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 history of the property over recent time.
In this case, the definition of ‘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 then 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:
- A tenancy schedule should be sourced for the property and checked totally. What you are looking for here is an accurate summary of the current lease occupancy and rentals paid. It is interesting that tenancy schedules are notoriously incorrect and not up to date in many instances. This is a common industry problem stemming from the lack of diligence on 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 property sale needs to be carefully checked against the original documentation.
- Property documentation reflecting on all types of occupancy should be sourced. This documentation is typically leases, occupancy licenses, and side agreements with the tenants. You should expect that some of this documentation will not be registered on the property title. Solicitors are pretty familiar with chasing down all property documentation and will know the previous property owner’s right questions. When in doubt, do an extensive due diligence process with your solicitor before any settlement is completed.
- The rental guarantees and bonds of all lease documentation 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 property 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.
- Looking for outstanding charges over the property should be the next part of your analysis. These charges would typically stem from the local council and their rating processes. It could be that special orders have been raised on the property as a Special Levy for the precinct.
- Understanding the outgoings charges for the properties in the local area is critical to your property analysis. What you should do here is compare the outgoings averages for similar properties locally to the subject property in which you are involved. There needs to be parity or similarity between the particular 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 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.