Emotions can run high when working out a commercial real estate (CRE) deal, and time is always of the essence when you encounter an opportunity that appears to align with your investment interests.
The Lure of Impulsive Strategy
You might be looking at a value-added property that will diversify your portfolio with the promise of double-digit returns, or you might be surveying a new office development in a high-growth metro with the potential for A-list corporate tenants. An opportunistic foreclosure may have just presented itself, offering you the chance to hold a remarkable amount of imputed equity or enter into arbitrage. Or perhaps this is your first foray into the CRE market altogether, as you consider joining an investment pool to acquire a two-story complex of multifamily units.
Whatever your investment strategy may be, it can be tempting to rush ahead and jump in with both feet at once to lock down a golden deal. Investing in real estate, after all, can be a fiercely competitive endeavor, and another investor will surely step in to take your place if you miss your window of opportunity.
Still, it pays to keep a cool head and maintain your sense of balance even in the heat of funding and negotiating a deal. Investors who fail to do so run the risk of neglecting their due diligence and overlooking important details and concerns that could jeopardize their chances of success in the long run.
In short, don’t let your zeal to close a strategic deal stop you from pursuing transparency in every aspect of the CRE process, including real estate capital solutions. To protect your assets and meet both your short-term and long-term objectives, take the time to examine the deal thoroughly from every angle and get all your critical questions answered by the sponsor, the seller, and the financial professional or lender.
Dangers of Forgoing Transparency
When you allow your short-term impulses to cloud your better judgment and obscure your view of the big picture, you are opening the door to unforeseen consequences that could negatively impact:
- Your liquid assets. A deal closed in haste could yield unfavorable outcomes down the line, as the property fails to yield cash flow due to longtime delinquent tenancy and your loan payments skyrocket after an initial term agreement that did, indeed, seem too good to be true.
- Your reputation. Other investors and CRE professionals may be reluctant to partner with you again in the future if a deal that you spearheaded goes sour.
- Your investment portfolio. What seemed at first like a golden deal turns into a lemon investment that drags down your other positions and requires your extra time and resources to remediate. Your planned objectives fall by the wayside as your long-term investment strategy is derailed by a single bad deal.
Achieving Transparency with Sponsors and Sellers
When assessing the viability of a CRE deal, you should always ask your sponsor and the seller to disclose critical information and documentation, including:
- Records pertaining to property conditions and maintenance history
- Rent rolls of property tenants
- Market analysis of the surrounding locale
- Current net operating income (NOI)
- Pro forma summary of estimated cash flow and ROI balanced against taxes and expenses
- Capex budget and other financials
- Private placement memorandum outlining the terms of agreement between the sponsor and investors
Achieving Transparency with Lenders and Capital Brokers
A widespread lack of transparency and accountability in the real estate financial system was the catalyst that propelled the U.S. economy into the Great Recession of 2008. In light of the sobering lessons learned from that crisis, commercial real estate is now under greater scrutiny than ever before, as investors and businesses, along with society at large, demand higher industry standards.
Fortunately, the CRE industry has adopted new regulations to promote greater transparency in its financial practices:
- The Investor Reporting Package (IRP), from the Commercial Real Estate Finance Council (CREFC), establishes the industry standard for disclosing information about the property, loan, and bonds associated with CRE deals.
- Information in the CREFC IRP pertaining to commercial mortgage-backed securities (CMBS) meets the report filing and disclosure guidelines of the U.S. Securities and Exchange Commission (SEC).
- The commercial specifications of the Mortgage Industry Standards Maintenance Organization(MISMO) provide a standardized dataset for the sharing of commercial and multifamily rent rolls between interested parties. The dataset includes a data dictionary model and expanded support for an array of use cases.
In addition to reviewing the publicly available information described above, all investors should take the necessary precautions to perform their borrower due diligence when vetting prospective lenders. Red flags such as excessive fees, overly favorable loan terms, and pressure to accelerate the funding process should give any borrower ample cause to withdraw their application in favor of a more responsible lender.
Balancing your impulse to close quickly on a strategic deal with a disciplined pursuit of informational and financial transparency is the key to realizing your long-term investment goals. Savvy CRE investors always look clearly and deeply before they leap.
Black Collie Capital is a real estate finance and investment advisory firm with a specialty in the middle market. Contact us to find out how we can arrange financing and creative capital solutions for your commercial real estate needs across all asset classes.