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AND before you can get green shoots like these in the commercial real estate markets … the first step is the market fundamentals have to stabilize. At some point rent and occupancy simply must stop falling and enter the category of “No Change” as the analysts in our industry survey the national markets. Only then can the turnaround … and those little shoots … begin to emerge.

Here’s a sign we may be seeing some stabilization sooner than most pundits had predicted.

Most of the national “experts” reported in the press over the last several months have gone on record predicting it will not be until the 3rd quarter (and most then say “at the earliest”) until we see the Commercial Real Estate Markets recover.

Here is a report showing 16 of 28 major markets in the US where multifamily rents are NO CHANGE in the fourth quarter of 2009. See the report at this link …

Could this be the first sign that some “green shoots” are on the way – might they be curled up under the surface yearning to emerge when the sun comes out all the way? Stay tuned …

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The Gross Rent Multiplier – the Rubber Chicken of Commercial Property Value Indicators.

GRM is calculated by dividing the Property’s sales price or value by the Gross Potential Income. 

1) We’re talking about “Potential Income” based on the Broker’s most optomistic projections of attainable rents.  The basic number has no basis in reality – especially if you are looking for a property with upside. Think about it for a second … if the Seller could get these rents for this property they wouldn’t be selling!

 

2) Gross income starts at the top of the financial statement.  For any particular property there is absolutely no relationship between the Gross Income, and the Net Operating Income (NOI) down on the bottom line. You have to know the Real Income and the Real Expenses to understand the actual NOI this property can produce.

I just ran into this website with it’s “Pay or Go” calculator. http://payorgo.com/

You plug in your numbers on what you owe and what you pay and it will tell you whether you should keep Paying or Go … walk away and trigger your “Strategic Default”

Is this the 2009 property specific version of “ambulance chasing”? I am certain this law firm could help you if you decide to “go” rather than keep paying. And this all begs the question is walking on your mortgage now socially acceptable. You be the judge and as one reader emailed me … “whether it is socially acceptable or not, the question of whether it is ethical remains.”

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Today Bloomberg announced that Morgan Stanley is doing just that for the second time in 2009. And the Wall Street Journal has had a series of articles on single family home owners and the epidemic of strategic defaults in home loans

More on Morgan Stanley …

Back in the boom days Morgan Stanley made a series of purchases of commercial property from folks like Sam Zell that turned heads because everyone in the industry knew they had over paid. Now the stuff is hitting the fan and Morgan Stanley is simply handing the properties back to the bank and walking away – even though the loans are still current!

• Last month they agreed to surrender 17 million square feet of office buildings to Barclays Capital after acquiring them for $6.5 billion in 2007 from Crescent Real Estate Equities.
• Now they are announcing plans to relinquish five San Francisco office buildings to its lender two years after purchasing them from Blackstone Group LP near the top of the market.

From Bloomberg:  “San Francisco prime office rents fell 37 percent in the third quarter from a year earlier, the biggest decline since 2001, as companies cut jobs, Colliers International said. The vacancy rate rose to 14 percent, the highest since 2005. Almost 1.4 million square feet of space was returned to the market in the first nine months of the year. ”

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Due Diligence is the disciplined process you use to lower the risk of investing in Commercial Property. This risk typically comes in four “flavors” when you are investing in Commercial Real Estate.

• Market Risk: Will the fundamental conditions of this market allow me to meet my return on investment (ROI) goals?
• Financial/Performance Risk: Does the projected financial performance of this property meet my ROI goals
• Tenant Risk: Will these Tenants allow me to meet my ROI goals?
• Physical Risk: Will the physical structure of this property support my ROI goals?

The third area of risk… Tenant Risk… deserves special attention when you are buying Retail, Office and Industrial Properties. These property types carry an additional layer of risk you don’t see in Multifamily because your Tenants aren’t just living in your building… they are doing business within your Property.

Their ability to pay your rent is predicated upon the health of their business and not just on their ability to draw a paycheck.

In order to lower your Tenant Risk you must understand the nature and strength of the businesses of each of your Tenants. Where in Multifamily you might stop at reviewing the Tenant’s background check and payment history… in Retail, Office and Industrial you have to go further and really research the viability of each Tenant’s business. This has never been more important than in today’s economy.

No matter what your Lease says, if your Tenant goes out of business, you will have a vacancy to deal with.

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Researching your Tenant’s Business has several steps…

1) Start with researching the businesses on the Internet.

a) Place the entire business name in quotations (like this: “International Outfitters”) and search on Google. See what shows up.

b) If the company is publicly traded, research their stock prices, analyst opinions and earnings projections. Call the corporate office and see what their plans are for this branch.

c) Do the same thing with the names of the owners and CEOs. Google them in quotes again… like this… “John Doe”

2) Ask each Tenant for current Financial Statements and analyze those carefully to get an idea of the business’ recent and past financial performance.

You won’t always get the financials from a private business owner… and you can always ask. What trends do you see in the financials in the last 6 -9 months?

3) Call each business Owner/Manager and arrange a sit down, face-to-face interview.

One logical time to ask for this interview is when it’s time to go over the Estoppel Letter and confirm its contents. While you’re discussing the Estoppel Letter, you can question them about:

• The strength of their business
• Their outlook for future business
• The challenges they see on the horizon
• How you might help them improve their business when you take over as their landlord

Make note of any concerns you have about the business strength of any of your Tenants.

4) Sit down with your team and discuss ways you could help the business of your current Tenants and mitigate against the loss of any of your weaker Tenants.

The goals here are to help when you can and have contingency plans in case any of your weaker Tenants goes out of business. Identify the businesses with the highest risk of failure and make sure you and your team know what you’re going to do if they actually do cease to be one of your Tenants. AND make sure you create proformas with and without the income from your weaker Tenants.

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You must perform these specific Tenant Due Diligence steps at the same time as you are completing the activities of Market, Financial and Physical Due Diligence for one simple reason…

You could be in the best property, in the most stable market with a glowing Proforma… and if your Tenant’s business falls apart… you will potentially lose money. Take the steps we have outlined here and you will dramatically reduce this Tenant specific risk.

AND never be afraid to walk from a deal if the Seller is not willing to discount the property because of Tenants at high risk of business failure.

Here’s to your investing success,

No-Hype Commercial Real Estate Training   |  Follow me on Twitter for the latest ]]> http://the-commercial-investor.com/commercial-property-tenant-due-diligence-secrets/feed/ 0 http://the-commercial-investor.com/why-your-property-manager-is-your-due-diligence-workhorse/ http://the-commercial-investor.com/why-your-property-manager-is-your-due-diligence-workhorse/#comments Thu, 10 Dec 2009 19:31:21 +0000 Dike Drummond http://the-commercial-investor.com/?p=481 Never Ever Ever … take a property under contract without a quality local Property Manager on your team.

Our latest “hype-free” Commercial Power Hour Teleclass shows you why your Property Manager is the workhorse of your Due Diligence Team in all phases of the process – Market | Financial | Tenant | Physical. You will dramatically increase the risk in your investment without them on board.

Download your copy for FREE here

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Let me show you a technique I call ”Move the Middle” that will naturally cause your negotiating counterpart to split the difference in your favor and move them in your direction …  toward the number you need.

It begins with a traditional “meet half-way” or “meet in the middle” basis for bargaining. I add a little twist I call “Move the Middle”, that benefits you in any negotiation. This is a simple negotiation technique that provides consistent profitable results for you in any transaction. It has enormous value and it is a tactic you can use again and again when bargaining.

Here’s the technique:

You just make note of the gap between THEIR opening number and  yours and make your response less than halfway. Basically you NEVER split the difference and always negotiate in smaller increments than your counterpart.

The following is a true example of a commercial property re-trade I negotiated:

The negotiation took place at the end of the Due Diligence period on a Commercial Property I eventually acquired. My calculations indicated I needed a $100,000 credit for repairs from the seller to make the numbers work. I began with a request for a $200,000 concession from the seller up front.

• The seller countered with $100,000.
• BINGO - notice he came up from zero to $100,000 in one step – he automatically split-the-difference… a response I expected when I made the request.
• An impulse response for me might have been to split-the-difference again and say $150,000. Instead I used Move the Middle and named a smaller amount than the expected $50,000 drop. I floated a request for $190,000 – and dropped by only $10,000.
• The Seller countered with $130K
• BINGO AGAIN - Notice again, he moved toward my offer by countering with $30,000 above his initial $100,000. I moved $10,000, he moved $30,000. I successfully applied the Move the Middle technique. I requested $180K next and the Middle moved my way again…

The Seller and I eventually settled on $145,000, a $45,000 increase above the $100,000 I actually needed, and the acquisition now worked on paper. After this technique got me what I wanted, I proceeded with the close of the transaction. The re-trade worked and the deal was $145,000 in our favor.

That is how you Move the Middle !

Look at the negotiation interval the other side is using and come back with a smaller one. The other side will come your direction as their natural tendency to “meet in the middle”.

Learn and profit from this bargaining tactic:

I really love this, once you get used to it, you just learn to rely on it. Try to Move the Middle in your next negotiation… especially if it seems like a just too simple tactic. The results will reward you again and again.

Here’s to your investing success.

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These dangerous contracts are often presented as if they are “standard”… Not True. You get what you negotiate. The last thing you want is to be locked into a contract with a poorly performing Property Manager… and no easy way out… OUCH.

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Contract Red Flags:

• The One Year Contract: The typical version is a Contract with a one full year term and you cannot replace the Property Manager until the year is up. Never sign a contract with anything more than a 30 day dismissal period
• Termination Fee: Are you kidding. You fire your Property Manager and then you owe them money. Heck, if they performed poorly enough to get fired, they should owe you money.
• Lease Signing Bonus paid to the Property Management Company: This is a big conflict of interest. They get paid to do a poor job of Tenant Retention. The higher the turnover, the more fees they make AND the less money you keep.
• Right to Represent the Property at the Sale Or First right of refusal to purchase the Property at the Sale: These are an even bigger conflict of interest. If your Property Manager runs the project into the ground and you are forced to sell because the investment failed… they get to purchase or represent the property when you sell. Please… this is a recipe for disaster.
• Clauses that limit the Manager’s Liability: The Property Manager is at ground level, performing the day-to-day actions of management and maintenance of the Property. They are fully responsible. Your Contract needs to make sure they hold the liability… NOT You.

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What to Always Put Into Your Property Manager Contract:

• 30 Day notice to terminate the Contract: If you want to change Management Companies, you only need to give your current manager a 30 day notice.
• Specific Performance Clauses: If you need to have the 10 fire damaged units in your Apartment Complex rehabbed and ready to rent in 90 days… put that in your Contract with your Property Manager. If they fail to meet this specific performance goal this becomes grounds to get out of your Contract. Ideally you and your Manager jointly developed this Asset Management Plan, so getting them to agree to be held accountable should be relatively easy.

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NOTE: Even if you have one Property Management Company for your entire portfolio of Properties, make sure you have individual contracts for each property with Property specific performance clauses.

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 Remember, negotiations occur in all phases of your Commercial Property Investment… not just with the Seller. Make sure you negotiate a Property Management Contract that protects you and your Investors and makes it relatively easy to change Managers if they do not perform.

Here’s to your investing success.

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