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How to Capture Millions of Dollars in Value on your Next CRE Acquisition

Otso Team
March 12, 2024
5 minute read

Underwriting and Assessing Commercial Property Values at Scale…and Why it Matters!

Updated February 2024

As a commercial real estate buyer, the decision to underwrite commercial real estate acquisitions is a critical one that can have a significant impact on your organization’s bottom line. Underwriting is a comprehensive analysis of the potential risks and rewards associated with a real estate investment opportunity. By conducting thorough underwriting, buyers can identify the benefits of investing in a particular property and make more informed investment decisions.

The standard due diligence of a commercial real estate acquisition focuses on title, inspection, environmental and financials of the asset. Title, physical inspections and environmental assessments are critical but relatively straight-forward. There are many available resources and vendors to buyers for assessment of these factors as it relates to a purchase.

Financial assessment is much tricker. While offering memorandums provide a snapshot of a property’s current (and potentially historical) income profile they are often layered with pro-forma assumptions that can obfuscate (as opposed to enlighten) the true financial history and projected income of an asset.

Ideally, buyers should be looking at historical financials of the asset with a focus on the consistency of tenant payments over time. Ultimately as buyers, we should be most concerned with the veracity of the underlying income stream of which the asset represents. Unfortunately, historical financials are often unavailable. Even so, how can a buyer most effectively project out future rent collection?

Ideally, a buyer will get access to an updated package of tenant financials on every existing lessee. This is the best way to underwrite, assess and score (test) the ability of the tenants to support the income stream for the property. How important is this? We would argue it’s the most important factor in a property’s valuation.

If a property has a NOI of $1,000,000 and a proposed cap rate of 7%, that results in a purchase price of just over $14.285M. Now, what if we analyzed the tenancy and found out that several of the tenants are in poor financial condition? Isn’t that income stream now at risk? If the NOI drops by something small, say 5%, the impact on the value becomes massive on a capitalized basis. For example, an NOI of $950,000 at that same 7% cap rate means the property is now valued at $13.571M…, almost $1M less. That is a game-changing difference in value.

So why are property acquisition teams not underwriting the tenants of these assets at scale? Well, from our feedback sessions we hear a similar theme:

“It’s difficult, we don’t know how to collect the financials from the Tenants.”

“We asked, but the Seller and Property Managers have not been collecting financials consistently.”

“We don’t know of any resources to help us run the analysis, even if we did get the financials.”

This scales, from small buyers to institutions. In our experience, we’ve seen our clients put properties under contract at exaggerated pricing only to find out they are over-paying, by millions. This isn’t a small change; we’re talking about literally saving millions of dollars of investor money. How do lenders feel about this? The exact same.

One of the primary benefits of underwriting commercial real estate acquisitions is that it helps to minimize risk. Underwriting involves a detailed examination of a property’s financial history, including its operating expenses, rental income, and projected cash flow. This information is used to create financial models that estimate the property’s potential returns. By conducting this analysis, institutional buyers can identify potential risks and take steps to mitigate them.

Underwriting also allows institutional buyers to negotiate favorable terms for their investments. Armed with the knowledge gained from underwriting, institutional buyers can engage in informed negotiations with sellers and lenders, securing better terms and conditions that improve the overall value of the investment.

Additionally, underwriting can help institutional buyers to make informed decisions about the best financing options for their investments. By understanding the potential risks and rewards associated with a particular property, institutional buyers can select the best financing structure, such as a fixed-rate mortgage or a variable-rate loan.

These resources did not previously exist…but with Otso now they do. We are helping purchasers collect, decision and assess property values at scale…based on actual tenant financial data. If you’re not assessing the veracity of an asset’s income stream you are highly likely to be overpaying or at minimum be under-informed. Risk=Rate as my favorite appraisers say…so let’s understand the risk!

Ultimately, the benefits of underwriting commercial real estate acquisitions for institutional buyers cannot be overstated. By conducting a comprehensive analysis of a property’s financial history, institutional buyers can identify potential risks, negotiate favorable terms, identify value-add opportunities, and make informed decisions about financing. These benefits help to maximize returns while minimizing risk, ensuring that institutional buyers can make the most of their real estate investments.

Otso is the leader in commercial tenant assessment and alternative lease security solutions, contact us today to see why we’re quickly becoming the standard for commercial real estate across the industry.

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