Boots on the Ground
At RealtyMogul.com, we thoroughly vet every investment opportunity that is featured on our website. While most of our quantitative and qualitative due diligence can be done remotely from our Los Angeles HQ or from one of our satellite offices across the country, we also know the benefits of getting “boots on the ground” before we green-light a transaction. So, what does that mean? It means we make it a point to visit each property and examine the real estate and the surrounding market because some things you can’t check via phone, email, or through a third party– some things you have to see with your own eyes. We believe it’s our responsibility to closely examine all investments opportunities in-person on your behalf.
The Site Visit
When evaluating a commercial real estate asset, it is easy to get bogged down in the numbers. Make no mistake, the financial analysis of an asset is a critical component, but it is also important to take a step back and understand what is driving those numbers. This is best accomplished by putting yourself into the shoes of the tenants who are the lifeblood of a property, and while doing so, answer fundamental questions about a property’s physical condition, location, and the viability of the sponsor’s proposed business plan.
Meeting the Property Manager
A site visit typically begins by meeting with the property manager on site. These individuals typically have the most in-depth knowledge of the property, the tenants who live or do business there, and the history behind it. Sitting down with the property manager for a few minutes provides invaluable insight.
The property manager can provide key pieces of information that will confirm facts that were used in the quantitative underwriting.
Let’s take a multifamily apartment property as an example. In this case, it would be important to ask the property manager about the current and historical occupancy, what different types of units are available and what rental rates are achieved. This helps confirm any written documentation or assumptions that were used in the financial analysis of the property. The property manager can also answer more qualitative questions about the property or the tenants that would be difficult to derive from commonly received financial statements or rent rolls. For example, do the tenants consist of families or single residents? What drew them to the property? Which unit types are most popular at the property and which seem to be the hardest to lease?
The sum of these answers can be very useful not only for evaluating the financial health of a property, but also the feasibility of the sponsor’s business plan, which may rely on a certain demographic or favor certain floorplans or amenities (for example, small studio units that are popular among a younger demographic or larger, multi-bedroom units that are favorable for families).
Walking the Property
The next step typically involves walking throughout the property with the manager and inspecting the grounds, the common areas, the amenities, and the units. If possible, it is ideal to see at least one interior of each type of unit at the property. The manager can also point out some of the key amenities or offerings. In the case of multifamily properties, these can include washer and dryer facilities, covered parking options, pools, gyms, or sports courts.
During this walkthrough of the property, it is important to have the property manager point out any areas of concern or deferred maintenance items that will require repair in the near future. This is a good time to inspect and discuss items such as the roofs, parking lot, landscaping and other common areas. The amount of capital expenditures that have been assumed as necessary during the financial analysis should be consistent with the findings that are obtained during the site visit. The buyer and/or lender for a transaction will typically order a set of third party inspection reports, such as an appraisal, a property condition report, a zoning report, or an environmental report. These reports will typically detail any deferred maintenance, structural, zoning, or environmental concerns that will need to be remedied by the new owner. It is important to review these reports prior to the site visit so any areas of concern can be identified and discussed.
RealtyMogul.com’s Commercial Real Estate Analyst, Chris Fraser, visiting the Beechmill Apartments in Indianapolis, IN.
Driving the Market
Equally as important as the asset itself is the market in which it is located. The second half of a site visit does not take place at the property at all. This half focuses on the market in which the asset is located and the comparable properties that were used during the financial analysis.
Location, Location, Location
The first step is driving around the area to evaluate the location of the property. Is it easy to access from major thoroughfares? Is it in a desirable location? Does it have good visibility from the street front with adequate signage? In the case of a retail property, it would be important to consider the traffic counts that regularly pass by the property in a given day, the ease of entering and exiting the grounds (referred to as ingress and egress), and its proximity to other major retail centers that draw consumers. In the case of a multifamily property, it would be important to consider the convenience of retail amenities nearby such as grocery stores, proximity to major employers, and the school district in which the property is located, which may be important to families who would consider living there.
Validating the Comparable Properties
Some of the most important pieces of data that we use when evaluating a commercial real estate asset are called comparable properties (or “comps”). After a property has been identified, we have the ability to search through large amounts of data and select other properties that are similar to the one we are evaluating—similar by location, property type, size, year of construction, tenant base, and more. There are two types of comps that we consider—sales comps and rent (or lease) comps.
Sales comps are records of property sale transactions that have occurred in the recent past for similar properties in the area. We look through many of these available comps and hand pick the ones that most closely resemble the subject property. Once we have our set of sales comps, we analyze it to answer important questions about the price of the asset we are underwriting—for example, what is an appropriate capitalization rate (required return) for this property, or what is a fair price per unit or price per square foot based on what buyers in this market are willing to pay for this sort of property? Furthermore, sales comps can have important implications on what we expect the property to sell for at the end of the investment period.
Lease comps are records that tell us what other similar properties in the area are charging their tenants for rent. These comps will help us to determine if the property we are evaluating is renting in-line with, below or above rents at similar properties in the market. Properties that are renting at below-market rents may potentially have an opportunity to increase rates and create additional revenue and property value. Lease comps are particularly important for supporting the assumptions that are used in the business plan for the property. If the business plan calls for a renovation at the property, for example, we can look at lease comps for other renovated properties in the area to see if the rents that are assumed after the renovation is complete are reasonable. Since the value of commercial real estate is essentially its ability to produce income, obtaining good lease comps is a very important part of the underwriting process.
Although these comps are carefully selected using all of the information that is available, it is very important to try to visit each one during the site visit and confirm that each is in fact similar to the subject property in terms of location, construction, age, amenities, and offerings. While doing so, it’s useful to consider any key differences from the subject property. If a comparable property is outperforming the subject property with higher rents or a higher occupancy, it is important to try to answer why that could be the case and determine if the sponsor’s business plan with remedy those shortfalls and bring the subject property more in line with those offerings.
Meeting the Sponsor
Site visits provide a valuable opportunity to get facetime with the sponsor who will be running the project, and often managing the property. In most cases, the sponsor will be present for the site visit and can provide insight about why they chose this property as an investment, their due diligence findings, and their plan once they take ownership. Sitting with the sponsor to discuss their thoughts about the property and their business plan, along with some background about their company and experience is a great use of time during a day visiting a property.
What It Means
Visiting each property that we offer as an investment opportunity is an important step in our underwriting process and helps confirm that we are accurately evaluating each property and the markets in which they are located. It’s another way for us to execute on one of the company’s core values: investor protection. Real estate investing carries inherent risks and does not guarantee a return of any kind. With that said, if we can pass along our confidence in the investment opportunities we offer, then we consider that a job well done.