- Every commercial real estate transaction is unique, but they all go through the same general lifecycle.
- In the identification and origination stages, the goal is to identify a subset of properties that present an attractive investment opportunity.
- In the underwriting stage, the candidate properties are analyzed and the potential returns are calculated. An offer is submitted for the most promising opportunities.
Every commercial real estate transaction is unique. They each have their own quirks, but they all follow the same general process. This process is known as the “transaction lifecycle” and there are five stages:
- Identification & Origination
- Due Diligence
- Asset Management and Disposition
It is important for investors to understand the key activities that occur in each phase and to recognize the trigger that moves the transaction from one stage to the next. They are the subject of this article.
Identification and Origination
The goal of the identification and origination stage is to find one or more properties that appear to hold promise as a potential real estate investment opportunity. This is easier said than done. Key activities in this stage include:
- Performing internet searches with targeted criteria
- Working with local brokers to communicate investment criteria and to encourage them to find properties that meet it
- Canvassing markets on foot and by car to identify potential acquisitions
- Networking with other investors, lenders, lawyers, architects, accountants, and municipal officials to identify potential properties
- Combing through legal records for foreclosures and past due property taxes to identify motivations for selling
- Direct mail campaigns to property owners
Ideally, the result of these efforts is to identify multiple properties that meet the required investment criteria. Unfortunately, it may take filtering through dozens or hundreds of opportunities to identify a handful that are qualified to move into the Underwriting stage.
The intent of the underwriting stage is to take the identified properties and to subject them to rigorous analysis. Activities in the underwriting phase include:
- Obtaining financial documents for the property including operating statements, bank accounts, balance sheets, and selected invoices
- Constructing a financial proforma to model a property’s occupancy, rental income, expenses, valuation, and cash flow
- Working with lenders and investors to identify the initial terms of the required debt and equity raise
- Performing market and submarket analysis
- Validating proforma assumptions by analyzing market conditions and demographic data
- Calculate key return on investment metrics like: internal rate of return, equity multiple, cash on cash return, gross rent multiplier, and debt service coverage ratio
- Working with the seller and/or their representatives to negotiate the initial terms of the deal
From the handful of properties that enter the underwriting phase, the goal is to have at least a few of them survive the analysis so that offers can be made. This is the trigger that moves the transaction into the due diligence phase.
The typical purchase and sale contract for a commercial property includes a specified period of time for the buyer to perform additional due diligence on the property. The purpose of the due diligence is to validate the initial underwriting assumptions and to verify that the property’s physical condition is as advertised. Typical due due diligence activities include:
- Interviewing the property manager about maintenance issues and the property’s track record of repairs
- Order a valuation report from an appraiser
- Ordering technical reports like a phase 1 environmental site assessment
- Walk the property to test all of the faucets, electrical sockets, and light switches to ensure functionality
- Working with structural engineers to verify that the property is safe for occupancy
- Verify zoning to ensure the property is approved for its intended use
- Assess what level of renovations, if any, need to be performed and complete the budgeting process for them
- Review all documentation to ensure there are no major issues
Upon completion of the due diligence process, investors should have a high degree of confidence that the property is in good working order. If any surprises are discovered, the sales price may need to be renegotiated or, if the issue is big enough, the investor may walk away. If everything checks out, the transaction is ready to move into the closing phase.
The closing stage is a relatively short one time-wise, but there are a significant number of tasks to be completed. The purpose is to finalize the details of the transaction and to sign all of the necessary paperwork to legally transfer ownership of the property to the buyer. Key closing activities include the following:
- Finalize pricing on the debt and equity capital. Get a commitment letter from the lender.
- Complete a title search and purchase title insurance on the property
- Draw up loan closing documents
- Sign all closing documents
- Transfer the funds to the closing agent
Once the funds have been wired and the documents have been signed, the property’s title has changed hands and it is now in the possession of a new owner. But, this does not mean the transaction is complete. For context, it usually takes about 60-90 days to get a transaction from identification to closing. But, it may be owned for 5 or 10 years, during which time the asset must be managed.
Asset management is not a one time activity. It is an ongoing set of activities that are required to keep the property in good working order. In some cases, these activities are performed by a third-party property management firm. In other cases, they are performed by the owner of the property. Either way, the following tasks must be completed in the asset management stage, regardless of property type:
- Execute the property’s business plan
- Continually review the property’s actual operating expenses against the budget and adjust as necessary
- Collect rent and deposit the funds into the property’s bank account
- Monitor past due reports and work with tenants to get their rent payment current
- Complete basic repairs and execute a preventative maintenance plan
- Oversee renovations and capital expenditures as part of a value-add strategy
- Monitor local market dynamics and adjust rental rates as needed.
- Negotiate lease renewals for existing tenants. Manage leasing activity for new tenants
- Work with with local regulatory authorities to ensure the property is in compliance with all laws and regulations
- Sell the property at a price that allows investors to earn a return
While it is important to acquire a CRE property at a favorable price. It is equally important to manage it efficiently. Otherwise, the property’s value could suffer, regardless of the asset type, asset class, or location.
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 firstname.lastname@example.org for more information.
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