3 Questions You Should Ask Before Investing in a Commercial Real Estate Property
1. Is this specific opportunity suitable for me?
Let’s assume a private real estate investment is what you’re looking for. When given a due diligence package, you should first look at the location. You want to make sure the building or development is in a city or area that you believe in long term – a place that, in 5-10 years, is going to hold value and still be coveted. If you’re buying what’s currently a high quality building with high quality tenants, but it’s in a location you’re unsure about, that’s a lot of risk to absorb in a real estate investment.
It’s important to look even further at the submarket and surrounding areas. Check out the city’s past performance and how it may have been affected during previous recessions. That alone will tell you a lot about the area.
2. What kind of tenants are in the buildings?
The second item that’s important to focus on is the property’s rent roll or tenancy. What kind of tenants are in the building? Do they fit the profile of the building? How long are their leases in place for? Is the anchor tenant of credit quality? Do you believe in the anchor tenant, and are they locked in long term?
A lot of these answers will vary depending on the type of investment you’re focused on. Assuming you’re looking for a cash flowing, stable deal, you’re going to want to look for a high quality anchor tenant. This doesn’t mean they have to be the “Amazons” of the world, but make sure they’re a reputable company that’s been around for a while, and ideally, has one or more locations (maybe this is their HQ). You may even want to look further into how they’ve done during COVID.
Having a quality anchor in place will take a lot of risk off the table from the start. Although the smaller tenants may not all be perfect from a credit perspective, it’s more important to look at how long they’ve been in the building, if they have a track record of paying their rents on time, or if they’ve been difficult to work with in the past. These few points only take a few minutes to research and can add an immense amount of comfort (or discomfort) to a potential investment opportunity.
One thing we, at Excelsior Capital, focus on is the weighted average lease term at the property. Basically, this is the average amount of lease time remaining, given the size of the tenant at the building. Usually if it’s 3-4 years or greater, you’re going to come into the investment with stability.
3. Does the overall investment strategy make sense?
The third aspect that’s important to focus on is the overall strategy that the sponsor is pitching for your particular investment. Almost any building could be a good investment, it just all depends on the strategy. Taking a step back, does the investment make sense? What is the firm communicating to you in their investment summary? Is the plan achievable?
Let’s look at an example: If the plan is to buy a building that’s 50% occupied, what assumptions are they making on the leasing side? Are they telling you they’re going to have it leased up in 3 months/12 months/18 months? What rental rates are they assuming in that lease up? These are all questions that are extremely important to consider.
Another point to consider is the debt that’s included in the model. Are you comfortable with the leverage point? Is it too high/too low? Evidently, what’s highlighted in the model compared to what happens in real life isn’t going to align perfectly, but if the assumptions in the strategy make sense and are suitable for the building and its location, generally you’re on the right track.
The list of different types of real estate is endless, and each sector has its own quirks you’ll want to review; however, generally speaking, the location of the building, the quality of the tenants, and the suitability of the strategy that the sponsor has laid out for you are all items you’ll want to get comfortable with when considering an investment.
As always, we’re happy to answer any additional questions you may have. Feel free to contact us at investors [@] excelsiorgp.com and we’ll be in touch as soon as possible.
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