A reminder to “sharpen your pencil” when analyzing commercial real estate acquisitions
Here is a fairly common scenario: a new client calls and wants us to draft a new contract to purchase a commercial property right away. Through their broker, the client has already found this property which perfectly fits into their purchasing criteria—right location, size, asset class and, more importantly, the right price for the returns they projected via the broker’s sell sheet and seller-provided information.
The well-prepared offering memorandum from the listing broker reflects a financial summary which meets the client’s goals: a six cap using the seller’s projected net operating income, an eight percent cash-on-cash return and 13 percent internal rate of return at year five, and a 1.2 debt coverage ratio, which should satisfy a lender should my client choose to debt on this new acquisition.
Upon further discussion with this new client, I recommended that we assist in preparing some additional in-depth financial analysis on this new target property beyond that provided by the seller and what was reflected in the offering memorandum. Not surprisingly, the listing sheet, while accurate in the operating data included, omitted some expense items which should have been very realistically expected by my client. For example, the seller had largely managed the property himself so the actual janitorial and management fees reflected in the listing were considerably understated.
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