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Why Are Credit Markets Still Tight?
I often get asked this question, especially lately as the stock market has improved and there is a general media perception that everything is better, hence, credit should be easier. So why does it still seem so tight?........Read More

 

How to Perform Complete Due Diligence
in Office, Retail and Industrial Properties

Due Diligence is the disciplined process you use to lower the risk of investing in Commercial Property. These risks typically comes in four distinct “flavors” when you are investing in Commercial Real Estate.

  • Market Risk
Will the fundamental conditions of this market allow me to meet my return on investment (ROI) goals?
  • Financial/Performance Risk

Does the projected financial performance of this property meet my ROI goals

  • Tenant Risk

Are these Tenants of high enough quality to allow me to meet my ROI goals?

  • Physical Risk

Will the physical structure of this property - and the money I will need to put into repairs or rehab - still support my ROI goals?

 
 
The third area of risk … Tenant Risk …
deserves special attention when you are
buying Retail, Office and Industrial Properties.
 
 
These property types carry an additional layer of risk you don't see in Multifamily because your Tenants aren't just living in your building … they are 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 strength of the businesses of each of your Tenants.

Where 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.

No matter what your Lease says, if your Tenant goes out of business, you will have a vacancy to deal with.

 


Researching your Tenant's Businesses has several steps ...

1) Start with researching on the Internet.

a) Place the entire business name in quotations (like this: "International Outfitters") and search on Google. See what shows up.

b) If the company is publicly traded, research their stock prices, analyst opinions and earnings projections. Call the corporate office and see what their plans are for this branch.

c) Do the same thing with the names of the owners and CEOs. Google them in quotes again … like this … “John Doe”

 
2) Ask each Tenant for current Financial Statements and analyze those carefully to get an idea of the business' recent and past financial performance.
 
You can't always get the financials form a private business owner ... and you can always ask. When you are looking at the numbers ... what trends do you see in the financials in the last 6 -9 months?
 
 
3) Call each business Owner/Manager and arrange a sit down, face-to-face interview.

One logical time to ask for this interview is when it's time to go over the Estoppel Letter and confirm its contents. While you're discussing the Estoppel Letter, you can question them about:

  • The strength of their business
  • Their outlook for future business
  • The challenges they see on the horizon
  • How you might help them improve their business when you take over as their landlord

Make note of any concerns you have about the business strength of any of your Tenants.

 
4) Sit down with your team and discuss ways you could help the business of your current Tenants and mitigate against the loss of any of your weaker Tenants.
 
The goals here are to help when you can and have contingency plans in case any of your weaker Tenants goes out of business.
 
Identify the businesses with the highest risk of failure and make sure you and your team know what you're going to do if they actually do cease to be one of your Tenants. AND make sure you create proformas with and without the income from your weaker Tenants.
 

You must perform these specific Tenant Due Diligence steps at the same time as you are completing the activities of Market, Financial and Physical Due Diligence for one simple reason …

You could be in the best property, in the most stable market with a glowing Proforma … and if your Tenant's business falls apart … you will potentially lose money. Take the steps we have outlined here and you will dramatically reduce this Tenant specific risk.

AND never be afraid to walk from a deal if the Seller is not willing to discount the property because of Tenants at high risk of business failure.
 
 


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