How to Evaluate a Commercial Real Estate Deal
In this article we are going to discuss what are the main steps to take in order to evaluate a commercial real estate deal.
Evaluation of the deal in offer is the core of every investment. It is also the most challenging process of all. Your ability to evaluate the deal majorly determines the success of your investment in real estate.
Remember, except for REITs, real estate investments are not a liquid investment type. You will not be able to withdraw from investment quickly in case of a mistake. Fear not, however. With proper knowledge and attention you will be able to easily identify a promising deal.
There are three major evaluation factors of a great deal: evaluation of the partner, evaluation of the property, and evaluation of the market the property is situated in. The partner in the investment process plays the most crucial role. As an investor you are going to entrust the responsibility of value creation solely to the managing partner, which would include vetting a deal, performing an acquisition process, arranging a loan, guarding the management process and final dispossession of the asset.
A great partner is knowledgeable about the market, transparent, able to assess the risks and has enough capacity to manage the deal. A great property is well located, in desirable condition, has a well-diversified tenant mix, and secured lease agreements which allow for rental growth over the holding period. A great market provides potential for future economic and population growth, is undersupplied in similar assets, and politically stable. We will cover the deal evaluation in greater detail further in this guide.
Whether a potential deal is a crowdfunded property, a direct investment, or a REIT (current portfolio or potential future acquisition), every deal needs to be evaluated by the criteria explained below:
- Evaluation of General Partner/Sponsor
The track record and past performance of a prospective sponsor is massively important. The success of the deal mainly depends on the capabilities of a Sponsor.
* Evaluation of the Property
Evaluation of the property includes making a feasibility study of a potential property. You as an investor have to make sure the property in question will be generating stable cash flow and will be sold at a profit.
* Evaluation of the Market
Market is one of the key considerations. Real estate is intangible asset class, which means it cannot be moved to a different location. Location of the property is the key. The area where the property is located must be economically strong with no political constrains for future profitability.
* The Structure of the Deal
This includes how the profit will be split between the partners and what company structure will be chosen for investment.
* The Fee Structure
Different sponsors offer different fee structures. You have to make sure you are agreeing on a good quality for your money.
* The Financial Structure
The financial structure chosen for the investment should maximize the return. Financial structure would usually include both mortgage and subordinated financing or mortgage only.
* The Business Plan
The Sponsor must present a transparent business plan. They must have thought through the upside potential for a property backed up by rigorous financial analysis.
* The Quality of the main Documents: The operating agreement and PPM
Transparency and references to trustworthy third-party research is important in creating a high quality investment materials.
With a REIT, an investor must evaluate the company as a whole. Look at its real estate assets and assess the past performance and future expectations in relation to this company. With a REIT there is no opportunity for an investor to assess each of the deals the company will enter, but information about the portfolio’s current assets should be publicly available.
Information about the REIT’s past performance is also openly available to the public. With Private Placement or the Crowdfunded Real Estate deals, investors have the opportunity to assess each deal as well as the company sponsoring the deal. The information about privately placed or crowdfunded deals is not as easily available and Investors will have to do some additional research for each deal. The investor needs to understand the exact structure, fees, management team, track record of the sponsoring team, and more.