Commercial Real Estate requires a different skill set.
For many different reasons, you might prefer to serve commercial clients. Whatever your reasons might be, you ought to understand that you have to be very competent to work in the world of commercial real estate.
You can become knowledgeable by taking professional development courses in commercial real estate and shadowing an experienced commercial real estate professional. As a commercial real estate sales professional, you have to be sufficiently knowledgeable about different types of commercial properties to offer the client the most viable option depending on their circumstances and needs.When advising clients on property acquisition, the old real estate mantra of “location, location, location” might come to mind.
Of course, location is important in any piece of real estate. However, in the world of commercial real estate, another mantra is used: “Jobs, Jobs, Jobs.” The current and future state of employment in the area where the commercial property is located has a significant impact on its current value and will have on its future value.
You have to be well-versed on the type of property you are going to suggest that the buyer acquire. Further, you have to consider the assets and resources of your client when making a specific suggestion.
Although it is a norm in the world of commercial real estate that the listing sales professional provide all the information and details related to the property, ranging from income potential to structural details, you as the buyer’s representative must perform necessary due to diligence on behalf of your buyer. Information and details have to be verified, from net income “claimed” to uses “allowed.” Therefore, proper due diligence is required.
Here are the most important aspects of due diligence that need to be carried out:
Due Diligence Aspect #1: Income
You have to understand that, generally speaking, your buyers are mainly interested in commercial properties to generate income.While the buyer is likely to have a mix of investment vehicles, such as a stock portfolio, Registered Retirement Savings Plan (RRSP), Guaranteed Investment Certificates (GICs), mutual funds, etc., the buyer is considering an investment in a commercial property. The buyer may wish to park their money in a tangible asset or commercial properties as these investments might offer superior tax-saving strategies.
Many investors believe that a positive cash flow will keep them above water when markets experience volatility and reduce overall exposure. So your first and foremost concern should be about the income generation of the property. You have to do your full due diligence on the income aspect of the property. The numbers disclosed might not necessarily take into account all of the deficiencies and costs related to the property.
Generally, the following are the numbers to watch as they have potential for error and miscalculation:
- All expenses are not disclosed. Watch out for a lack of information regarding management, vacancy and maintenance costs.
- When calculating expenses, the listing agent will naturally present a best-case scenario. Cost lines such as utility use, routine cleaning, etc. might be minimized to reflect the best case scenario.
- In some cases, miscellaneous expenses which are mostly related to administration, management and supervision of the property might not be accounted for. In addition, managerial expertise and experience cost items that may be ignored.
By far one of the most overlooked items when calculating income is “tenant credibility.” The net income numbers might suggest purchasing the property is justified, but you have to remember that some tenants may have established a profitable business, but others may be in financial difficulty. Corporate searches and due diligence might reveal that the tenant is in financial difficulty.
Your first and foremost concern should be about the income generation of the property.
Corporate searches and due diligence on tenants, especially the ones that occupy bigger spaces in the building, are a must. Further, you may ask for financial statements from the existing tenants. In fact, your financial lender might require those statements from the tenants of the building anyway.
Due Diligence Aspect #2: Capital Expenditures
A property’s income might seem very attractive, but you may not be aware of the capital expenditures required to operate the building. These expenditures could be big-ticket items such as replacing windows, roof repairs, HVAC upgrades, mechanical systems, etc. There could even be structural issues with the property which could sometimes cost more than the purchase price. You should solicit inspection reports from HVAC and engineering specialists.
Due Diligence Aspect #3: Specific Requirements
When acquiring commercial properties your client may have specific plans for the property. These plans could be implemented right after the property acquisition or in the future. Below are a few examples of issues and pitfalls that you may want to investigate further.
When the Property Is Owner-Occupied
In addition to the above due diligence items, if your client intends to operate a business in the property, you have to find out if the legal use of the property will allow your client to do so. If not, then ascertaining what permits and additional items are required is for you to find out.
In addition to zoning, some uses might require a business license. For example, a day care center might require a playground to get its license, and a restaurant might need additional parking spots to get approval. Do not assume you do not have to carry out due diligence if a similar business is in the property. For example, a restaurant that operates as a fast-food takeout restaurant compared to a sit-in restaurant might have different zoning and parking requirements. So due diligence is required to be assured of the correct future use regardless of the existing use of the property.
Excerpt from chapter 19 of James Hussaini’s book –Yours Independently