As a private equity commercial real estate investment firm, we are constantly on the hunt for new investment opportunities into which our capital can be deployed. But, we aren’t willing to purchase just any commercial property. Each potential investment must pass a rigorous due diligence process and it must be approved by our senior leaders before an offer is made.
In this article, we will provide an overview of that process. There are 4 stages: identifying the property, initial underwriting, due diligence, and final approval.
Identifying the Property
Imagine the investment process as a funnel where all deals go into the top of the funnel and only the best ones come out of the bottom. In this analogy, the “Identifying the Property” stage is where we find deals to put into the top of the funnel. We believe that strong deal flow is a critical component of our investment success and we leave no stone unturned when looking for real estate properties to purchase.
We believe there are three keys to sourcing strong commercial real estate (CRE) deal flow:
- Relationships: Commercial real estate brokers are the deal gatekeepers. The best ones have long standing relationships with property owners and can act as a matchmaker between them and buyers with capital to invest. We believe that developing a wide network of broker relationships is a critical element in the effort to build strong deal flow, but just having a relationship may not be enough. It is equally important to build credibility with each broker and to demonstrate the financial capacity to close on deals that they present. We do both.
- Clear Investment Criteria: We don’t just want any deal. We want deals that fit our investment criteria and it is our job to communicate these criteria to brokers and other referral sources. Doing so allows them to act as a pre-screen of sorts to curate the deals that best fit the criteria provided. In doing so, we can reduce time spent on deals that turn out to be dead ends. In our case, the property types we prefer are: NNN leased properties, grocery store anchored shopping centers, and properties with service based businesses in target markets.
- Data Driven Approach: The key to being able to quickly filter through a high volume of deals is to take a methodical and data driven approach to analysis. For example, if we require a minimum of 15% IRR, 2.5x Equity Multiple, and tenants with a long history of on time rental payments, we can quickly eliminate deals that don’t meet these targets and focus on deeper analysis for the ones that do.
The desired result of this stage is to review dozens or even hundreds of opportunities and to narrow them down to a small handful of properties that meet our investment criteria. For those that do, we move into the initial underwriting stage.
The opportunities that move into the initial underwriting stage are subjected to detailed financial analysis. Key activities include:
- Requesting the property’s financial statements, property tax bills, rent roll, and host of other important documents
- Review the property’s existing leases to confirm their start/end date, rental amount, and key provisions.
- Perform market and demographic research to assess rental trends
- Begin conversations with a lender to determine the approval process for a commercial real estate loan. Identify key approval requirements like LTV, Debt Service Coverage Ratio (DSCR), and occupancy.
- Construct a proforma projection of the property’s income and operating expenses. Use the output to calculate Net Operating Income (NOI) and key cash flow metrics like cash on cash return and internal rate of return.
- Compile all findings into an approval memorandum.
Typically, the initial underwriting work described above is performed by an analyst and they compile the results of their analysis into an “approval memorandum.” This document is presented to our investment committee, which consists of our most experienced and senior leaders. Together, the committee reviews the specifics of the deal and votes whether or not to proceed. If the deal is approved, an offer is made. But, just because an offer is made doesn’t always mean that the deal is going to work. The seller may not like our price or we may not like theirs. Because of this, we typically make offers on 2 or 3 properties with the goal of getting at least one of them to close.
If the offer is accepted and the sales contract is signed, the deal moves into the due diligence stage. In it, our analyst(s) and our third-party partners (engineers, appraisers, inspectors, etc.) review the property from top to bottom to ensure it is as advertised and safe for occupancy. At a high level, due diligence activities include:
- Interview the current property management company to confirm leasing activity and validate current vacancy rates
- Order an appraisal to verify the value of the property
- Ensure that the zoning for the property is adequate for its intended use
- Perform a site visit to speak with current tenants, drive the market, and inspect the property’s condition on our own
- Review the output of third party reports to ensure there are no major environmental or structural issues with the property. If there are, assess the scale of the issue and create a budget for the required renovations and repairs. If necessary, renegotiate the purchase price.
When due diligence has been completed and the results have been compiled, the transaction goes back to the investment committee for a second and final approval.
Final approval is our chance to take one more look at the transaction to ensure it is consistent with our investment criteria and objectives. We also look to ensure the desired return hurdles will be met and confirm that it is an asset that our real estate investors will be happy with. We perform these activities with the knowledge that our investors trust us to get it right and we take that job seriously. If the transaction checks all of the required boxes, it proceeds to closing.
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 investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.