What should Investors look for while screening a Commercial Real Estate Deal
Updated: Dec 16, 2022
It is necessary that an investor keeps in mind that not every prospect ends up being a deal. A screening system needs to be set up in place so that you can save your time by only underwriting properties that can potentially make you money. Even if you get a significant amount of prospects, it will be beneficial only if you can distinguish between the prospects you should follow from those that you shouldn’t.
How to prescreen a deal?
It is important to ask the potential seller the right questions to help determine whether a deal is worth investing or not.
1. Reason for selling: Asking this question will help you identify why the seller is selling the property and how ready is he to do so.
2. The Ask price: Knowing how much the seller is expecting to make from the sale of the property can help you estimate an initial offer to make.
3. Estimating the cost of repairs: One should not go by the seller’s word on how much the repair and renovation might cost, but should also do their own due diligence for the cost of repairs and deferred maintenance.
4. The Market: A commercial real estate market is a targeted geographical area where the investor might invest. The geographical location plays a crucial role in any real estate investment. Market analysts often define a real estate market by political divisions such as county, city or metropolitan area. Market trends are compared between real estate markets such as growth of Area X versus the decline of Area Y. Such comparisons at a large geographical scale are valuable because they can identify potential opportunities and potential failures.
5. The submarket: The real estate decision is a site-specific decision. Submarkets are areas within the larger market area and an analysis of the appropriate submarket is required to support the real estate decision. Sub-markets offer the investor a more granular perception of a property’s location along with the financial, cultural and other factors. Sites within the submarket are at the same stage of cycle with one another while perhaps being countercyclical with sites in the larger market or other submarkets.
6. Jobs and Businesses: It is extremely important to understand the industries that thrive and their impact on the CRE market. What local drivers are creating jobs? Is there a certain industry dominating the economy? Understanding the market’s landscape enables investors to make more predictive and forward-looking decisions.
7. Average Income and Spending Power: Before investing in a new market, investor must ensure whether the tenants can generate revenue to pay the rent. If the median salary does not support the new multifamily development, then investing there might not make sense. Investor must understand whether or not the local income supports their investment thesis.
8. Demographic: Is the population growing or shrinking? What accounts for a large influx or reduction in new residents? Examining the population growth trends along with the immigration trends and the broader forces shaping them can yield insights about these markets.
9. Asset Classes: Analyzing the CRE market helps investors in understanding which asset classes drive the highest returns. Financial capitals might prove to a better investment avenue for office investors while tourism hotspots will hold more opportunity for hospitality focused investors.
10. Supply and Demand: This is an extremely important factor in determining whether the prospect should be pursued further or not. If there isn’t adequate demand in the area the property is located it, it might not make much sense to invest in it at the time.
On the other hand, it is equally necessary to analyze the supply in the market which can also offer clear insights into how tough the competition will be, because if there is too much supply against little demand, it again makes no sense to invest at the time.