As the opportunity for listing commercial investment property arises, we can sometimes be too eager to take the listing without getting all the important facts that affect the price.
Check the leases on a commercial investment property before you talk about price on the property as the leases may assist or hinder the sale. They can also dictate a sale strategy. This says that a good commercial real estate broker or agent must know the structures of a lease and what makes a good lease.
Depending on the age of a property, the next phase of its lifecycle may be refurbishment, demolition or remix of tenancies. Every phase is different. The demographics of the region in which the property is located will also have something to do with the future of the property.
A property that has a majority of leases that are soon to expire may be attractive to a purchaser that wants to owner occupy the property or a developer that wants to change the site and create a new building. On the other hand, the same property in such circumstances will not be attractive to a new investor unless they want to undertake refurbishment works and re-position the property with new tenants. Decisions are based around strategy needs and timing; an agent or broker for a commercial property you need to be the ultimate strategist.
Know These Leasing and Tenant Mix Facts
When looking at the potential sale of the property, the lease aspects requiring future awareness and understanding in the sale include:
Rent review profiles – are they strong and well-timed or do they just gear to the consumer price index? Also look for the market rent reviews and see if they are well timed or if they expose the property owner to volatile cash flow changes.
Lease expiry dates – these are always a concern if the property requires stable cash flow, so look for multiple lease expiries that are close to each other, and also that may consist of a majority of the lettable space in the building. Understand the cash flow in the property before the sale process starts. What tenants should stay in the property at lease expiry? Will you need to fix those occupancy facts before sale marketing?
Option periods – from a landlord perspective, lease options are not always a good thing to have as they can frustrate the future of the property; it really depends on what the landlord thinks that they want to do with the property. It is of note that many large shopping centres and malls do not allow lease options for that very reason.
Details of any current incentives with existing tenants – some lease incentives carry on impacting the property for some months or even years. When the property is to be sold, these incentives must be offset or discharged at settlement as the future purchaser may not want to take over the burden of such.
Outgoings recoveries – leases and most particularly net leases will allow the landlord to get back some of the building operating costs. It pays to check the leases to see exactly what those recoverable items may be as it can impact the property sale or buyer interest
History of income and expenditure performance – I always go back at least 3 years to check these numbers and to see what have been the major changes in the outgoings. What you are looking for is overly large imbalances in outgoings from year to year that indicate that something major has impacted the property or a strategy has changed. Get reasons for any changes of this type so that any astute buyer can be given logical explanations.
The current budget of income and expenditure performance – every commercial investment building of any type should function to a budget each year and the details should be available for your review. Parts of the expenditure that impact greatly on the property are the rates and taxes as they take up on average a full 33% of most building expenditure. You need to know that these rates and taxes are on average with other properties in the region.
Property performance elements such as these will affect the potential income from the property well into the future and will also dictate the best time to sell the property. In an ideal world, you would time the sale so that the income is optimised and the outgoings are controlled to acceptable levels. This cannot always be done especially in markets like that which we have today, but you should know where you stand on the property performance before you proceed into a sales program. Strengths and weaknesses of cash flow should be identified and logical reasons provided before any sale campaign starts.
As you promote, sell and then document the property transaction you will soon come across the fact and event of ‘due diligence’.
This element of the commercial real estate sale is very common and will be the subject of most contracts with the exception of those that adopt the auction method.
As you would expect the process of due diligence can make or break a sale. For this reason, it is wise to question a seller well in the listing stage of the sale to ensure that no ‘deal breakers’ or problems are hidden in the cupboard. Due diligence will likely find most problems on and with the property.
What is Commercial Property Due Diligence?
So what can be looked at in ‘due diligence’? Consider these:
Due Diligence is simply a detailed checking process that is undertaken prior to sale and settlement by ‘experts’, to review all relevant data involved in the sale.
Usually, solicitors and/or audit specialists are the nominated parties to undertake the work on behalf of the purchaser.
The concept of Due Diligence is that the sale and settlement of the property will only occur if the Due Diligence process is successful.
On large commercial properties, it is not unusual for Due Diligence to continue for days if not weeks. A special condition of the contract will allow this to occur.
The process is undertaken under the strict control of the Seller. It usually occurs in the Seller’s property management office or at the Sellers solicitor’s offices and is usually in a controlled environment (locked room). Only authorized parties are allowed into the room so as to preserve security and confidentiality of documentation.
A good Agent or Broker will provide total support to the Due Diligence activity. Expect Due Diligence to check just about everything involved in the sale.
The five professional areas usually covered are:-
Cover These Property Issues Plus More
Expect questioning and document discovery to include the following:-
Engineering: Includes verification that the property structures and building services comply with the Building Code of Australia and Local Government building Approvals. Questions will cover safety risks or non-compliance of structures, fire protection, air conditioning, electrical supply, hydraulics, lifts, escalators, and stand-by emergency power. Expect the questions to involve adequacy of structures, mandatory service compliance, remaining life expectancy, capital expenditure, and sinking fund requirements for future major repairs or replacements.
Environment: Includes a wide range of issues such as identification and analysis of environmental and physical risks to the property or land and its use. Issues will include site contamination, dangerous goods and hazardous substances, asbestos, hazardous industrial waste, trade waste, stormwater management, occupational health and safety, heritage factors, and statutory requirements.
Finance: Includes all actions and dealings associated with property financing, review of taxation implications, substantiation of income and expenditure statements, arranging mortgages, financial analysis and modelling, company or entity investigations, plus all other supportive or related documentation.
Legal: Includes all conveyance documentation, easements, permits, titles, contracts, leases, searches, incentives to tenants, site details, compliance with any legislative requirements, outstanding litigation, and any town planning issues.
Management: Looks at any issues associated with ongoing asset management, facilities management, building management, lease management and negotiation, rent collection, arrears, financial reporting, insurance, car-park supervision, cleaning, pest control, landscaping etc.
A customer wants to be well served in their shopping needs and feel good about it when they visit your property. Visit the competition shopping centre properties nearby to compare them to that which you are currently leasing. You must understand the other properties that you are competing against together with the strengths and weaknesses that they experience.
The tenants that seem to feed customers off each other
The amount of time that people spend at the shopping centre
The busier days for customer shopping
When looking at these other properties it is wise to take selective photos of the things that may be relevant to compare to your property. You can analyse the photos later and revisit your ideas. Note that some property owners and managers will be sensitive to you taking photos around their property. Discretion is the rule here.
The only way you can underpin your rental and strengthen it is through a good tenancy mix. Given that the leases in premises are for lengthy periods of time, any mistake with tenancy mix will exist for years and frustrate the rent, the customer, the tenant, and the property. Hence you must choose tenants well and then place them with a lease that is in harmony with the surrounding premises.
Shopping Center Review Process
As parts of that process look at these issues in balance so that any concerns of tenant mix occupancy are removed and nullified. Understand:
Income exposure at expiry
Option exercise potentials
Exclusive or Permitted uses in the leases
Vacancy effects on other existing tenants
Relationship building or conflict potential between sitting tenant types
Know why tenants like or dislike your property
Know how your existing tenants maximize their business operations at your property
If you follow these steps, you will be armed with the strategy you need to put you in the ‘driver’s seat’ as you implement a new leasing campaign and tenancy mix for your managed property. You will know the tenant you want and you will have the selling points to attract them.
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