How To Analyze A Commercial Deal?

Question

Hi BP,

I just received a lead on a commercial property on the outskirts of Houston. It has office space on busy highway and it sounds like a decedent deal, it has 100% occupancy and the owner wants to sell, to capitalize for another project. However, I have no idea how analyze a commercial deal.

I have asked for the sale price, rent roll and tenant count up to this point. What else should I ask for? What makes a bad commercial deal?

Zachary Curry · Answer

Roland congratulations on sourcing a commercial deal. Currently as Hedge Funds are experiencing major outflows and high volatility we are seeing these large institutions begin to invest largely in commercial real estate to provide a base line growth from the steady returns commercial real estate provides. Houston is a great are to be in as the growth, despite the oil turbulence, is quickly growing.

Commercial Real Estate is fun and can provide amazing returns.

If the numbers work meaning asking and rent roll, and you return a profit then move into what terms are provided. Are the tenants paying for CAM or common area maintenance? Are the tenants a triple Net meaning they pay taxes and all costs associated with their lease?

If these are all yes then proceed.

Now what type of returns are you wanting and look 3, 5, 10 years and review the tenants as most commercial spaces provide for long term tenancy. Are these current lease terms going to provide the long term gains you are looking for?

Something to review since this is a business environment is what type of business are the tenants participating. Law offices which are consistent or a call center which may or may not excel over time?

Additionally look to any value add scenarios. Is the space large enough and positioned that if you were to contact a lab corp or a ct scan franchise company and provide them with lower rent, to latter attract doctors turning your office space into a medical office building to achieve greater returns? Hospitals in close proximity are not competition they are complimentary***

Also what industries are exploding that you could reposition your building appropriately, such as upgrading the building with high powered networking infrastructure. Imagine buying an office building in Palo Alto 15-20 years ago what return you would have now.

Contact your local Chamber of Commerce they can assist you with a lot of information, they will even have members looking for office space if you have vacancies. Another great contact is your local business development in the government. These are the agencies that are actively seeking new companies and they provide tax incentives for them to open offices.

A "bad" commercial deal would consist of tenants not paying for Common Area Maintenance, and long term leases with low incremental increases in rent.

So things to ask.

What type of leases do the tenants have?

What long term projections/Return on investment will I receive?

Are there any long term value add positions to achieve greater returns?

Good luck, and think big.

Zachary Curry · Answer

@Roland Thomas

I review returns from a banking perspective.

First look at the 10 year bond yield. 10yr Bonds

Then evaluate your local inflation rate. HPI Summary Tables

Take the qtr inflation rate and the 10 yr bond average and you should structure your current deal with that standard. They are usually similar but you want to outperform these metrics. Currently they are low. So a 2% would be healthy.

Example:

Florida 1.99

10 yr bond as of yesterday 1.85

This would be a minimum of 1.92

You can do this is a hyperlocal market as well which will change a rural area will under perform vs. a metro.

The reason you use these numbers for yourself are to provide a risk margin for your investment. Less risk to invest in a guaranteed 10 yr bold yield. So if you incur more risk you should incur more return. It also shows how to structure a deal for a tenant long term securing a trend in rental increases appropriate for the current markets. Meaning they benefit from signing a 10 year lease rather than a 5 year not knowing what future markets hold.

Roland Thomas · Answer

@Zachary Curry Is there a common thumb percentage ROI on rent? For example in residential you want rent to be around 1-2% of the ARV or MKT Value.

I wouldn't want to acquire a building and lease terms are below common rates for the area. Or am I thinking too residential?

Roland Thomas · Answer

@Zachary Curry THANK YOU SO MUCH!!! This is a major help!