in the best possible light. We review it in detail to learn as much as we can about the asset, its current lease terms, property management company, and zoning. We compare the learnings to our own observations.
- Vacancy Analysis: We review the rent roll to determine the current occupancy/vacancy rates and we compare them to historical trends for the same property. We use this rate as a key input into our pro forma financial model.
- Lease Analysis: We analyze the existing leases for each tenant listed on the rent roll and identify the key terms. For example, we look for key provisions like: start date, end date, termination rights, co-tenancy issues, and covenants. If there are any red flags, we review them with the broker/owner.
- Financial Models: For every property, we develop a financial model with a detailed projection of the property’s cash flows and operating expenses. We compile these numbers into a multi-year proforma and use them to calculate key operating and return metrics like: rental income, Net Operating Income (NOI), maintenance costs, property taxes, internal rate of return (IRR), and the equity multiple. These calculations provide valuable insight into the potential returns that can be achieved.
- Financing Options: We review the terms under which we can obtain debt and equity financing. This includes reviewing key terms like interest rates, valuation, and down payment needed.
The outputs of our underwriting efforts are compiled into a credit memo and presented to our investment committee for preliminary approval.
What is the Investment Committee?
The investment committee is a group of our most senior and experienced individuals. Their job is to review the analysis in the credit memo and to decide whether the deal presents an acceptable risk to our firm and our investors. They meet at regular intervals to discuss the pending transactions and there are three possible outcomes of the meeting: more analysis needed, denial, preliminary approval.
For the deals that receive preliminary approval, there is a final step, the site visit.
The Site Visit
Up until this point in the process, we may have only seen pictures of the property or we may be generally familiar with the market. This is sufficient for preliminary underwriting, but we will not consummate a commercial real estate property purchase without physically visiting the site and performing our own due diligence. Key site visit activities include:
- Speak with current tenants to solicit feedback about the true nature of conditions on the ground.
- Drive the Sub-market to look for things like road conditions, proximity to highways, ingress/egress to the property, and other features that could drive traffic to the property.
- Inspect each unit for signs of work that needs to be performed
If the site visit is satisfactory, we go back to the investment committee for final approval. If received, the deal is turned over to our closing team to ensure that the transaction is closed and ownership is transferred free and clear of any potential issues.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Investor and would like to learn more about our commercial real estate investing opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.