When assessing commercial real estate, it is necessary to understand the financial factors that the property creates. This is before you price the property or consider it suitable for purchase. In doing this, it is not only the financial factors today that you need to look at but also those that have formulated the property’s history over recent times. In this case, ‘recent time’ is the last three or five years. It is surprising how property owners try to manipulate the building income and expenditure at the time of sale; they cannot, however, easily change the property history. This is where you can uncover many property secrets.
Once the history and current performance of the property are fully understood, you can relate to the accuracy of the current operating costs budget. All investment property should operate to a budget that is administered monthly and monitored quarterly. The quarterly monitoring process allows for adjustments to the budget when unusual items of income and expenditure are evident. There is no point continuing with the property budget, which is increasingly out of balance with the actual property performance. Fund managers in complex properties would normally undertake budget adjustments every quarter. The same principle can and should apply to private investors. So let’s now look at the main issues of financial analysis on which you can focus in your property evaluation:
You are looking for an accurate summary of the current lease occupancy and rentals paid. A tenancy schedule should be sourced for the property and checked totally. Interestingly, tenancy schedules are notoriously incorrect and not up to date in many instances. This common industry problem stems from the lack of diligence of the property owner or the property manager to maintain the tenancy schedule records. For this very reason, the accuracy of the tenancy schedule at the time of the property sale must be carefully checked against the original documentation.
Property documentation reflecting all types of occupancy should be sourced. This documentation is typically leases, occupancy licenses, and tenant-side agreements. You should expect some of this documentation not to be registered on the property title. Solicitors are familiar with chasing down all property documentation and will know the previous property owner’s right questions. When in doubt, do extensive due diligence with your solicitor before any settlement is completed.
All lease documentation’s rental guarantees and bonds should be sourced and documented. These matters protect the landlord at the time of default on the part of the tenant. They should pass through to the new property owner at the time of settlement. How this is achieved will be subject to the type of rental guarantee or bond, and it may even mean that the contract needs to be reissued at the time of sale and settlement to a new property owner. Solicitors for the new property owner(s) will typically check this and offer methods of solution at the time of sale. Importantly, rental guarantees and bonds must be legally collectible by the new property owner under the terms of any existing lease documentation.
Understanding the rental charged across the property is essential to property performance. It is common for various rentals to be set across the different leases in a single property with multiple tenants. This means that net and gross leases can be evident in the same property and have a different impact on the position of the outgoing landlord. The only way to fully appreciate and analyze the rental situation is to read all leases in detail. The next part of your analysis should look for outstanding charges over the property. These charges would typically stem from the local council and its rating processes. It could be that special orders have been raised on the property as a Special Levy for the precinct.
Understanding the outgoing charges for properties in the local area is critical to your property analysis. It would help to compare the outgoing averages for similar properties locally to the subject property you are involved in. There needs to be parity or similarity between the properties in the same category. If any property has significantly higher outgoings for any reason, then that reason has to be identified before any sale process or a property adjustment is considered. Property buyers do not want to purchase something that is a financial burden above the industry’s outgoings averages. The depreciation schedule for the property should be maintained annually so that its advantage can be integrated into any property sales strategy when the time comes. The depreciation available for the property allows the income to be reduced and hence less tax paid by the landlord. It is usual for the accountant for the property owner to compile the depreciation schedule annually at tax time.
