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.

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.

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This is a very basic screening for potential warm multifamily markets … ones with lower levels of both rates. AND remember, just because state level statistics are negative does not mean there are no local markets in the same state that show promise … all real estate is very, very local.

Here is the map … enjoy…

Great minds think ….

Here is the full post

Lesson #1: Beware of Market Forecasts … even by experts.

He specifically says you might want to ignore the forecasts completely since most Wall Street strategists are paid to be bullish and almost all underestimate the risks of any particular investment. My spin: true for stocks and perhaps not as much of an issue for Commercial Property.

Certainly don’t believe a person trying to sell you on a particular Real Estate Market without stats and forecasts to back up their assertions. REIS and other reporting services really level the playing field here. You have access to the same statistics and market analysis the institutions use to make decisions. So, on this one, get out there and do the analysis and you will be able to make your own market forecasts of much higher quality than you will find on Wall Street.

Lesson #2: Never Underestimate the Importantance of Asset Allocation.

Now Mr. Bogle is talking about allocation between stocks and bonds here. This “lesson” is nothing new since studies have shown that asset allocation is the source of much of the returns you can expect from any portfolio. AND let’s widen things out here. Asset allocation into Commercial Property would have saved a lot of people a world of hurt in this recent Stock melt down. I strongly believe most of us should include investments Wall Street believes to be “Alternative” in our portfolios … things like Commercial Property. Nuff said.

Lesson #3: Mutual Funds with Superior Returns Often Falter.

This is the old one-two of performance chasing and “regression to the mean”. Since performance is always measured looking in the rear view mirror … this month’s “top performer” was only a top performer in the previous months and may be a real dog right about the time you get in. And any superior return is inherently unstable … performance will always tend to track back towards the average … or “mean”.

Remember too that Bogle is a “buy and hold” kind of guy. In Commercial Property we are talking about becoming expert market timers. You get in when the market is set to roll and get out when everyone else is getting in at the top. Since Commercial Real Estate market cycles are predictable and usually slower than stock cycles, timing is possible … no, it’s essential. Our job is to get out before regression to the mean can even occur.

Lesson #4: Owning the Market Remains the Strategy of Choice

I could see this one coming since Bogle pioneered the Index fund industry. Also an expected “lesson” from a buy-and-hold investor. In Commercial Property, the key is to have a lock on where the Market is headed … “owning it” from an information standpoint, so you can time your entry and exit.

Lesson #5: Look before you Leap into Alternative Asset Classes.

Amen Mr. Bogle … Amen! Never invest in anything you don’t understand. Most individual stock investors don’t understand the companies they own. You need to understand everything about the market, the project and the sponsor/asset manager before investing in Commercial Property. AND Commercial Real Estate is not an “Alternative Investment” class. It is bread and butter, cash flow acquisition … not some made up credit default swap bullcrap.

Lesson #6: Beware of Financial Innovation.

The latest and greatest, newfangled, “can’t lose” investment is likely to be hooey. If it sounds to good to be true … it is. That’s why Commercial Property works from an intellectual standpoint. This is basic Monopoly structure. We buy a building, charge our tenants rent, pay the expenses and split the profits. Now lots of innovation can be going on in the way you manage the property, the upgrades you make to the building, increasing tax write offs with cost segregation …. etc. and the structure of this investment is a solid “old school” winner.

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There you have it … my spin on Bogles 6 lessons. To your investing success.