Analyzing the Financials
In part one of this series, Managing Risk for Commercial Real Investing Part 1, we talked about inherent risks, and why projects fail. Now part 2 focuses on the financial analysis of the deals. Managing risk for commercial real estate investing for many is trial and error. That is not a good methodology for making decisions. You must understand the details and the facts pertaining to reality.
Our company looks at dozens of proposals each month. The majority of the Offering Memorandums received, by far, show numbers that are projections. They show the potential returns, assuming all spaces have been leased, rental rates will be increasing, minimal repairs and maintenance expenses will be incurred, etc. But what if these don’t happen? Even when you evaluate actual expense numbers, you need to ensure that the expenses are proportionate to the size and structure of the asset. Maintenance contingencies need to be built into your financial analysis. You should be working with at least the last two years of expense data. Key categories of expenses should include management costs, administration costs, utilities, repairs and maintenance, grounds (parking lots/structures, landscaping, signage, etc.) and reserves for future contingencies. Also needed is an understanding of the trends in taxes, insurance and maintenance.When you evaluate actual expense numbers, you need to ensure that the expenses are proportionate to the size and structure of the asset. Click To Tweet
Expenses are one-half of the analysis. There is the also the income side. How complete and current are the numbers you are working with? Looking at the rent roll, you need to look at lease expiration dates and the feasibility of having a good percentage of the tenants renew. And what rate could you charge or is the rate locked in based on the options the tenant was granted in the lease? Creating a matrix evaluating each tenant by size, term and stability will help identify any exposures for the current tenant base. Be careful not to obtain estoppel certificates too far in advance of closing or assumptions of retention will be jeopardized.
Next in the series in Part 3, we will explore How to mitigate risk and see what conclusions we reach.
Image Courtesy “Risk Ahead Sign Shows Dangerous Unstable And Insecure Warning” by Stuart Miles FreeDigitalPhotos.net