When a commercial property is bought or sold, it is common for potential buyers and sellers to want to know key information about the property. To deliver this information, it is a standard practice for an “offering memorandum” to be prepared for the property.
In this article, the offering memorandum is described in detail including what it is, why it is important, and how it helps to facilitate a commercial real estate transaction. When finished, readers will have a complete understanding of the importance of this document and the knowledge needed to create and/or read one.
In the investment opportunities that we evaluate, we always ask the listing broker for the property’s OM and use it to begin creating our financial models. For more information on our current property offerings, click here.
What is an Offering Memorandum in Real Estate?
A real estate offering memorandum, sometimes referred to as an OM, is a marketing document used to describe a property that is being “offered” for sale. Offering memorandums are very common in the commercial real estate industry, and they are typically prepared by the brokerage firm that is chosen to list the property.
Why an Offering Memorandum is Important in Commercial Real Estate
The importance of an offering memorandum in a commercial real estate transaction depends on which type of real estate professional is using it.
From the seller’s standpoint, the OM is an important marketing tool because it is given to potential buyers as a way of summarizing the key points of the property and the transaction.
From a buyer’s/investor’s standpoint, the OM is a very helpful document that can be used to quickly determine whether or not the deal is worth pursuing. For example, a potential buyer may go through 25 OMs for various properties and use them to filter the opportunities down to 1 or 2 that meet their investment criteria.
Even though all transactions tend to be unique in their own ways, offering memorandums tend to be fairly similar in their composition.
What Are the Elements of an Offering Memorandum?
All offering memorandums are customized for the real estate they are meant to represent, but they typically contain the following sections.
Offering memos can be very lengthy and can easily stretch to 50 or 100 pages. This is a lot of information for investors to go through so it can be helpful to summarize it at the front of the OM. In short, the executive summary is meant to provide a good first impression to investors by summarizing all of the key deal points mentioned below.
If an investor was only going to read one part of the document and get all of the information that they need to know, it would be in the executive summary.
The property description is both a qualitative and quantitative description of the property being offered for sale. A good description includes the following elements:
- Property Type: Commercial real estate property types include multifamily, retail, industrial, office, etc.
- Property Size: Total number of square feet, units, and/or land area.
- Location: A description of both the geographic market and the specific location within the market, including the street address and parcel number.
- Class: The property classes will give an indication of the condition and risk for the property. Class A properties are high quality and the least risky. Class D properties are the oldest and most risky. B and C are in between.
- Construction: Highlights the materials used to construct the property including things like the roof type, HVAC, plumbing materials, wiring, and number of stories.
- Zoning: Describes the local designation that governs the allowable uses of the property.
These elements of the property allow a potential buyer to quickly assess whether or not it meets their investment criteria.
Because offering memorandums are part of the marketing materials for a potential investment transaction, it is only natural for them to highlight the investment opportunity for potential buyers. This is usually done by highlighting the most logical investment strategy for the property.
For example, the OM could say something like “this is an excellent value add opportunity for an investor who has the expertise needed to renovate the property with updated finishes.”
The financial analysis may be the most important section of the OM. It summarizes the historical financial performance of the property and estimates the future financial performance by creating a pro forma projection of income, expenses, and cash flow.
From this proforma, key profitability metrics are calculated like net operating income (NOI), Internal Rate of Return (IRR), Equity Multiple, and cap rate. These figures give prospective investors an idea of the potential profitability of the property. The best OMs also provide detailed notes about the assumptions used to create the proforma, which allows investors to judge its potential accuracy. For example, the notes may state that there is a 3% vacancy assumption, but an investor may feel that this is too aggressive. In their own financial model, they used 5% and would adjust the offer price accordingly.
As part of the financial analysis, an OM will include a rent roll so that potential buyers can see who the current tenants are, when their leases expire, and how much they pay in rent. These are all very important inputs in the financial model.
The market and location of a property is one of the most important factors in the success of an investment. As such, the OM will provide important details on the market, including things like:
- Market size
- Growth rate
- Major employers
- Transportation options
- Home prices
- Future development
- Population demographics
These items – and others – help investors to determine whether or not the property is located in a strong, growing market.
Pictures and Maps
All offering memorandums contain pictures of the real estate property. The best OMs contain high quality, professional photos of every aspect of the property including the interior, exterior, parking, roof, finishes, and lobby. The idea behind the photos is to provide investors with a good feel for the property’s condition without actually having to visit it in person.
Maps are also a very helpful way for investors to understand what surrounds the property. The best maps will make notes of important points of interest such as highways, schools, offices, major retailers, and other points of interest.
Rent and Sales Comparables
One of the best ways to determine whether or not the proforma rent and sales assumptions are realistic is to compare them to similar properties in the sale market. As such, OMs will often provide tables that highlight how the property offered for sale compares to similar properties on both a rental and sales basis.
For example, the table may highlight that the market average rent for similar properties is $10.00 PSF. If the proforma assumption for the property offered for sale is $12.00 PSF, it would cause an investor to dig into the details of the transaction to determine why or if a 20% rental premium is justified.
OMs may contain more information than the above because they are tailored to the specifics of the property. The real estate broker who creates it makes the final determination of what to include/exclude. In reality, they are often working from pre-set templates that their firm has created for branding purposes and to make sure all of their marketing packages are consistent.
Offering Memorandum vs. Investment Prospectus
Because they contain similar information, offering memorandums are often confused with an investment prospectus. But, there are key differences between the two.
An OM is a commercial real estate marketing document. It is meant to highlight the key points of an entire property and it is used as part of the due diligence process for a buyer when considering a potential purchase. An OM is provided to anyone who has interest in the property.
An investment prospectus is a legal document that is meant to highlight the terms and conditions under which a real estate investment in a specific property is being offered. These are most common in a private placement where a transaction sponsor is trying to raise capital to finance a purchase. The prospectus may only be given to investors who meet the criteria necessary to participate in a private placement offering.
Summary & Conclusion
An offering memorandum in real estate is a market document created by a listing broker and it is used to highlight the key selling points of a property.
Although every commercial real estate transaction is unique, every offering memorandum typically follows a similar construction, which includes the following sections: executive summary, property description, investment opportunity, financial analysis, market overview, rent roll, and photos.
An offering memorandum is similar to an investment prospectus in terms of content, but very different in terms of function. An OM is a marketing document meant to help sell a property. An investment prospectus is a legal document meant to help raise capital to purchase a property.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, 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 Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.