Scotsman Guide - July 2009 Commercial Edition

Get the Facts Straight
Help clients dig deeper with their due diligence before they purchase income-producing property
By Rhonda Garland, managing principal, Investment Analytics Group

Property-buyers can fall into many due-diligence pitfalls when purchasing income-producing commercial real estate. Perhaps the most-sig-nificant is not customizing the underwriting assumptions to the specific property they wish to purchase.

Buyers often rely solely on underwriting assumptions when considering an investment-property purchase. initially, underwriting assumptions are somewhat standard for most buyers.

in a stable market, these often include a 2-percent to 3-percent annual

Ultimately, buyers must do their due diligence to back up their assumptions. Here’s why.

Capital expenditures Because projected capital expenditures can have the most influence on under-

Rhonda Garland, managing principal of Investment Analytics Group, has more than 10 years’ commercial real estate experience, including management, leasing, acquisitions, due

diligence and financing. Before co-founding IAG, Garland was vice president of due diligence for one of the largest U.S. real estate investment companies, where she oversaw all due-diligence functions on more than 100 properties valued at more than $1.2 billion. Visit www.iagroupllc.com; contact Garland at (208) 846-8476 or rgarland@iagroupllc.com.

rent-growth rate, a 5-percent vacancy allowance, a 75-percent probability that existing tenants will renew and allowance of a 15-cents- to 50-cents-per-square foot capital expense.

Due diligence that customizes and substantiates underwriting assumptions is critical. in a tight credit environment, buyers seeking financing must be able to substantiate and support their assumptions more than ever.

it isn’t enough to rely only on appraisals and property-condition assessments (PCas) to ensure feasible underwriting.

Beyond simply being a financing source, mortgage brokers can help their clients by knowing how to ensure that property underwriting is customized to the property in question. They also should know how proper due diligence can help.

Knowledge of these issues can help ensure that a property’s actual financial performance won’t be drastically different than the initial or preliminary underwriting.

assess the property’s condition and future capital costs. PCa reports commonly over-project the remaining useful life of equipment or building components or fail to project costs to correct existing conditions adequately. This is because a visual inspection rarely reveals deficiencies in the existing conditions. additional investigation is needed that PCa consultants typically do not perform.

Further, more-complex properties may expose buyers to greater risk in projecting capital costs accurately.

For example, consider a midrise office building that has more-complex heating, ventilation and air-conditioning equipment like chillers, boilers and vari-

able-air-volume boxes for air distribution with computerized controls compared to a small neighborhood retail center, with split heating and cooling systems or roof-top-packaged units for the tenants’ heating and cooling needs.

The office building’s greater exposure would warrant investigating the

“Beyond simply being a financing
source, mortgage brokers can help their
clients by knowing how to ensure that
property underwriting is customized
to the property in question.”

writing results, buyers should investigate the asset’s current condition thoroughly. Lenders often require a PCa, which will provide some basis for projecting ongoing maintenance and repair costs, as well as capital expenditures.

One mistake many buyers make, however, is stopping there with their efforts to

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