As our group continues to provide data to corporate real estate authorities, we are finding a greater number of these decision-makers seeking potential properties to purchase in an effort to consolidate their operations, absorb vacant space in financially distressed buildings, and lease the remaining space to like-minded businesses, in essence strengthening their internal network without leaving the building or paying for employees.  Given a slowdown, one that now looks to continue for Houston business for the next few years, corporate relocation brokers are finding their clients stepping off of the sidelines and looking for solutions that will help them pare employees, as well as high-price rental space, in an effort to ‘get lean’.

So, to prepare for those looking at purchasing their own building for use and taking in some rental income to offset costs, we have provided some helpful insight into financial aspects of a commercial property. As most sophisticated business owners and investors (excluding non-traded REITS) know, forming an opinion about a price without comprehension of its parts is a multi-million dollar losing proposition. The financial aspects of the property will most likey have a significant impact on the purchase price, especially given a climate with very few bidders.

We have detailed 10 (of 20) of the major aspects for financial concern in a commercial property purchase or sale scenario. While these are not the only items that should be scrutinized, they are the most important in the majority of circumstances. We will update the second half next week.

If you are not using our services, we recommend that you create a checklist using these items for your next property review.

1. The Asset Schedules: The property will contain many fixed, as well as moveable assets. These will normally be detailed on the asset register. A well maintained commercial property will have an up-to-date asset register for your review. Obtaining the asset register as early as possible is very productive as it will tell you, in detail, what you are being sold.  Also, it will become part of the negotiation process.
2. Bank and Personal Guarantees: An investment property comprises of leases and other documents which support tenant occupancy. A normal leasing process would involve and create some form of guarantee to be provided by the tenant to the landlord for the duration of the lease. It is important that this guarantee has both strength and substance to reimburse the landlord in situations where the tenant defaults under the terms of the lease. At the time of property sale, these guarantee documents should have the ability to be transferred or re-issued to the incoming purchaser. This process is called an assignment of the guarantees. You should consult with the landlord’s management to identify the types of guarantees involved, as well as the ease to which it is provided.
3. Capital Expenditures: Major items, such as the building’s air conditioning system, which are replaced in a commercial property are usually regarded as capital expenditures and are separately itemized for the purposes of taxation and depreciation over a period of time. Taxation laws will stipulate the depreciation terms as they apply to different types of capital expenditure. For example, a computer that is purchased for the building control system will depreciate far quicker than the air handling unit which was purchased for the air conditioning system. Well maintained property records will include a detailed capital expenditure register and the date at which the capital item was purchased. Purchasers to the property will be interested in the depreciation that this register provides against the cash flow in coming years.
4. Taxation: Every property has its own unique tax issues relating to property, particularly in an investment property. In the purchase process, it is important that these matters have been handled property and are up-to-date. Sometimes, it is necessary to view the returns for the property over the last few years.  You can also seek written confirmation from the owner of the property that all taxation matters are current.
5. Income and Rent Analysis: The income for the property is a reflection of the leases and occupancy within. It is essential to understand that the rent has been collected in accordance with the leases and that all rental matters are up to date. Part of this process will also involve checking the rent review profile and the expirations of all leases. A property with weak leases that are soon set to expire will impact the price or purchaser’s interest. When reviewing tenant occupancy, you should review the original documents and cross reference this to the tenancy schedule as well as information provided by the landlord.
6. Independent Valuation: Many property owners will obtain a valuation regularly in support of their property financing package. It is not unusual for such valuations to occur annually. It is important they are done by a qualified and registered commercial appraiser. If you utilize an appraiser during the pricing process for the property, the landlord should consider the true independence of the valuation, when it was performed and its relevance to the current market. Some valuations for financing purposes may not be in line with the existing market conditions. It pays to sometimes seek a true independent valuation at the time of sale or in preparation for sale.
7. Lease disputes: Rarely is there a property that does not have an existing lease dispute or has been impacted by a previous lease dispute. For this reason it pays to question the matters of lease dispute and resolution. If in doubt, seek a copy of correspondence and any subsequent agreement between the appropriate parties. Unresolved lease disputes can jeopardize, or at the very least, slow the process of property sale.
8. Mortgaged interests: Most commercial real estate properties will have a mortgage with a lender. When a mortgage exists, it is necessary to understand how it will be handled or removed in the process of sale. The broker should consult with the mortgagee to clarify these matters for you. In a situation of distressed properties, the sale of the property may need to realize a particular price before clear title can be achieved.
9. Operational expenditures: The management of a commercial property will involve the operational expenditures attributed to its working costs. Most of properties of particular types in the same location will have similar operational expenditures.  If a property has excessive operational expenditures, above average for the area, then the property will likely to be difficult to sell due to its high maintenance. Most brokers understand the averages of property expenditures realistic for each property type and location.
10. Rent reviews: A significant concern in the sale of a property is the size and stability of future rent reviews. It is the rent reviews which examine the cash flow and attractiveness of the property to purchasers. It is essential that the landlord’s real estate broker read all of the leases, before any assessment of price or method of sale is given. It is quite possible that the rent reviews projected for leases will either negate or attract interest in the property.

See second half next week!