What I'm Learning: Commercial Real Estate Is Changing How I Think

Question

As someone making the transition from residential investing into commercial real estate, I've noticed a shift in how I evaluate deals.

When I first started investing, my focus was pretty simple: "Will this property cash flow?"

The more I've studied commercial real estate, the more I realize experienced investors seem to start with completely different questions:

- How is the deal being financed?

- What's the business plan?

- What's the exit strategy?

- How strong is the tenant?

- What assumptions could prove wrong?

It's changed the way I underwrite opportunities. I've found myself spending more time understanding the structure of a deal than getting excited about the property itself.

For those of you who have already made the jump into commercial real estate, what was the biggest mindset shift you experienced?

I'd genuinely enjoy hearing what changed the way you evaluate deals.

Michael K Gallagher · Answer

my biggest shift was how much more nuance there is in each deal, even within same asset classes, different jurisdictions, slightly different use cases, all can impact deals.  but I think that is ultimately what excites me about it as a whole, the flexibility, and nuance and creativity involved.

Evan Polaski · Answer

There is definitely nuances in how you think about deals.

But, I think this nuance comes from experience, regardless of asset class.  Will it cash flow is still a very reasonable consideration for any deal, assuming that is your investment goal.  And, really, all your follow-on questions are practical and important to anwering that question.

Even single family rentals: if your tenant is someone that destroys the property causing $30k of damage and disappearing... well even if it did cash flow for the 12 months prior to moving out, it isn't cash flowing for years to come to earn that back.

But, to answer your question, it is just more of the same questions diving deeper down the nuance hole.  I invest in retail assets, specifically multi-tenant strips.  So, tenant line up and strength of tenant directly impacts the strength and reliability of my cash flow.  Current condition of the property also impacts my cash flow.

But, it gets to traffic counts, signalized access, side of street, sales volume and foot traffic of anchor tenant, current rents, market rents, cotenancy issues, visibility, signage, parking counts, current market vacancy, tenant mix, current tenant concepts, etc

All of the above lead to likelihood of current tenant base renewing upon end of term, while also impacting demand for new tenants.

And as for specific deals: why is seller selling?  In my area of focus, when I am on seller interviews, it is almost always driven by sellers running out of money to pay for TIs.

I like tertiary grocery-anchored shopping centers. Why? Everyone needs to eat and rents in these markets typically do not make sense for new development.

Priyanshu Adathakkar · Answer

Sometimes, the absolute best deal you'll ever make in real estate is the one you decide to walk away from.

Recently, a client brought us in to evaluate an older extended-stay hotel. They were excited about the potential upside and the seemingly bargain purchase price. The property had decent historical occupancy, mostly hosting long-term project crews.

But when we looked under the hood, we saw a money pit waiting to happen.

With these 30-plus-year-old wood-frame properties, what you pay at the closing table is just the beginning. We stress-tested their game plan, and the cash flow this property was generating would have been completely wiped out by the massive renovations needed just to keep the doors open. Modernizing a 90s-era hotel means tearing into the bones of the building—replacing aging HVAC, plumbing, and roof systems.

Furthermore, massive institutional funds are buying up these older portfolios left and right. They have the bottomless pockets needed to completely gut them or convert them. For an independent investor, trying to play their game without a flawless execution plan is incredibly risky.

When the numbers looked this rough, our advice was simple and direct: drop the deal. The client trusted us, kept their powder dry, and is now ready for a much cleaner opportunity.

It’s tough to tip your hat and walk away when you’ve spent weeks crunching numbers, but protecting your downside is exactly how you build wealth in this business over the long haul.

Jayson Vespia · Answer

Thank you for taking the time to explain your thought process. I appreciate you sharing why you focus on tertiary grocery-anchored centers. It's interesting to hear not just what experienced investors buy, but the investment thesis behind it. That's exactly the kind of perspective I was hoping to gain by joining this forum.

Ronald Rohde · Answer

My biggest shift was having more confidence to raise money. Small deals in SFR and being limited to your own equity. Now I can raise other people's money and make a lot more for myself

Gibran Ramia · Answer

The shift for me was realizing I wasn't buying buildings anymore, I was buying contracts. The building is just where the lease is stored.

In residential the house is the asset and the lease is a state form you sign at the end. Flip to commercial and it inverts. Take the same box, same rent, same NOI today. Put a 10 year lease in it with 3% annual bumps and a guarantor with real financials behind it, and it's worth a lot more than the identical box with a tenant on month to month. Nothing physical changed. The document changed. That was the moment it clicked for me.

The other one I'd add to your list is WALT, your weighted average lease term. You're already asking about the exit, and the exit gets decided years before you sell, by the terms you signed. A buyer is paying for how long your income is contractually locked and who's actually on the hook for it. You want to be selling into term, not into a stack of expirations.

Claudia Rodriguez · Answer

One of the biggest mindset shifts I’ve seen is realizing that a good property and a financeable deal aren’t always the same thing.

In commercial, I spend much more time thinking about how all the pieces work together the purchase price, NOI, DSCR, leverage, tenant strength, lease terms, liquidity and ultimately the exit strategy.

A deal can look fantastic based on projected cash flow, but then you start asking: What happens if rents don’t increase as projected? What if a major tenant leaves? What if expenses are higher than expected? Does the property still support the debt?

I think that’s the biggest shift: moving from “Does this cash flow?” to “How does this deal perform when my assumptions are wrong?”

That downside analysis tells you a lot about whether you’re looking at a good investment or simply a deal that looks good on a spreadsheet.

Henry Clark · Answer

OP.  I will fail no matter how much experience and analysis I bring to the table.  Then I make sure I have addressed the top 90% of the deal.  Then I fail on small items such as landscaping, extra lights, advertising, etc.  That way I spend my time in the top issues versus worry about all of the small issues that even if they blow up they are small.

Stress testing the extremes.  Occupancy I always push a scenario to break even, which means all expenses and P/I are covered.  Last was 50%.  Assuming interest rate goes up a couple points.  2% is fine.  Either during development and rent up.  Or at 5 year balloon period.

Cost overrun we might use $100k overrun on a $1.?mm job.

Our lenders appreciate this.

What I'm Learning: Commercial Real Estate Is Changing How I Think

Most Popular Reply