Welcome to the official blog of Block Real Estate Services, LLC (BRES). BRES seeks to offer insight and news concerning commercial real estate, financial investments, construction and development of the 212 communities we serve locally and nationally.

Thursday, August 27, 2015

Valuation of Commercial Real Estate: Part 4

Valuation of Commercial Real Estate: Part 4Don't let your higher potential returns override your gut instinct.
If it doesn't feel right, walk away. The only way to factor in all of the intangibles that can't be qualified.
  • Who are you buying from?
  • What city are you buying in?
  • What market factors are at work?
  • General sentiment?
  • Touch/Feel of a project
Most analysis is done on a pre-tax basis. Individual taxes vary, some are tax exempt. However, the ability to shield income is one of the most important benefits of real estate. Other tax considerations are:
  • Writing off interest expense
  • Cost recovery (aka depreciation)
    • Commercial = 39 years, apartments = 27.5 years
    • Tenant improvements = useful life
    • Cost segregation can advance schedule
    • Shields only income, not capital gains
There are some risks to consider in real estate. Just remember, no investment is worth a sleepless night. Historically real estate seen as higher risk.
  • Return hurdles higher than equities/bonds
  • Recent thought that more transparency and available information decreased risk – not true
  • Still less transparent and less regulated than most
  • Recent “credit crisis” is partially due to inappropriate pricing of real estate risk
  • Never enough potential return to account for a bad deal
  • Financial Risk
    • Will NOI cover debt service?
    • Potential for capital calls even in good deals (i.e. TI’s)
  • Inflation Risk
    • Agreements lock in rates for many years – will they keep pace with inflation?
    • Some LL’s use CPI rate increases to hedge
    • Most have base stops for expenses or NNN structure
  • Political Risk
    • Changes in laws change inability to produce NOI
    • Zoning, building codes, environmental law, tax law
      • Examples: 1986 tax law changes, ADA compliance
  • Market Risk
    • Changes in economic and market conditions
    • Can be micro or macro
  • Projection Risk
    • Use numerous assumptions when creating DCF
    • Changes to assumptions has big impact on CF’s
    • Importance of conservative underwriting
    • Only thing you can be certain of is that you will not hit your projections exactly
  • Liquidity Risk
    • Real estate is a cash business.  Cash is always king.  Needed for tenant improvements, operations, debt service, capital repairs, etc.
    • Never assume something can be sold, even at a deep discount
    • Capital markets (both debt and equity) serve as “oil” of the real estate engine.  
  • Interest Rate Risk
    • Floating rate loans typical for construction and short-term notes
    • Can hedge with caps, floors, collars, swaps, etc.
While risks may be present, there are ways to manage that. Here are some risk management strategies:
  • Due Diligence
    • Know everything about a property you can before you buy
  • Diversification
    • Buy different product types in different markets
    • Key advantage of fund structure vs. one-off deals
  • Insurance
  • Credit Enhancements
    • Lease guarantees, loan guarantees, letters of credit, corporate backed lease
  • Shifting Risk to Tenants
    • CPI, base stop and/or NNN


Aaron Mesmer - Block Real Estate Services, LLC (BRES) 
Aaron Mesmer
Acquisition & Sales

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