Mental underwriting

You’re a real estateur with a desire to gown your portfolio. You know deal flow is key but now it’s LoopNet and MLS and Broker Blasts non-stop. How do you regain your inbox but not miss out on a new deal?

As you can imagine, I look at a lot of commercial real estate deals so it’s important for me to quickly screen properties to determine what is worth pursing for clients. Here is a rough framework I use to analyze the properties I see come on the market from other brokers. For perspective, for every 100 properties I see, I do this mental underwriting on maybe 10. Only 5 make it all the way through.

Each section below will one day be a full write up – this is just a quick glance. If I complete this entire process, I’ve invested about 2-3 minutes into mental underwriting. For comparison, if I am going to present the opportunity to a preferred buyer client, I will have invested about 30 minutes into that comprehensive process.

Hand in the Dirt

The absolute first thing I look at is the property on a map. The location is the ONLY thing you can’t change about a property, so you better be comfortable with it. I look to see if I’m familiar with the exact location and if I have a pre-conceived opinion. Is this a retail property on a hard corner surrounded by middle class housing? Is this an under built property in the path of progress? Am I being pitched a shack an hour outside town? Understanding the location is the first test in continuing to analyze the deal.

There are a few main questions I’m looking to answer:

1)    Is this a growing trade area?

2)    Have I been working in this neighborhood or sub-market?

3)    Are there factors about this location that make this interesting or unique?

4)    Does this fit into a specific client’s profile?

5)    Is the location going to drive the demand, or will the improvements?

Sticks and Bricks

Do you remember the Three Little Pigs? A house each of clay, sticks and bricks. The second step in our quick underwriting is the property condition. Am I looking at a 1980s apartment building that appears to have been renovated two cycles ago (I wish! Send me these if you have them!!), a brand-new multi-tenant retail center or an old warehouse on a busy street? Understanding the improvements tell me where my brain needs to focus. If the building is newer and stabilized, I have one route. If it’s boarded up or falling apart, I can take another route.

What’s the play?

I hope you’re tracking along at home. Quite simply, after understanding the location and the building, what do I think the business plan for this exact property should be? If it’s a vacant warehouse I may have the idea to sign a long-term credit tenant and then sell it as a stabilized asset for a profit. If it’s an irreplaceable retail center I may have the idea of creating some exterior modifications to help drive customers to my center and then increase rent potential. What levers can I pull to make this a viable business venture?

I stress this all the time with clients: I can’t underwrite a deal unless I know what we think we can accomplish. I can tell you how it looks today, but I can’t give a medium- or long-term picture without some type of vision.

Counting Beans

By the time I’ve opened my calculator, I usually have a good idea of if the deal is viable or not. In this section, I want to know one thing:

Does the deal Pencil?

Does this quick underwriting give me a reason to dig further into the property?

In my calculator, I will do a quick calculation of the AS-IS metrics and some rough numbers on what I think it could get to in subsequent years. If I’m looking at an apartment building in SW Atlanta and know I can get $1.20/ft in rent and the units are 900 square feet, I’ll do the quick math, get an estimated gross revenue, take out 40% for expenses and arrive at my NOI. From there I’ll see how that looks as a going in cap rate. If it’s ball park, I’ll keep going.

Do I have a competitive advantage?

I was representing an owner who had 5 properties in one neighborhood in Atlanta. He wasn’t the biggest player but he was known and the neighborhood was changing by the week. A group from outside Atlanta put 3 properties up for sale at once for way lower than market. Because of our competitive advantage (knowing that particular sub-market better than almost anyone!), we were able to pay over asking price to beat out competition and get all 3 properties for less than what we would have been willing to pay.  

Do I or my client have an information advantage that we can use?

What am I missing?

I like to just think for a second if there is something I’m missing. Are these two single family homes that fell into commercial zoning and have huge potential? Would the property benefit from an easily obtainable re-zoning? Is there a better use for this property? Would purchasing this property enhance the value of a neighboring property?

I hope this gives you a quick mental checklist to use when analyzing on market and off market property listings.