Commercial property transactions can be complex and require detailed analysis and care right from the due diligence stage to the deal structuring and closing phase.

The first step in the process is assessing a deals attractiveness. While less experienced investors would be strongly advised to consult with professional advisors before investing, there are certainly early indicators that can be sought to assess if this particular deal warrants further inspection.

Tenant:

When purchasing a building with a tenant in place, the identity of that tenant is of serious importance. The tenant isn’t simply living in your building, but 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 more importantly strength of the businesses of each of your Tenants.

Whereas 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.

Losing a tenant and suddenly finding yourself with a vacancy to deal with can lead to serious ramifications for your investment.

Lease:

If your tenant, or more specifically anchor tenant, should fail or move out at the end of its lease, the building as a whole may require restructuring and retrofitting or, at a minimum, some downtime until a new anchor tenant can be found.
With this in mind, you, as the potential owner, are looking to see as long a period of time as possible remaining on the lease. Ideally, you want to have initiated your exit strategy before any new lease is required as this will mitigate any risk of being left with a large vacancy.

Market:

The investment documentation will most likely include a market analysis detailing the current environment and how the investment sits, or will sit, within the market. This is vital and warrants a thorough investigation by the potential investor. Are the figures taken from a reliable source? Are the figures relevant? Is the report based on assumptions, or true analytical data? Is the data current? Does it relate to the correct market?

Sponsor

Like all property investment opportunities, ultimate success truly rests with the sponsor’s ability to perform as planned. Their experience, and preferable success, in the market place is obviously the best indicator of the likelihood and one should be on the look out for a strong bio. In addition, one would like to see the sponsor contributing a percentage of the required equity themselves. This is a statement of their confidence in the deal, as they are not only risking your money, but their own.

The US economy grew at a faster than expected 5.7% annual pace in the fourth quarter, the quickest in more than six years.

The first estimate put Q4 gross domestic product growth at its fastest pace since the third quarter of 2003. The economy expanded at a 2.2% annual rate in the third quarter. Analysts had forecast GDP, which measures total goods and services output within US borders, growing at a 4.6% rate in October-December period.

Growth was boosted by a sharp slowdown in the pace of inventory liquidation, a factor that could serve to mask the strength of the economic recovery. However, even stripping out inventories, the economy expanded at an annual rate of 2.2%, accelerating from the 1.5% increase in the third quarter, reflecting relatively strong performance from other segments of the economy.

Business inventories fell only $33.5 billion in fourth quarter after dropping $139.2 billion in the July-September period.

The change in inventories alone added 3.4 percentage points to GDP in the last quarter. This was the biggest percentage contribution since the fourth quarter of 1987.

In the last three months of 2009, consumer spending increased at a 2% annual rate, below the 2.8% recorded in Q3 when consumption received a boost from the government’s car scrappage scheme.
Consumer spending, which normally accounts for about 70% of US economic activity, has been held back by the worst labor market in a quarter century.

Business investment in the fourth quarter grew for the first time since the second quarter of 2008 as the drag from the troubled commercial property sector was offset by robust spending on equipment and software. Business investment rose at a 2.9% rate.

The growth of spending on new home construction slowed sharply in the fourth quarter to an annual rate of 5.7% from an 18.9% pace in the third quarter. Export growth outpaced imports, leaving a trade gap that contributed half a percentage point to GDP growth in the last quarter.

Equity Interface is an online real estate investment service designed to connect developers and accredited investors. By offering unparalleled research tools and information, Equity Interface empowers members to discover mutually beneficial real estate opportunities. For more information, please visit www.equityinterface.com

LaSalle Investment Management today released the 2010 edition of their Investment Strategy Annual. A publication that provides an outlook for global real estate markets.

The report notes that the plunge in values has stopped in most major markets it follows and sings of increasing investor confidence are beginning to be seen.

LaSalle anticipates a further re-alignment in the pricing of risk with an increase in deal flow as sellers slowly move from denial to acceptance. Investors should seek an appropriate balance between total risk aversion and inappropriate risk tolerance. The former is already resulting in a surplus of capital targeting a handful of ultra-safe deals.

Jacques Gordon, Global Strategist at LaSalle Investment Management said: “Overall, investors in commercial real estate should be cautiously optimistic about the outlook in 2010. However, as a late cycle participant in the general economic recovery, real estate will behave differently from other asset classes. The income streams from leased buildings weathered the global recession in remarkably good shape, but as leases mature in generally weak markets, net operating income will be under downward pressure in many countries for several years to come.”

“At the same time, in terms of stimulus packages and bail outs, commercial property has been treated quite differently from residential real estate, banking and other industry sectors. And private equity prices have not yet recovered as robustly as stocks or bonds. All these differences mean that real estate’s diversifying power in a portfolio will be restored.”

The firm goes on to state that in 2010 investors can look forward to more rational pricing and, in cases of distressed properties and owners, some hugely interesting opportunities. As they develop investment strategies for 2010-2011, investors with a clear view of the returns they require can take full advantage, says LaSalle.

William Maher, Head of US Strategy, LaSalle Investment Management said, “Investment opportunities in North America will improve but are likely to remain limited in 2010, particularly in the United States and in Mexico. In the US, the best opportunities, both core and higher return, will evolve from the resolution of the large level of maturing and failing loans.”

La Salle go on to recommend that investors in the US focus on low-risk re-priced core properties. A large number of opportunities are expected to emerge from the problems caused by the excessive leveraging of the real estate sector over the past five years.

As regards high return strategies, the areas to focus on include distressed debt (public and private) and a wide range of structures that focus on the provision of “rescue capital” to private real estate funds, developers, individual assets, and lenders.

Not surprisingly, the major risks to Commercial Real Estate according to the report is with the capital markets, which are expected to be the main driver of performance, while economies are weak. Real estate capital markets could be quite volatile in the years ahead, says LaSalle. The unintended consequences of monetary and fiscal stimulus policies could lead to too much money flowing back into property ahead of a solid recovery in fundamentals. This excess liquidity risk is already building in China and, to a lesser extent, the UK. To manage this risk, investors should maintain a strict discipline that focuses on achieving a required return with realistic and diligent underwriting.

Equity Interface is an online real estate investment service designed to connect developers and accredited investors. By offering unparalleled research tools and information, Equity Interface empowers members to discover mutually beneficial real estate opportunities. For more information, please visit www.equityinterface.com

During the last number of golden years in the Real Estate market, the only word that investors wanted to hear was ‘returns’. Now, according to Ernst & Young, this is being replaced by another ‘R’ word: risk.

Ernst and Young are witnessing a marked change in the priorities of large Real Estate investment firms. When once, at the height of the real estate boom, they were focused on generating the highest possible returns for their investors now that attention is primarily targeted at managing risk.

In material documented from market research on over 40,000 client meetings globally, Ernst and Young said that firms should be developing a “plan of action” if they are to benefit from the downturn. That plan needs to focus on capital availability, reevaluating the business model and risk management.

With almost 75% of real estate executives anticipating a “permanent change” in the risk management of their organizations, Ernst & Young said everyone had to learn lessons as they tried to prepare for “success”.

In the ‘Lessons From Change’ report, the firm added that real estate companies need to be adept at controlling the expectations of investors who were used to seeing exorbitant returns in times past. They now need to “accept lower returns as some companies focus on lower yielding but lower risk investment”.

The issue of increased regulation is also something that the report identifies. Global Real Estate leader Howard Roth said this would be one issue facing all investors, particularly private equity and real estate funds. Here there is a growing demand and expectation for greater disclosure of investment plans and asset verification.

Dean Hodcroft, Ernst & Young’s Real Estate leader for Europe, the Middle East, India and Africa, continued by stating that: “Two years ago, real estate executives spent most of their time on new deals. Now they spend most of their time firefighting: protecting assets, controlling costs and, most importantly, managing cash flow.”

Equity Interface is an online real estate investment service designed to connect developers and accredited investors. By offering unparalleled research tools and information, Equity Interface empowers members to discover mutually beneficial real estate opportunities. For more information, please visit www.equityinterface.com

Real Estate Syndication involves bringing a group of individual investors together to pool capital for investment in real estate.

It has become increasingly popular over the last number of years as a means of investing in commercial real estate The main appeal is that it typically offers individual investors the opportunity to gain access to large-scale property transactions/opportunities that they would not ordinarily have the resources to participate in individually.

Conversely, on the developer’s/deal originator/syndicators/ side it can provide an alternative source of capital for which to take advantage of an opportunity.

Real estate syndicates typically own income-generating residential or commercial real estate, with investors having an interest in tangible “bricks and mortar” assets. This characteristic is untrue of many other investments and provides added security for the investment.

One of the key benefits of this structure for the investor is the professional management which might not otherwise be economically feasible for the small investor.

Parties Involved

There are three central participants, or sets of participants, as follows:

- The syndicator or promoter who creates the syndicate in the first place;

- The syndicate manager who typically sources the equity and manages the syndication. In certain instances, this can be the promoter as well;

- The investors who purchase the investment units.

Legal Structure

The structure of a real estate syndicate is invariably based upon one of the following six legal relationships: co-ownership, divided ownership, corporation, trust, general partnership and limited partnership.
Selecting the form of organization involves practical as well as legal and tax considerations. The responsibility rests with the syndicate manager to ensure that the appropriate structure is used. Each of the available entities has advantages and disadvantages.

The corporate form insures centralized management as well as limited liability for the investors but is seldom utilized in modern syndicates because of its negative tax implications.

The general partnership (joint venture) avoids the double taxation normally involved in a corporate entity but the unlimited liability provision and lack of centralized management inhibit its use.

The limited partnership combines nearly all of the advantages of the corporate and partnership forms. It has the corporate advantages of limited liability and centralized management and the tax advantages of the partnership. As a result, the limited partnership form of organization is the one most frequently selected for real estate syndicates.

Another form of business, the limited liability company, was added in 1994 and includes liability limitation similar to that afforded shareholders of a corporation.

There are various laws and regulations that govern the actual formation, and day to day operations of real estate syndications. These laws will vary by state, and it is important to speak with a qualified Real Estate Lawyer in your particular area to see what suits/works best.

Earnings/Fees

- Investors typically receive:

A preferred annual return on their invested capital. They receive a percentage figure which is stated from the outset on invested capital prior to the developer / owner receiving payment. Depending on the risk attached to the deal, this typically rests somewhere between 5% and 10%. In some rare cases, this may be a guaranteed minimum return, which is guaranteed by the developer / owner; (note: It is important to clarify whether this return is simple or compound. It can vastly affect figures.)

A priority of repayment of capital in the event of a sale or re-financing of the property;

A percentage share of the profits at exit. This is typically based on a waterfall model whereby the sponsors’ cut of the profitincreases as the profits rise. Differing ‘hurdle rates’ are set which dictate the profit split.

Example:

- The sponsor typically receives:

Fees for services provided to the partnership / venture, which may include any or all of structuring the syndication, identifying the property, managing the development of the property, providing property management for the finished property, managing the partnership / venture, managing the disposal of the property;
(probably put in market averages here).

A share of the profits after payment of a preferred return on the investors capital and the return of their capital; (as illustrated above)

A return on the equity it has contributed to the venture.

Potential Pitfalls

Investors must remember that the underlying investment is real estate, and as such, normal real estate risk factors apply. There are also other risks that relate to the structure of the investment. Typical risks for an investor to bear in mind when reviewing syndication include:

- Possible unforeseen costs or liability associated with the properties. Very important to ensure that the debt secured by the sponsor is non-recourse and thus in a worst case scenario the investor can only lose their original equity.
- Uncertainty in general market conditions related to the future sale of properties
- Uncertainty regarding future taxes.
- Real estate is “illiquid” and so it could take a long time to sell.
- Issues with Sponsors that own affiliated companies that service the properties.
- Possible conflicts between Sponsor and Investor. Investor needs to have full faith in competency of sponsor as management and decisions moving forward rests with them. conversely, Sponsors need to ensure they have complete control and can operate without any impediment from an awkward investor.

Getting Started as a Syndicator/Sponsor

If I want to put together a syndicate of investors, what do I need to do?

Historically, sponsors would approach equity raising houses, or syndicate managers who would raise the required equity and manage the monies on behalf of their clients. These firms will also put together the appropriate structure to incorporate these clients. Typically, the company would charge the sponsor a fee of anything from 2% to 5% of equity raised. This covers the professional fee’s involved in structuring the investment vehicle (legal, tax), the marketing material used to sell the deal to its clients, and for the provision of equity to the sponsor.

The other option is using Equity Interface (www.equityinterface.com), which offers you direct access to their pool of accredited investors and allows you commence dialogue with those that are interested. This could potentially save you hundreds of thousands in equity raising firm fees.

Do I need an attorney?

An attorney is imperative. All measures need to be taken to ensure that liability doesn’t rest solely with the sponsor in the event of the deal not succeeding as planned.

What other advisors do I need?

Tax – It is the sponsor, or syndicate manager’s, responsibility to ensure that the investor has minimal tax exposure. With that in mind, a tax consultant is one of the most important cogs in the syndication wheel. They will instruct you, or your firm, on the best entity to use for each possible scenario. As every real estate deal is different, there will often be subtle nuances that require a specialist to review and advise.

Marketing – Elements of the syndication process can be seen as a sales excise as ultimately you are trying to sell your product to a willing audience. The publication of a complete offering memorandum is central to this, and it is important not to understate its importance. Many large syndication firms have departments solely dedicated to the production of offering memorandum’s and other supplementary marketing materials like summary sheets, web pages etc.

How do I vet potential investors?

If you are using an equity raising house then this should come under their remit. However, the basic rule is to ensure they are accredited investors. In the United States, for an individual to be considered an accredited investor, they must have a net worth of at least one million dollars or have made at least $200,000 each year for the last two years ($300,000 with his or her spouse if married) and expect to make the same amount this year.

Getting Started as an Investor

What are the key things to look out for in an investment?

When assessing possible opportunities, there are a number of key elements, which should be focused on, the main one’s being;

Sponsors Track record: The sponsors experience in the field is one of the most important things to look out for when assessing a real estate investment. Look for past successes/failures and how they are viewed in the market place. While the real estate asset is the investment, it is really the team who plan on turning this opportunity into returns that you are truly investing in.

Returns: Be sure to note if returns are stated as a simple percentage rate, or compound. The method which is often used to state returns is Internal Rate of Return(IRR). Technically, this is the discount rate that makes the net present value of all cash flows equal to zero. More simply, it’s the year on year return of the project. Below is compared the return on a five year project with an equity stake of $100,000. As can be seen, the difference is great.

Fees: Ensure that fee’s are both comparable to market rates and highly transparent. Often fee’s can seem to be wrapped up in the deal but are really just going into the sponsor’s back pocket. Ideally, the main sponsor’s slice should be incentivised to help ensure that they will endeavor to push returns as high as possible, thus benefiting the investor in the long run.

Asset:The offering memorandum should provide detailed information on market comparables and where the market is thought to be moving. Alarm bells should be ringing if this information is not provided in a high degree of detail. When sponsors are anticipating returns, be sure that these returns are based on a realistic, or even pessimistic, valuation of sales price.

Other things to look out for regarding the asset are;

- quality and stability of tenant
- possible added value potential
- planning issues
- rent roll and status of leases
- Sponsor supplying equity: While not imperative, it is a good sign in an investment if the sponsors are contributing a percentage of the equity themselves. This shows a confidence in the deal and also means that the sponsor is working for their own money too and not jst the investors.

Many developers begin looking for investors by producing  a comprehensive package of materials detailing their  opportunity.  Such packages often include, but are not  limited to, site maps, renderings, current state photos,  finished design samples, hard and soft cost proformas,  resumes and the all important “expected cash flow  summary”.  However, the packages often neglect to include  a snapshot of the deal from the investor point of view.  At a  high level – how much investment is required, for how  long, at what rate of return and how will that investment  and return be repaid.

Investors are interested to know if a deal makes sense for their investment strategy and how a particular opportunity stacks up against other deals that they are currently reviewing.  If a deal is presented in a beautiful, large package that has to be read from cover to cover to determine its essence it can be a major turnoff to the busy investment professional and casual investor alike.  This level of detail is only required after a first level decision has been made. To remedy this habitual overload of less important information, we suggest a simple spreadsheet investor summary.

Begin with the name of the project and a very brief description of the deal (it may be that this is the only document that the investor will look at to determine their interest in your project).

After this initial description comes the project cost and the request for funds – “equity requirements”. The equity requirement is similar to the sources and uses component of a traditional debt term-sheet.  It shows the investor how much the sponsor is committing to the deal themselves and how much is being sought externally. A typical equity split involves investors providing 90% of the required equity with the sponsor adding the remaining 10% (a 90:10 split).

It is then important to show the investor what they will get in return for participating in your deal – “Expected Returns to Investor”.  Here you overview what you are going to pay (typically broken out per year) followed by an internal rate of return calculation. The IRR tells the investor what their annual return would be if they invested in your project for x number of years. Three to four years is a typical investment timeframe, but investors do love deals that have long term high returns as long as they are verifiable (It should be noted that the “I hope to hold this deal for my grandchildren” is not always the best response to the investor timeframe question!).

Once you have laid out the equity requirement and the associated returns over the timeframe, you next have to prove your model.  In the example template below we have presented a breakdown of the cashflows to the investor and the sponsor and the refinance assumptions that feed the model.  On the supporting worksheets in the financial package it is prudent to model every aspect of the deal so that when an investor sees a number in the summary sheet that is questionable, he/she can follow the links and understand where that number originates.

Pulling together an investment summary can be a relatively easy process especially if you have the proforma model outlining all the costs and revenues – it is really just highlighting the right information and presenting it in a clear and concise manner.  Without it however, your deal can die before it is even reviewed by the investor.

We hope this helps you to think like an investor and to more easily secure the equity you need for your projects.

Sample Template

Analyzing real estate opportunities can be a daunting task. In an industry renowned for its terminology and abbreviations it can be difficult to see the wood from the trees. ERV’s, LTV’s, NNN’s, jump off the page and often only serve to muddy the waters when scanning over a possible deal. However, there are a number of key indicators that can help you quickly decide between those that merit further investigation and those which are resigned to the ‘ghosts of real estate deals past’ pile!

So, what should I be looking for? To make it easy here are 5 key indicators that should help you weed out the “good” deals from the “not so good”.

1.  Developer Experience

Typically, one looks to invest equity with the developer or joint venture partner who has sourced and strategized the deal. In essence, you are really investing your equity in this person, as they are the ones who will drive the project and hopefully deliver the estimated returns at exit.

With that in mind the more information that you can uncover about this sponsor/developer the better. Ideally, you want to see a long list of previous projects in the same geographical and property type market.  At the very least, you should be looking for one previous venture of a similar fashion.

2.  Developer Interest

‘Skin in the game’, call it what you like but you want to see the sponsor having an equity involvement of their own in the project. If they talk a good game about the potential returns of this ‘unmissable’ opportunity but have no investment of their own on the line then alarm bells should be ringing.  Sponsors who suggest that they have put “sweat equity” into the deal should be discounted. Ten percent of the equity requirement is a much safer investment for a passive investor to rely on.

3.  Returns

You’re in this to make money right? So it follows than the project return is the key performance indicator that you will first assess. Returns are usually stated as percentage IRR (Internal Rate of Return). Another abbreviation, but if you’re going to rank them, this is the most important! Essentially IRR is a measure of how hard your money is working for you; this should be aligned with the risk profile of the deal, and the type of investment. Look at similar deals in the market and what they purport to be turning out, or ideally, source information on historic deals and what returns were achieved. Endless information should be available on the kind of return to expect from such a project so make sure the figures are attractive but more importantly that they make sense and are viable given current market conditions.

4.  Fees

Its one thing finding a respected, experienced developer to joint venture with, however if they are maligned by greed then it renders their abilities and experience void. Both parties should be in the project together so it should not be necessary for the sponsor to pile on high management and general partner fees to ensure that they are compensated regardless of how much profit is generated at the end of the deal.  They are due compensation for management and for sourcing the deal in the first place, but make sure that fees are in line with market standards. It is often prudent to base fees on results that motivate the developer to hit target returns to the investor before being compensated themselves.

5.  Support Team

A Real Estate investment by its nature is relatively complex and so requires a number of complimentary professional resources to come together at both its inception and in order to function throughout its term. From CPA’s to attorneys the set-up needs to be as professional as possible. The initial offering memorandum should state the various firms working at each level of the deal. Here we look for reputable names and businesses that are established in their field. This will not only give us solace in our support team, but will give us further indication of the seriousness and commitment of the sponsor to proceed with the deal. We don’t want to see the local one desk, one employee law ‘firm’ listed here, but rather the seasoned attorney who has seen it all before.

If you are satisfied on these five elements of the deal that you are reviewing it is definitely worth picking up the phone and having a conversation with the developer to dig a little deeper into the deal.  A site visit and a review of the partnership and operating agreements is next, followed by a more careful analysis of the market and the sponsor’s business plan.  If you are still interested in the deal at this point it is worth your while to start paying some professionals on your side to assess the merits of the investment.  Use the best advisors that you can and listen to their advice, but remember the decision ultimately comes down to you – your advisors are trying to reduce your risk exposure, but that means money in FDIC insured accounts at 2%, you can probably stomach some risk and do slightly better than that. Good investing.

Managing your risk is an essential component of all investing, and real estat is no exception.  In this section we will look at the diiferent elements of investment risk and explore how we can understand the external and internal factorsaffecting risk.

Real estate investing runs the gamut in terms of risk and investment success. The first rule of real estate investing, even before location, location, location, is be very careful with whom you are dealing. For some reason, real estate is fraught with unscrupulous characters, many of whom you’ll see on late night television commercials with their “no-money” down methods of becoming millionaires. Only a very small percent of these so-called real estate gurus are legit.

If you are seriously considering investing in real estate property, it means essentially that you will need:

• Investment capital, or a legitimate means of attaining some without putting yourself in debt.
• A good knowledge of the real estate market and the neighborhood in which you are looking to buy property.
• Good management, people and negotiating skills on late night television commercials with their “no-money” down methods of becoming millionaires. Only a very small percent of these so-called real estate gurus are legit. 

  If you are seriously considering investing in real estate property, it means essentially that you will need:

  • Investment capital, or a legitimate means of attaining some without putting yourself in debt.
  • A good knowledge of the real estate market and the neighborhood in which you are looking to buy property.
  • Good management, people and negotiating skills
  • The ability to do repair work or access to people who can do it for you.
  • The name and number of a property inspector or engineer.

  Unless you are able to find, evaluate and buy houses that are either in foreclosure or fixer-uppers, which can be turned around quickly, you will most likely serve as a landlord for the property while it increases in value. Be careful to whom you rent because your property must be well-maintained.

  Since legitimate real estate investing means having some money to make money, you need available capital. For this reason, many people go into real estate after coming into a sizable amount of money. For example, empty nesters who sell a large home for $500,000 and buy a smaller condo for $250,000 have money to purchase another property or two.

  Make sure to research your location. Go to local town board meetings, do research in libraries and go on the Internet to find out as much as possible not only about the location today, but about plans for the area over the coming years.

  And then there are REITs — Real Estate Investment Trusts. This is a way of investing in real estate for a lot less money and without having to worry about fixing a tenant’s leaking bathroom pipes in the middle of the night.

  REITS invest in various corporations involved in real estate, ranging from industrial parks to shopping centers to construction companies. They are listed on the NASDAQ and the stock exchange.

  Essentially REITS work in the same way as mutual funds, except they set up a diversified portfolio that deals only in real estate. They primarily pay the bulk of their earnings in investor dividends. Before investing in a REIT, consider:

  • The economic conditions where the key holdings are located
  • Past performance of the REIT and future projections
  • The manager of the REIT, who operates like a mutual fund manager
  • The overall state of the real estate market

  REITS, like stocks, bonds and mutual funds, have high and low periods. Like other income-producing vehicles, they can be strong investments over time and pay dividends. They are fairly liquid and are a much safer way of investing in real estate than buying property.