Commercial Real Estate: Due Diligence Explained

by Phill Tomlinson | Jul 30, 2021 | Blog

If you are planning to buy a commercial property, either as an investment or for your business, you should consider conducting due diligence as it is an important element in your negotiations and in the contract. Due diligence is defined as research and analysis of a company or organization done in preparation for a business transaction.nnFrom a commercial real estate (CRE) standpoint, due diligence is the process of doing “homework”—checking and confirming any important information on the property you are planning to purchase. It is a systematic way of analyzing and mitigating risk or financial uncertainties from a business or investment decision.nn n

Due Diligence Period

nA due diligence period is the time allowed for a buyer to enter the property and conduct inspections, examinations, and tests to all areas of the property as the buyer deems, in their sole discretion, appropriate and necessary.nn nnWhen does the due diligence period start and how long?nnSince the objective of due diligence is to reveal all elements affecting the feasibility of the buyer’s intentions—whether the property is a good, average, or a bad deal, it is reasonable if you want to conduct due diligence as early as possible.nnDue diligence period can occur prior to or after signing the purchase and sale contract. However, if you prefer to conduct due diligence prior to signing the contract, the seller will usually limit what is provided and require a confidentiality agreement to be signed. Typically, the due diligence period in CRE is 30 days or less depending on the needs and processes of both parties. It can be extended up to 60 days if there are necessary documentation needed to be reviewed as long as both parties agree to the extension.nn nnThere are three (3) major areas in the due diligence process that we think you should focus on:n

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• Physical

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• Financial

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• Legal

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n nnPhysical Due DiligencennA thorough examination of the physical condition of a commercial property is part of the acquisition due diligence process that you cannot afford to go without. The physical assessment of the property is the most important of the three because this is the area that is costly to correct and can greatly affect the property’s long-term value.nnPerforming physical due diligence will help you understand if the commercial property you are planning to buy has been properly maintained or not. If not, you can use this information to better negotiate the sale price or even back out of the transaction.nnHiring a professional inspection company that specializes in physical due diligence of a commercial property can be highly beneficial to make sure that all areas of the property have been assessed and checked thoroughly. The inspection company should perform inspections not limited to:n

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• Building/property condition assessments

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• Building/property risk assessments

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• Capital expenditure forecasts and cost plans

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• Facilities management reviews and risk analyses

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• Property management KPIs

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• Replacement cost estimates

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n nnFinancial Due DiligencennOne of the essential due diligence steps is financial investigation. Financial due diligence is investigating a property’s cash flow by checking the income and expenses if it matches the seller’s representations and to determine if the property’s rent roll is sustainable.nnTo mitigate risks, a proper review of the asset’s financials should be conducted before closing the acquisition of a commercial property. Do not believe the books and records given by the seller. It is your responsibility to check and double-check the financial statements of the property by verifying each dollar reported coming in and spent on the property.nnSince this process is a series of audits—lease audits, contract audits, rent roll analysis, cost analysis, market analysis, etc., it is helpful to hire a qualified accountant who has experience in commercial real estate accounting. This qualified accountant will be part of your A-team in all of your real estate transactions moving forward so make sure that you only hire the best of the best.nn nnLegal Due DiligencennThis phase of the due diligence process focuses on the variety of jurisdictions that might govern a property. Legal due diligence involves:n

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• Title examination

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• Survey report

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• Analysis of existing permits

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• Liens and tax issues

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nMany problems may arise in acquiring a commercial property without proper legal due diligence. Such potential deal-breakers—potential environmental problems, defects on the title or survey, proper and improper special uses and encroachments that affect the property can put your investment property at risk.nnHence, before you go forward with this deal, hire a real estate attorney in conjunction with a title insurance company and a CRE broker who are committed to having these risks mitigated or identified before you sign the purchase and sale agreement.nn nn n

Conclusion

nConducting due diligence prior to any purchase of a commercial property is essential since a lot of elements should be thoroughly inspected, investigated, reviewed, and tested. A risk assessment is necessary to avoid any problems that may arise in the future which could cost you some serious damage either on your finances or on the property itself.nnIf you fail to gather all the information necessary during the due diligence period and it expires, there is no turning back if ever you uncover discrepancies or potential problems that do not align with your intentions and visions for the property. With that being said, your deposit money becomes non-refundable and you will either go forward with the transaction, or withdraw from the deal with your deposit money forfeited.nnThis is why for every transaction with millions of dollars on the line, rigorous due diligence becomes a “non-negotiable” for any real estate investment.nn

nnEven after outlining all the information above, investing in CRE can still seem daunting. That’s why the Leveraged CRE Investment Team at Commercial Properties, Inc. is here to help you achieve your investment goals. Contact us at (480) 330-8897 or email us at request@leveragedcre.com.nn nnNeed help on how to get started investing in commercial real estate? We got you covered! We prepared a free e-book that will serve as your guide to achieve your long-term business goals or obtain that property you’ve always been dreaming of!nnn nnPhill Tomlinson is a commercial real estate broker with Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, and owner of the Leveraged CRE Investment Team specializing in investment sales and tenant/landlord representation in the Phoenix and Scottsdale submarkets. Phill applies over 21 years of experience in the Real Estate industry helping investors and owners maximize their returns. nn nnBookmark www.leveragedcre.com to learn more about the Commercial Real Estate market and keep informed of relevant real estate strategies designed to maximize your income property investment results. Connect and follow Phill on Social Media at sm.leveragedcre.com/smplatform. #LeveragedCREnn nn 

5 Steps to Buying Your First Commercial Property

by Phill Tomlinson | Jul 23, 2021 | Blog

Not all investments can be successful as you hoped they would be. Commercial real estate (CRE), like any other investment, requires a lot of research, knowledge, and effort to be successful — most especially if you are a first-time buyer. That’s why it is important to weigh the pros and cons before making your first purchase and to understand that though investing in CRE can potentially yield big returns, there are also risks imposed in this type of investment that you should be mindful of. As the saying goes, “The bigger the risk, the bigger the reward.”nnPurchasing commercial property is a great investment for your business but it can also be a long process. In this article, we will help you cover all your bases and will walk you through the important steps to purchasing your first commercial property.nn n

5 Steps to Buying Your First Property:

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1. Ask and assess

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nThe first step is to identify your “why”. Ask yourself why you want to buy a commercial property in the first place, or why would you choose this type of investment. Determine your end goal because there is no point in investing in a commercial asset if you don’t know what you hope to accomplish.nnThen, assess the “what” in your goals. What type of commercial property do you want to deal with? As you may know, CRE is a broad term – it simply doesn’t limit itself to high-rise buildings near the downtown area.  It can include everything from office and medical buildings, industrial complexes, retail shops and restaurants, apartment buildings, and many more; as long as it is used for business purposes. Thus, assess what type of commercial property suits your business plan – the type of CRE that would help you achieve your ultimate goal.nn n

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2. Secure financing

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nBuying your first commercial property can be quite a challenge and before you start searching for your first property to buy, figure out your financial position first. Like many individuals, you’ll likely need financing to purchase a commercial property. Any bank, credit union, or lender will require you to procure a personal financial statement which lays out all your assets, debts, and other financial obligations. This is one way for them to assess whether you are creditworthy or not. Therefore, it is better to have this form ready in hand when shopping for the best lender.nnHere are some of the Types of Commercial Property Loans that could help you finance your first commercial property:n

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• Bank Loans

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• Life Insurance Companies

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• Agency Loans

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• Debt Funds

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• Commercial Mortgage-backed Security (CMBS) Loans

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nIt is also in your best interest to know whether the type of commercial property you wish to buy is within your budget; otherwise, the bank, credit union, or lending company will most likely deny you financing. That’s why it is wise to line up your financing options in advance.nn n

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3. Build the right team 

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nnnPurchasing commercial property is a complex process and involves a lot of components. Thus, it is important to surround yourself with the right people. It may seem costly hiring these professionals, but it will surely save you from making mistakes along the process. That being said, building your A-team will make sure your investment will go smoothly and have the best chance of success.nnYour team should include:n

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• an accountant to assist you in analyzing your financial position and what properties you can afford, not to mention the tax benefits you get with buying that property.

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• a commercial real estate broker that specializes in completing this deal. He/she can help find the right property for you – which meets your criteria. Your CRE broker will also alert you with viable properties that just hit the market.

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• a commercial real estate attorney, the main role of your CRE attorney is to help you prepare the contract for the purchase transaction of your chosen property. He/she will also oversee the legalities of the transaction.

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• a commercial property mortgage broker who can work with you in obtaining the financing you need for your investment. He/she will also take care of the financial aspects to complete the transaction.

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nSeveral professionals can also help especially if the property you choose to purchase is a bit complex. Outside of that, consider hiring these experts at the very least as they will help you land that first property you always have been dreaming of!nn n

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4. Mind due diligence

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nYou may already have a property in mind that you want to purchase. But before closing that deal, you should consider doing your homework first; hence, mind due diligence.nnA lot of factors are to be considered in choosing the right property for you. Always run the numbers and analyze the deal as a whole. Location is usually the most critical factor – see to it that the property is accessible since location is significant in your business operations. Also, make sure that your chosen property is best suited to your business goals. If not, consider looking for other commercial properties.nnLastly, there will always be risks in any type of investment. Therefore, make it a point that the inherent risks are worth the potential rewards you will gain in the long run.nn n

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5. Make an offer and close the deal

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nAfter considering all factors and once you find a property worth pursuing, write up an offer. At this point, your CRE agent will help you in making your purchase offer. Once a contract is drafted it should be reviewed by your attorney first before you sign it. Some sellers ask for earnest money as a sign of good faith that you are interested in buying the property, so be prepared for this.nnMore importantly, make sure that you write an offer with a contingency clause. In cases that certain problems may arise or that the commercial property doesn’t pass your inspection during your due diligence period, you have an escape hatch and can discontinue the transaction.nnIf the transaction looks good, all things considered, continue to mind due diligence by reviewing all included documents until you move forward toward closing the deal. During this time, you will need the help of your team of experts in checking that everything looks good since the deal is coming up to a close.nn

nnBuying your first commercial property is not that easy and everyone should consult a professional before moving forward with a CRE purchase. Even after outlining all the information above, investing in CRE can still seem daunting. That’s why the Leveraged CRE Investment Team at Commercial Properties, Inc. is here to help you achieve your investment goals. Contact us at (480) 330-8897 or send us an email at request@leveragedcre.com.nn nnNeed help on how to get started investing in commercial real estate? We got you covered! We prepared a free e-book that will serve as your guide to achieve your long-term business goals or obtain that property you’ve always been dreaming of!nnn nnPhill Tomlinson is a commercial real estate broker with Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, and owner of the Leveraged CRE Investment Team specializing in investment sales and tenant/landlord representation in the Phoenix and Scottsdale submarkets. Phill applies over 21 years of experience in the Real Estate industry helping investors and owners maximize their returns. nn nnBookmark www.leveragedcre.com to learn more about the Commercial Real Estate market and keep informed of relevant real estate strategies designed to maximize your income property investment results. Connect and follow Phill on Social Media at sm.leveragedcre.com/smplatform. #LeveragedCREnn nn nn nn 

What is Absorption in Commercial Real Estate?

by Phill Tomlinson | Jul 15, 2021 | Blog

Absorption, or absorption rate, is a measurement used in Commercial Real Estate (CRE) to indicate the difference between the amount of space vacated by companies or tenants in a certain time period and the commercial space they or other tenants have moved into within the same locality or time frame.nnTo put it simply, absorption is the rate at which commercial space is “absorbed” (sold or leased) over a specific period of time in a given market, described as positive or negative.nn nnThere are two (2) metrics that go hand-in-hand and have a huge impact on CRE. One is the absorption rate, and the other one is vacancy. Vacancy is defined as the units or square feet available in a commercial property, expressed in percentage or number of available units. Vacancy has a direct effect on the net operating income (NOI) of a commercial property – low vacancy means more rental income being generated. Both absorption and vacancy rates are used by real estate investors as determining factors whether to hold, buy, or sell commercial properties.nn nn n

Gross Absorption and Net Absorption

nWhen real estate investors talk about absorption rate, it can only be one of the two – Gross Absorption or Net Absorption. In a leasing context, here are the differences between both:nnGross Absorption refers to the total amount of space that a tenant physically moved into in a specific time frame in a given market.nnWhereas Net Absorption refers to the total amount of space that a tenant physically moved into minus the amount of space they vacated during the same time period, described as positive or negative. Thus, net absorption is a very important metric used by real estate investors in analyzing the commercial market’s supply and demand trends.nn nn n

Net Absorption further explained

nSince net absorption rate is the metric being used by commercial real estate investors most of the time, this article will focus more on understanding net absorption.nnTypically, you can gauge the market’s supply and demand dynamics by knowing the net absorption rate, which can be described as either positive or negative.nnnnIf the market indicates a positive absorption rate, it means that more space is being leased or occupied than vacated. There is basically a decrease in the supply of commercial space in a given market resulting in a rent increase. If the market indicates a negative absorption rate, it means that more space is vacated than occupied. This means there is an increase in supply for occupancy resulting to rent rates being lowered to attract commercial tenants. With that being said, knowing the absorption rate in a specific area in a given time frame helps real estate investors forecast cash flow in their investments.nn nn n

How to calculate Net Absorption rate and Vacancy rate

nSince absorption rate goes hand-in-hand with vacancy rate, here is an example of how to calculate net absorption rate in relation to vacancy levels.nnLet’s say the commercial property has 24,500 square feet of leasable space and 2,250 square feet is available from 5 individual spaces. To calculate the vacancy rate, divide the amount of available square feet by the amount of total leasable space in square feet.nn2,250 SF (vacant) / 24,500 SF (total leasable space) = 9.2% (vacancy rate)nn nnTo calculate the net absorption rate, let’s assume there is a 2,250 SF of available space throughout this year, a new tenant moves in and leased 1,200 SF of space. It means that the vacancy rate has decreased to 4.3%.nn2,250 SF (vacant) – 1,200 SF (new tenant occupies this amount of available space) / 24,500 SF (total leasable space) = 4.3% (new vacancy rate)nnWith the new tenant “absorbing” a 1,200 SF of space, it leaves an available space of 1,050 SF vacant from the total vacant space of 2,250 SF throughout the year. It creates an annual net absorption rate of 53.3% (1,200 SF absorbed out of 2,250 SF of space available in a year). Thus, it indicates that there is a positive net absorption rate for the commercial property in a period of one (1) year.nn nn n

Factors that influence Net Absorption

nA lot of factors can impact the net absorption rate of a commercial property. As an investor, you should consider these factors so that you could plan the next steps to take for your investments to be successful based on the market’s current status. Here are three (3) major factors that greatly influence the market:nn n

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1. Availability

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• Consider analyzing and taking into account the commercial availability in your area. Businesses that just opened up will quickly occupy spaces that were vacated for them to operate in areas with little availability. This means there is a high net absorption rate in that certain area. While in areas with high availability, commercial properties are experiencing low net absorption rates due to competition of occupancy with other properties. Therefore, evaluating the overall availability in your geographical area will help you in your decision-making about your investments based on the commercial market’s current conditions.

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2. Pricing

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• Rent rates relative to leasable space can greatly influence the net absorption of a commercial property. Businesses or tenants will look for spaces that not only fit the needs and day-to-day operations of their business but also spaces having low rent rates. If you are a landlord or an investor, knowing what price to set for your commercial property can prevent high vacancy and negative absorption rates.

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3. Economic Conditions

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• One of the factors that have a strong impact on net absorption is the change in economic conditions. Take for example the time when COVID-19 hit us and many people and businesses have suffered globally. During this time of economic struggle and crisis, many businesses decided to close and those that planned to expand or open up a new business chose to hold it off because of uncertainties and risks of losing their investments.

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n nnIn addition, the COVID-19 pandemic shifted the business processes and operations of companies to remote work. It led to commercial properties being vacated and a decrease in occupancy. Other businesses tend to lease smaller spaces to cut overall costs since employees are now working from home. With this new setup, the net absorption rates of commercial properties are greatly affected.nn nn n

The bottom line

nCommercial real estate is highly competitive, and there are a lot of factors, including net absorption that impact the market. Gathering data, taking advantage of these elements, and analyzing the market’s current trend can be a game-changer in handling your investments.nn nn

nnEven after outlining all this information above, investing in CRE can still seem daunting. Please feel free to contact us anytime with your questions and concerns. The Leveraged CRE Investment Team at Commercial Properties, Inc. is here to help you achieve your investment and business goals. Contact us at (480) 330-8897 or send us an email at request@leveragedcre.com.nn nnNeed help on how to get started investing in commercial real estate? We got you covered! We prepared a free e-book that will serve as your guide to achieve your long-term business goals or obtain that property you’ve always been dreaming of!nnn nnPhill Tomlinson is a commercial real estate broker with Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, and owner of the Leveraged CRE Investment Team specializing in investment sales and tenant/landlord representation in the Phoenix and Scottsdale submarkets. Phill applies over 21 years of experience in the Real Estate industry helping investors and owners maximize their returns. nn nnBookmark www.leveragedcre.com to learn more about the Commercial Real Estate market and keep informed of relevant real estate strategies designed to maximize your income property investment results. Connect and follow Phill on Social Media at sm.leveragedcre.com/smplatform. #LeveragedCREnn nn nn nn