When you're working a deal to buy a Shopping Center, it's easy to get carried away and overlook really strong indicators that perhaps this isn't the right deal. In that case, it's important to know that a deal is negotiable even while you're working through the due diligence phase of the purchase. As new information comes up, whether it's the quality of the leases, condition of the building, or other outside conditions, it's crucial to know when it's time to move forward, renegotiate, or simply walk away and look for another deal.
Rent Roll
It's easy to assume that every Rent Roll is created equally but is it? Not every property owner is as equally well versed in commercial accounting and disclosure practices so there could be hidden figures that will grossly throw off your numbers. For example, in Florida, commercial properties must charge a sales tax on rent collected. If you're not careful, you could easily overlook this fact and end up overpaying. Always ask if the figures includes sales tax. This happened with one of my deals and we had to walk away. The rent roll included sales tax but it wasn't shown on a separate line item and in essence overstating the overall rent being collected by 6%. At the price point we were negotiating, this 6% made the difference.
Leases
Ideally, you're looking for long term tenants with structured step leases that will account for a more planned and secure growth strategy. If an owner provides multiple month to month leases, it just makes for a more challenging approach to managing the property and keeping it profitable. A month to month scenario is not necessarily a deal breaker since it could work in your favor. Poorly managed properties could exhibit below market rents for a number of reasons, i.e. insufficient capital to improve property, lack of market knowledge, or poor tenant screening. For the right price, it's not necessarily a reason to walk away.
Condition
I have literally inspected properties that are in such poor condition, that there are trees growing out of the windows. Here is a real picture of such a property. Unfortunately, the landlord was unwilling to budge after we did our due diligence and the deal fell through, but it was a smart move to walk away. As long as the owner is willing to negotiate or the repair costs keep you within a rate of return you're happy with, it's worth continuing to work the deal. If not, walk away.
Development Potential
This is another part of the lease structure that could play a vital role in the properties future value. It's always good to have leases which stipulate the landlord's ability to cancel the lease if the landlord decides to remodel and or re-develop the property. This comes in handy when trying to resell for development purposes and the buyer doesn't have to deal with "buying out" the tenants. 90 day clauses are typical in smaller C or B class shopping centers. If it's your intention to sell the property or flip it for it's development potential, this is crucial. If it's not on the lease, you may just want to walk away.
Time
With every deal, time is of the essence. Typically, you should be able to get all leases, plans, boundary survey, or other documents that are needed to complete the first phase of qualifying a property within 3 business days of contract signing. At times, you're going to find owners that take a very long time to provide any documentation or are simply missing information that would make your evaluation that much easier to complete. Depending on the property, this may or may not be a deal breaker. This does, however, show signs of a poorly managed property and potential for further negotiations once the documents are provided. This is not necessarily a reason to walk away but one that merits closer scrutiny since the seller may be hiding something that could affect you negatively further along in the purchase process.
Septic or Sewer
A property that is on a Septic system simply can't compare to one that is directly connected to the sewer system. You will most likely be severely limited on the types of uses you could have at any given time and even if you can change uses. Septic tanks that are undersized for a given property can be penalized by not being allowed to change use. This gives you, the buyer, a much stronger negotiating platform since you can always use this to show that the property simply isn't in the same ranking as other properties that are connected to the sewer. This alone shouldn't be reason to walk away unless there is a serious deficiency with the property. An example would bet that the property can't change use and the nearest sewer line is a mile away. If this seems improbable, this is actually a real life example that I've run across so I highly encourage extra care in this area.
Tenant Improvements
It's important to inspect and consider the tenant improvements for any building to gauge the quality of tenant and future growth potential. When you see tenants that have spent a considerable amount of time and effort to make their space look presentable and appealing to customers it's a strong indicator of quality tenants. This also helps greatly in valuating the property when reselling. If you see poorly improved spaces, just keep in mind that the purchase price has to match the condition of the property. So, if the condition is a lot poorer than expected, it may be time to renegotiate and not walk away.
In summary, any deal is negotiable through the due diligence period. It's a matter of how willing each party is to budge on the agreed upon figure. Of course, it's always best to reach a number from the beginning that you're happy with and accounts for all of your findings through the inspection process. The point is that there are going to be surprises, but you should position yourself and the deal so there are still options. Most importantly though, is sticking to your bottom line. You have to be honest with yourself and or your investors. If the property doesn't match your expectations, either renegotiate or walk away. There is always another property around the corner.
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www.allrealtymanagement.com
Rent Roll
It's easy to assume that every Rent Roll is created equally but is it? Not every property owner is as equally well versed in commercial accounting and disclosure practices so there could be hidden figures that will grossly throw off your numbers. For example, in Florida, commercial properties must charge a sales tax on rent collected. If you're not careful, you could easily overlook this fact and end up overpaying. Always ask if the figures includes sales tax. This happened with one of my deals and we had to walk away. The rent roll included sales tax but it wasn't shown on a separate line item and in essence overstating the overall rent being collected by 6%. At the price point we were negotiating, this 6% made the difference.
Leases
Ideally, you're looking for long term tenants with structured step leases that will account for a more planned and secure growth strategy. If an owner provides multiple month to month leases, it just makes for a more challenging approach to managing the property and keeping it profitable. A month to month scenario is not necessarily a deal breaker since it could work in your favor. Poorly managed properties could exhibit below market rents for a number of reasons, i.e. insufficient capital to improve property, lack of market knowledge, or poor tenant screening. For the right price, it's not necessarily a reason to walk away.
Condition
I have literally inspected properties that are in such poor condition, that there are trees growing out of the windows. Here is a real picture of such a property. Unfortunately, the landlord was unwilling to budge after we did our due diligence and the deal fell through, but it was a smart move to walk away. As long as the owner is willing to negotiate or the repair costs keep you within a rate of return you're happy with, it's worth continuing to work the deal. If not, walk away.
Development Potential
This is another part of the lease structure that could play a vital role in the properties future value. It's always good to have leases which stipulate the landlord's ability to cancel the lease if the landlord decides to remodel and or re-develop the property. This comes in handy when trying to resell for development purposes and the buyer doesn't have to deal with "buying out" the tenants. 90 day clauses are typical in smaller C or B class shopping centers. If it's your intention to sell the property or flip it for it's development potential, this is crucial. If it's not on the lease, you may just want to walk away.
Time
With every deal, time is of the essence. Typically, you should be able to get all leases, plans, boundary survey, or other documents that are needed to complete the first phase of qualifying a property within 3 business days of contract signing. At times, you're going to find owners that take a very long time to provide any documentation or are simply missing information that would make your evaluation that much easier to complete. Depending on the property, this may or may not be a deal breaker. This does, however, show signs of a poorly managed property and potential for further negotiations once the documents are provided. This is not necessarily a reason to walk away but one that merits closer scrutiny since the seller may be hiding something that could affect you negatively further along in the purchase process.
Septic or Sewer
A property that is on a Septic system simply can't compare to one that is directly connected to the sewer system. You will most likely be severely limited on the types of uses you could have at any given time and even if you can change uses. Septic tanks that are undersized for a given property can be penalized by not being allowed to change use. This gives you, the buyer, a much stronger negotiating platform since you can always use this to show that the property simply isn't in the same ranking as other properties that are connected to the sewer. This alone shouldn't be reason to walk away unless there is a serious deficiency with the property. An example would bet that the property can't change use and the nearest sewer line is a mile away. If this seems improbable, this is actually a real life example that I've run across so I highly encourage extra care in this area.
Tenant Improvements
It's important to inspect and consider the tenant improvements for any building to gauge the quality of tenant and future growth potential. When you see tenants that have spent a considerable amount of time and effort to make their space look presentable and appealing to customers it's a strong indicator of quality tenants. This also helps greatly in valuating the property when reselling. If you see poorly improved spaces, just keep in mind that the purchase price has to match the condition of the property. So, if the condition is a lot poorer than expected, it may be time to renegotiate and not walk away.
In summary, any deal is negotiable through the due diligence period. It's a matter of how willing each party is to budge on the agreed upon figure. Of course, it's always best to reach a number from the beginning that you're happy with and accounts for all of your findings through the inspection process. The point is that there are going to be surprises, but you should position yourself and the deal so there are still options. Most importantly though, is sticking to your bottom line. You have to be honest with yourself and or your investors. If the property doesn't match your expectations, either renegotiate or walk away. There is always another property around the corner.
Remember to Register on the link above to make sure you don't miss any updates.
www.allrealtymanagement.com
written by: Victor A. Abreu