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December 7th, 2017

Commercial Deals: A Few Distinctions

By Mark Hulsey

For all of us working in the real estate industry, it’s a common question about the difference between commercial and residential. And it’s a great question that can really benefit a residential agent to understand. Some agents may think that all real estate transactions are created equal, but that’s not true once you cross the line into commercial deals.

Commercial real estate is complicated. So is residential. However, the distinctions between the two brokerage disciplines are many including valuation, marketing, financing, due diligence, title, and the people involved. Here’s just a few examples in key areas.

Valuation

Property valuation methodology is one fundamental difference between commercial and residential real estate. Valuing a single-family home is primarily based on market analysis or a CMA. While commercial also relies on market comps (usually measured on a PSF basis), income analysis is the cornerstone of valuation for most commercial buildings. Even on an owner-occupied commercial property, it’s important to know not only how much that “product” is currently trading for PSF, but also market income expectations. With income understood, expenses are quantifled to arrive at net operating income (NOI). Other key financial measures including cap rate, cash-on-cash returns, or discounted cash flow or debt service models can also be studied. Finally, the market versus income analysis is reconciled to establish a disposition value opinion. As you can imagine, this level of commercial asset valuation work is no small task if you’re doing it right.

Marketing

In this seller’s market, it seems like a residential agent doesn’t need to do much more than win the listing, get pictures, throw it on the MLS, and watch the offers roll in. Of course, that’s an over simplification, but the MLS does seem to do a lot of the heavy lifting in residential real estate marketing. When marketing commercial assets, not only is the marketing brochure (or offering memorandum, OM) more comprehensive and time consuming to build than a home flyer, but commercial real estate requires its own set of proprietary web-based, marketing and advertising platforms. This often comes with hefty fees to not only gain access to data, but to“feature” your listings so they you don’t get lost in the clutter. Even property signage can be a very expensive challenge in marketing commercial properties. Bottom line, marketing commercial assets requires very tight listing management systems and the people to run them.

Due Diligence

It’s interesting to hear more people lately use the term due diligence in their everyday conversations. In all real estate sales, a thorough understanding of the due diligence process is essential. In most home sales, there are often a few hurdles that must be overcome as part of the due diligence process including the home inspection, testing for radon or lead, or financing and appraisal approval. In commercial brokerage, common due diligence items include detailed review leases and P&L statements, ALTA survey, physical inspections, Phase I or II environmental reports, geotechnical studies, as-built floor plans, zoning use verification or conditional use permit (CUP), financing approval, estoppel certificates … and the list seems to go on and on. Due diligence on commercial deals can be a complicated and demands attention to detail.

The People

Commercial brokers and residential agents alike must deal with their respective reputations and stereotypes in the marketplace. It’s sometimes said that commercial brokers are not the most inviting people to do business with. Sometimes described as an “old-boy’s network” that does not want to let anybody in. While that’s certainly an exaggeration, there’s some truth in there too. But that’s largely based on one’s experience with commercial transactions. Many commercial brokers in larger markets do not believe in residential agents selling their product. Many would say that they would never consider selling a house because they know nothing about home sales even though they’re a real estate professional, so why do some agents that sell homes believe they should broker commercial assets? Why should they be paid a commission when they don’t know what they’re doing? There’s the rub. But one that can be silenced with education and experience (and a little humility can go a long way too).

Other notable differences between the residential home sales and commercial real estate include how we must disclose information, touring of properties, qualifying buyers and tenants, interacting with attorneys for nearly all transactions, very long sales cycles, negotiation of fees, and state statute considerations.

All real estate sales professionals require a lifetime of learning to stay at the top of our game. We’re fortunate to work in an industry with unlimited earning potential while still helping people along the way with some of their most important life and business decisions regarding where they live and work.


Mark Hulsey is managing broker of RE/MAX Results – Commercial Group, a full-service commercial and investment brokerage. Mark can be reached anytime at mark@resultscommercial.com.

December 1st, 2017

Due Diligence: Do or Die 

Due diligence is the comprehensive investigation and examination of a property or asset prior to acquisition. The due diligence period is one of the contingency periods outlined in the Letter of Intent (LOI) or Purchase Sales Agreement (PSA). Proper due diligence on a commercial deal is critically fundamental and if not done properly, can cost the buyer much more than the property itself.

 

Commercial real estate due diligence is extensive and complicated. Requirements vary between product classes (land vs office) and due diligence requirements are often defined by the lender, as well as the buyer. Common CRE due diligence includes full physical property & systems inspections, certified or ALTA survey, verification of zoning uses, environmental (Phase I or II) and geotechnical reports, title restrictions, wetland delineation, permit & licensing approvals, tenancy issues, and much more. Missing just one component of due diligence can be extraordinarily risky for a buyer unless they fully understand the potential future liabilities.

 

On the other hand, there are times when discounted cash-only AS-IS, WHERE-IS deals, auctions, or bank-owned (OREO) assets have purchase parameters that do not make traditional due diligence easy or even possible. This is when each critical due diligence item must be considered in a worst-case scenario and then, quantify the risks & potential costs as best as possible prior to making the offer. These types of deals naturally come with high risk and should not be entered into by buyers or brokers without fully understanding the ramifications. 

 

When it comes to managing the due diligence process for CRE deals, it takes an experienced broker and counsel to navigate the waters. Due diligence is one of those areas where “you don’t know, what you don’t know.” And, that’s like playing with fire.

A Seller’s Market!

It’s a well-known industry axiom: “Commercial follows Residential.” And, with commercial real estate (CRE) inventory at one of the lowest levels we’ve seen in years, this principle holds true again today. Anyone who has searched the CRE databases over the past few months will quickly find it’s tough to identify good quality product in our market right now. While the multifamily market has been dealing with a public inventory drought over the pastsix year
s, the same now holds true for office, retail, industrial, and urban land properties.
 On top of low inventory and continued historically low interest rates, the Twin Cities has an abundant CRE buyer pool, both local and national, competing for properties. It can be a challenge for the professional investor or 1031 tax exchange client, but the owner-user searching for a new place to locate their business can really feel the pain. There is a tremendous amount of capital chasing deals today and the ‘cheap’ CRE inventory (under $500k – $1M), is nearly non-existent in our core metro areas. Cap rates remain compressed on quality NNN assets, if you can find them. This CRE environment creates an even bigger “insider” marketplace where more deals are trading off-market and if you’re not in-the-know, you’ve got nowhere to go.