Many investors, including myself, have become spoiled by the returns they are reaping from the investments they made during and in the wake of the recent real estate led recession. Real estate is once again a popular vehicle for investment and the increase in demand coupled with limited new inventory/supply has led to a healthy increase in real estate values. Many critics are pointing to this rapid increase in real estate values as a sign the market is overheated and are advising to curb investment. However, with the markets recovering, this is where playing the real estate game becomes interesting because attention to detail, proper underwriting, diligence, and experience play a pivotal role in identifying the right deal. As always, there are good and bad real estate investments on the market, but overall, from a macro perspective, I am of the opinion it is still a good time to invest based on the following: 1) interest rates are still near historic lows; 2) the overall economy is on the rebound and strengthening which will lead to increases in rents and employment rates; and 3) the economics do not support new development in many areas, providing a preserved demand for existing product. I am still investing and helping others invest and manage their properties and below are some tips that I myself utilize (and that you may find helpful) in navigating through the acquisition process in today’s market:
1) Common Sense & Importance of the Site Visit
I am surprised when I meet investors or sponsors who are ready to move forward with an investment after a cursory site visit. Many of these investors become enamored with their detailed preliminary financial analysis and spreadsheets and they sometimes lose site of the basics. Common sense plays a key role in being a successful real estate investor. What typically scares me and forces me to stay honest to my underwriting and diligence process is the fact that once you enter into contract on a properly marketed property, you have beat out all other potential, some presumably sophisticated, buyers, i.e., right now you are the one willing to pay the most amount of money for this property. A scary thought when you think about it in that manner. Therefore, instead of going through your site visit and inspections with tunnel vision regarding your preliminary analysis, take a step back and constantly ask yourself the same questions—Is this still a good investment? Why? Are there better investments on the market? What is the tenant profile and are you happy with it? Why is the Seller selling this property? Does this property and its use make sense in this location? Do you have enough capital to maintain and/or add value to this property?
2) Financial Analysis with Honest Assumptions
A detailed financial analysis of the property is important to properly understand whether this is a good investment opportunity. After you have reviewed the seller’s operating data for the past few years, you will then need to analyze the future operations of the property if you take over ownership. Since this is an analysis of the future you will be making several assumptions, i.e., rental rates, occupancy levels, operating expense increases, capital improvement expenses, etc. Most investors tend to overinflate the value they can add to the property. They typically overestimate rent collections and growth and underestimate operating expenses. It is important to stay honest through this process and to do your homework. Properly accounting for these assumptions is often the difference between acquiring a good investment as opposed to a bad one.
Example: I recently entered into contract to purchase a multi-family property in Sacramento, CA, a market I am familiar with and like. What attracted me to the property was the cost per unit and the ability to add value based on my property management background. The property was situated in a tough neighborhood and had some good things going for it, but it had been plagued with over a decade of bad ownership resulting in a negative reputation within the community. After my physical inspection and review of the seller’s disclosures, I realized I underestimated the utility expenses and cost of stabilizing the property and overestimated my ability to attract quality tenants at higher rental rates. Given the negative reputation of the property I tempered rent collections and adjusted operating expenses to account for the higher cost for utilities, this proved to be enough to make this a deal no longer worth pursing. I was taking the risk to turn this property around when others had failed and even if everything went according to plan I would be earning a return slightly above market. The risk was not worth the reward.
3) Understand the Market You Are Investing In
You cannot change the location of your property, so understanding the make up of the local market is vital to the success of the investment property. The evaluation needs to occur at the city/county level and the neighborhood level. The key here is not to only focus on the return being earned but to see if there is that “it” factor or synergy brewing locally that will add value in the future. How the technology industry helped transform the South of Market (SoMa) district in San Francisco is a great example.
4) Build A Knowledgeable Team
Acquiring real estate is a team effort, it is important to understand what you as an investor are skilled at and then to build a team to assist you with the acquisition, diligence, and management of the property. Typically the team should consist of a real estate agent/broker, an attorney, contractor/inspector, civil engineer/surveyor, lender/mortgage broker, and property management company. Leveraging the strength of others to supplement your core skills will help you get the right deals and manage them effectively.
About the Author
Manroop “Roop” Purewal, Esq. is a real estate attorney and investor, he created PUMCO Property Management to self-manage his real estate portfolio and to manage his client’s investment properties. Client’s appreciate his practical, real-world perspective. If you have any questions about this article or require any help with your commercial real estate needs, please contact Roop at firstname.lastname@example.org or (916) 834-2172.