Real Estate Adds Stable, Long Term Growth to Your Investment Portfolio

Source: Realty Biz News Written by Brad Walker

Modern communication networks have effectively shrunk the size of the planet. Information can now travel in seconds rather than the hours, days or even weeks it took data to cross the globe just a couple of generations ago.

This rapid flow of information means that a “bargain” never lasts for long in today’s financial markets. Once a promising investment opportunity has been identified, the money flows that direction until the asset price reaches (or often exceeds) perceived value equilibrium.

When you throw in ultra-low interest rates and sluggish macroeconomic conditions in the US and Europe holding bond yields down and central bank stimuli overheating global equity indices, investors cannot find many low-risk, reasonable-return investments today.

Astute investors understand that the beginning of an interest rate cycle is not the time to be investing in bonds and that that the risk-reward ratio is simply not attractive with stocks at historic highs on the strength of smoke-and-mirrors political promises.

Fortunately, the alternative investment class has grown notably over the last decade or two to include private equity, futures, commodities/precious metals and real estate. Recent surveys also suggest that real estate is the fastest growing category of alternative investment, with sovereign investment funds worldwide projecting an almost 10% increase in real estate investments in their alternatives portfolio over the next five years (from 38% to over 41% of total alternatives portfolio).

Overview of 2017 US Housing Market by Region

Although millions of Millennials have been living with their parents for the last few years, many financial analysts say this trend is winding down. They argue that Millennials and even older Gen-Xers are just now reaching prime home buying ages, and that many of these now not-so-young adults will be moving into their own places over the next few years.

The analysts argue this bodes well for the US housing market, especially as the ongoing economic recovery is also producing more jobs and driving up wages.

Most well-known housing market analysts expect housing prices nationwide to be up by at least 3% in 2017. January clocked in with a 3.3% annual rate increase in existing home prices, so we are on pace to meet that projection. That said, growth will vary dramatically by region and by city, with many second-tier cities leading the way as growth slows down in major markets like San Francisco, LA and Boston.

With notable exceptions like NYC, housing price growth in the Eastern US and the Midwest is expected to lag growth in the other areas of the country listed below.

Southeast

The Southeastern US has been experiencing solid growth in home values for almost a decade. According to Zillow, Orlando, Florida is one of the hottest cities in the country, and will see home prices increase by an average of 5.7% in 2017. Knoxville and Nashville, Tennessee appear on Zillow’s top ten list with a projected home price growth of 4.4% and 4.3%, respectively.

Southwest

Utah is a housing hot spot in the Southwest part of the country. Zillow anticipates home prices in both Salt Lake City and Provo will move up by 4.3% in 2017. Denver is also seeing strong demand for housing, with home prices expected to climb by 3.2% this year.

West

Seattle continues to be an economic powerhouse and a magnet for new residents. Zillow is projecting that home prices in Seattle increase by 5.6% in 2017. Portland is just 170 miles south of Seattle, and Zillow is projecting housing prices move up by 5.2% in 2017 in this dynamic city. Sacramento, the capital of the Golden State, is also experiencing a real estate boom these days, with home prices expected to appreciate by 4.8% this year.

Medium to Long-term Investments Make Sense for Most Baby Boomers

Baby Boomers have different investment needs than earlier generations of retirees.

Up until the Great Recession, demographers and economists projected that most Baby Boomers would retire and move south much like the preceding generation. However, the stock market crash of 2008 decimated the retirement plans of many Baby Boomers as well as savaged their home values.

The net result is that a lot more Baby Boomers are working longer than they or the demographers expected to try and make ends meet. Related to this, an increasing number of boomers are staying in their family homes to remain near their jobs, children and grandkids.

Moreover, those Baby Boomers who are retiring are increasingly opting to stay in their homes rather than downsize. Part of the reason for this is their children (Millennials) have had a hard time finding decent jobs and moving out. Some surveys have suggested that 20% to 33% of the adult children of Baby Boomers are still living at home and one in three is still getting some kind of financial support.

These surveys also suggest that even when their children have moved out, BB parents want to have a big place for their kids and grandkids to come visit. For a large number of BBs, that means deciding to stay in the family home.

Whether you want to call it postponing retirement or reinventing it, it is clear that BBs have a different idea of how to spend their “golden years” than their parents and grandparents did. Given that pensions are disappearing, Social Security payments only cover a fraction of the cost of a middle-class lifestyle in a major city, and interest rates are so low, BBs have to think out of the box to support their “retirement”.

As mentioned above, many older Americans are choosing to stay in the workforce longer, but that’s not possible for everyone, and age does place limitations on the ability to work. Improvements in medical care also mean BBs can expect to live longer, so most can afford to take a longer-term perspective on their investments.

When you put all the pieces of the retirement puzzle together for BBs, a thoughtfully selected portfolio of real estate investments emerges as an ideal solution. No investment is risk free, but BBs who seek steady long-term income and appreciation have many low-risk real estate investment vehicles to choose from today.

Due Diligence for Commercial Real Estate

Source: creonline.com Written By: Ray Alcorn

Commercial real estate properties are a completely different animal from residential properties in regards to assessing value. That may seem like stating the obvious, but it is easy to overlook the many details that come into play.

For commercial real estate, value is determined in an inverse proportion to the degree of risk inherent to the continuance and stability of the income stream from the property. And of all the commercial property types, perhaps none is more complex in evaluation than a multi-tenant property, either office or retail.

The function of due diligence is to verify, verify, verify.

The exception to that general statement is a true triple-net property. Much of the terminology used for years by commercial real estate professionals has been abused to the point of making what should be easily understood a mish-mash of doublespeak.

Since understanding exactly what kind of property is being considered is of utmost importance in selecting the course of action, it is worth a short digression to clarify this particular term “triple-net.”

A note on triple-net properties

Rarely will you find a true triple-net, multi-tenant property. A true triple-net leased property means the tenant is responsible for all expenses of operating the property, including property taxes; property casualty, and liability insurance; all maintenance including: structural components, mechanical systems, plumbing and drainage systems, glass, and the roof.

Ownership of the property is vested fee simple, inclusive of the entire “bundle of rights” inherent to real estate. In short, the only responsibility of the owner is to designate where the rent check goes. In the case of a multi-tenant property, about the only way to make that happen is to have a master lease for the whole building, and the master lessee then sublets to the individual tenants.

Obviously, an owner focused on maximizing returns and enhancing value is not going to be very keen on the idea of leaving the fate of a property representing a sizeable investment in the hands of a tenant for sub-lease, except in the most unique of situations. Hence, a multi-tenant deal represented as a triple-net investment bears a hard, hard look.

Chances are the property is the subject of a poor definition rather than a triple-net lease. While due diligence for a true triple-net property is somewhat simpler due to the reduced exposure for risk and expense, I’ll focus on the more commonly found properties that are either owner managed or managed by a third party under close contract with an owner.

Due diligence starts in negotiations

Due diligence actually starts in the contract negotiation. Unless the seller understands what you are going to be asking for before the deal is signed, there is going to be automatic trouble in getting to the closing table. I can almost promise you that when the average seller sees my list of required due diligence items, he is going to be overwhelmed.

In fact, I had one seller get so mad that he walked out on the deal right there. Now granted that was an exception, and that fellow did eventually come back to the table. The point is that many of the items I’m absolutely going to insist on examining are of a personal nature, and no seller is going to be comfortable with just turning me loose with his box of documents.

Sometimes I think just having the list is as intimidating as the information that is revealed, and a seller’s reaction can be very revealing as to his general character. Including the list of required due diligence items is a must in the purchase agreement, and you can expect that there will be some negotiation as to what will and won’t make it to the final draft.

When negotiating the contract, be sure to provide ample time (at least 30 days AFTER delivery of all documents) to complete due diligence. Our agreements state that we must give written notice that all due diligence is complete and satisfactory IN OUR SOLE DISCRETION, or we have no further obligation and are entitled to the return of the earnest money deposit.

We generally will not proceed with due diligence until after the contract is executed by all parties. We also keep any time triggers tied to the delivery date of the LAST document, with provisions for the extension of time based on the appearance of any non-disclosed material defects.

By requiring our written acceptance of the due diligence items, we retain control of the deal. We also have a small bit of leverage on the seller as the drop-dead date nears. If I’m really questioning the parameters of the deal, I will often wait until the last hour of the last day before accepting the due diligence, and then only after gaining some concession.

Be careful though, I have also had this blow up in my face when a seller decides they have had enough of my games. There is a fair amount of psychological guesswork, as well as having a feel for personalities involved in deciding just how hard to push a seller.

Leave no stone unturned

As far as how to proceed with due diligence, I have some advice I have paid dearly for over the years. Beyond the physical condition of the building, there are multitudes of intangibles that have to be taken into account when evaluating a commercial property for acquisition. Literally EVERY document concerning the building and its operation MUST be examined.

This includes leases with any and all extensions and modifications, notes and mortgages, whether you are assuming them or not, title policy, certificate of occupancy, insurance policies, ADA compliance, elevator maintenance contracts, tax tickets and history, licenses (in some jurisdictions), parking lot contracts, etc.

Using the list generated in the Purchase Agreement, I go over each item and assign the task for it to some member of the acquisition team, whether it’s the lawyer, surveyor, building inspector, environmental firm or whomever. I make sure they are each contacted, given the timetable for the deal and then follow-up on a very regular basis.

Except for financing, more deals are blown in this stage than any other. It only takes one missing document to completely stall a closing. Each day a closing is stalled, the chances increase for some other element of a deal to come unraveled. Do not skimp on these details. If you’re not going to do them yourself, then make a nuisance of yourself making sure your delegate gets the job done.

Study those leases!

Of the due diligence documents listed for office/retail properties, the most important are the leases, insurance policy, and title policy. The leases are supremely important. I have seen some of the strangest stuff couched in obscure language: First options on purchase, the right to take over adjacent space, tenant ownership of plumbing fixtures (really!), agreements for new carpet every year. You name it, it could be in there.

Very few properties of any considerable age have just one boilerplate lease… over time every owner gets in the position of having to sign a tenant at any cost, and the language of the lease will reflect concessions that one tenant holds out for.

On the flip side, I have found forgotten sources of income, such as a tenant that agreed to pay for the first $250 of HVAC repairs that might go back to the original owner, but was overlooked by subsequent managers.

Read every word of every lease. Make notes of things you don’t understand or need to clarify. Then have someone else read every word of every lease, and take notes. Then compare notes. Then go after the answers. This is so important to me that I don’t dare delegate it to anybody.

I have to understand every element of every lease, or I am buying a stream of income “in the blind.” I want to be able to ask such obscure, penetrating questions of the owner about each one of his tenants that he tells me stuff he didn’t mean to tell me, but figures he better because I’m hot on the trail to find out.

There is also the possibility that my questions will bring back a memory of a tenant fact or a quirk in some system that I wouldn’t otherwise have known. So I ask the questions, and ask, and ask, and ask. This is the only chance I will have to elicit information from the owner with him having an attitude of wanting me to be satisfied.

After we close, he may or may not return a call when I have a problem, but before he gets my money, he’s going to be pretty interested in getting me the information I’m asking for, or a damn good reason why I can’t get it. When I sit down with the owner (or manager) to go over the leases, I also ask for the payment history on each tenant.

If there is a problem tenant, I want to know about it up front. If the problem is chronic, I will discount the cash flow accordingly, which translates to a lower price when value is determined by the NOI.

Similarly, if the owner or manager says they don’t have detailed payment records or bank statements verifying deposits, I have an opportunity to explain why the property just became more risky for me, and how that risk translates into a lower price. Often, the records somehow become available.

A goldmine of information

The insurance policy can be a gold mine of information, especially in the case of a building with some age. Insurance inspectors have seen every trick in the book, and if you can get a copy of the last risk assessment you can be miles ahead of the game. The insured (generally the owner) has to request this, but insist on getting a copy.

Also get a claims history for the property. In many cases you will have to rely on the owner’s memory if he has switched insurance companies frequently. That fact alone isn’t a red flag. Many owners shop insurance regularly because the industry is so competitive and volatile. Some people don’t.

But at the very least, require an affidavit from the owner that says he attests to the truth of the claims represented as being complete to the extent of his knowledge. Courts are littered with suits against “successors in interest” as a way to get an insurance company to settle for the cost of litigation, and very few seller will stand still today for a clause in the contract that states warranties survive closing.

An existing title policy will give you the obvious information regarding easements, rights of way, etc. Be on the lookout for any special exceptions to title. Get a General Warranty deed if you can get it. A savvy seller will offer a Special Warranty deed which will only guarantee title for the period s/he owned the property.

In my home state of Virginia, we go after a General Warranty deed with English Covenants of Title. That goes back to the original land grants from the King of England, and is not often used outside the original 13 states. Other useful information found in title policy can be as seemingly innocuous as who the attorney happened to be that prepared it. It pays to know when a relative is involved!

Physical due diligence items can be handled in a number of ways, and the methods will vary depending on the organization and resources of the buyer, the nature of the property, and the type of financing used. I will not go into inspection as there are experts in the field that would be routinely engaged to satisfy the various engineering and environmental requirements in today’s world.

There is no substitute for thorough due diligence, but it can be a two edged sword. I’ve never seen a property without some hidden defects, though I have often not found them until after we own it.

Some investors are so professional in their due diligence that they routinely make full asking price offers, knowing that they are going to beat the seller down with the due diligence info. There are even professional due diligence firms that are paid partly by a percentage of the savings realized by the buyer.

I’ve been on both sides of this equation, and my experience is that as a seller I can protect myself by knowing what a buyer needs to know before he knows it, and disclosing it up front. That essentially takes the bullets out of the gun. As a buyer, I consider it unethical, as well as a waste of time, to sign a contract with any terms other than what I intend and agree to perform if the property is in fact in the condition represented by the seller.

Quality of the tenants

Commercial properties are particularly vulnerable to sudden economic downturns. A building with a 100% occupancy rate can become 50% overnight with the bankruptcy of a large tenant because that tenant’s business may be dependent on market factors in China, or Russia, or Serbia.

To assess the risk of the likelihood of the continuance of the income stream from a commercial property, you have to gauge the underlying quality of both the tenant base as well as the physical asset, and that’s what due diligence is all about.

Examination of rent rolls, payment histories, and credit files of existing tenants can be very enlightening in quantifying the risk quotient of a particular tenant. But much information can be collected just in the normal course of conversation regarding a tenant’s business. Ask open-ended questions, and seek out any resource available to aid in your decision making.

You’ll rarely have all the answers…

The end result of a thorough due diligence process is that when the time comes to present your deal to either partners, investors, lenders, or another buyer, you will have the level of information and knowledge surrounding the property that very clearly states that you are a professional at what you do.

No one expects anyone to have all the answers. In fact, for many years I was continually frustrated by the repeated experience of going over and over my research into some property, and feel I was completely ready to present it to my father, who founded our development and investment company.

He would listen to my presentation, and invariably somewhere in my monologue he would ask at least one question I did not know the answer to. That used to infuriate me–not make me mad at my father, but with myself for not having anticipated the need for the information.

The experience stayed with me. I have learned that even now, with over twenty years of experience in this business, I rarely, if ever, ask every question that needs asking. I also rarely have all of the answers. So I keep people around me that can look at deals with fresh eyes long after mine are bleary and red, and together we manage to find answers to almost all of the right questions.

And the ones I miss? Well, they get put on the updated due diligence checklist!

Preliminary due diligence checklist:

  • Financial records: Annual profit and loss statements (P&Ls) past 3 years minimum (5 years preferred)
  • At least one year monthly P&Ls (preferably two years)
  • Balance sheet (3 years)
  • Rent Roll including term, deposit, and payment history
  • Tax returns- 3 years
  • Insurance: Insurance Policy; including all riders, risk assessments, and disclosure affidavit for carrier
  • All Existing Loan Documents: including notes, deeds of trust, closing statements, title policy, rate riders, etc., and contact names and numbers.
  • Deed
  • All Leases: entire copies plus any addendum or riders.
  • Any service or advertising contracts: (Trash, extermination, maintenance, management, commission agreements, union agreements, vending, billboard, pay telephone, etc. and any instrument or contract to be assumed by Purchaser)
  • Copies of all recent appraisals, engineering reports, environmental reports
  • Survey (as-built), legal description, architectural and engineering plans and specifications
  • Payroll register: List of employees including name, position, wage rate, and entitled benefits
  • Business license
  • Physical inventory of furniture, fixtures, and equipment, and supplies.
  • Utility bills: Water, Sewer, Gas, Electric (at least two years of monthly statements) (or recap report from provider showing usage and cost)
  • Bank statements showing deposits for last twelve months (optional)
  • Phone system documents (y2k compliance letters)
  • Computer systems (y2k compliance letters)
  • Fire System inspection reports and y2k compliance
  • Property Tax tickets for the past three years (real estate and personal)
  • Litigation History: details of any past or pending litigation (if none, then affidavit from owner)

Comprehensive due diligence: pre-closing

  • Engineering Inspection and Survey
  • Environmental Inspection and Survey: Key Issues: Asbestos, Lead Paint, underground tanks, wetlands
  • Environmental Phase One: An Environmental Phase One (1) Assessment is an inquiry conducted to determine the environmental status of a property or facility in connection with a real estate property transaction. It follows standards which includes those published by ASTM.
  • Environmental Phase Two: Assessments/Subsurface Investigations: These projects include but are not limited to subsurface drilling and sampling, monitoring well installation and sampling, ground penetrating radar, and asbestos and lead sampling.
  • LUST survey- leaking underground storage tanks
  • Financial Audit
  • Title Search and policy
  • Property tax verification
  • Tenant Estoppel Letters
  • Mortgagee Estoppel letters
  • Legal Verifications: licenses, permits, zoning