Commercial real estate investing - due diligence
So, you’ve chosen which commercial real estate sector (office, industrial or retail) suits your investment strategy and now you’re about to undertake due diligence to identify the property – or properties – you’ll choose to pursue.
There are three factors you need to understand before diving into any type of investment: the macro economic environment, the local market and the asset itself.
Understand the macro economic environment
You should be wary of buying property in a market that has a high vacancy rates without any outlook for business and employment growth. Examining macro Australian economic data is a good start, as well as global and political policy. For instance, if major importing countries are placing tariffs on Australian exports, you should look to see whether your property – and its likely tenants – might be affected. If the unemployment rate is falling, then businesses should be growing, meaning they may potentially be looking for more space for their business.
Understand the local market
Once you have a clear idea of the performance of the macro economy, it’s time to get more micro. In most instances, the performance of an asset has more to do with the strength of the local and state economies rather than the national perspective. You need to be able to answer the following questions about the location in which you are considering investing in:
• What is the population growth and demographic makeup of the area?
• Is it a located in a growing residential or business market?
• Are there other similar types of properties in the market?
• Vacancy rates – is there tenant demand for such a property?
• Are rents moving up or down?
• What type (and how much) of new building construction is occurring in the area?
The answers to these questions will advise you on whether it is a wise decision to buy commercial property in this location. For example, an area that has a low population growth and low tenant demand for the type of property you’re interested will have an impact on your yield and future capital growth. On the other hand, a property located in an area experiencing high business growth and a growth in rental prices will be a stronger market in which to buy – albeit, more expensive.
Understand the asset
Of course, the most important due diligence should be carried out on the asset itself. Here are a few questions you should ask when investigating the property:
• What are the lease terms and conditions for the current tenant (if the property is tenanted)?
• What is the lease expiry profile of the asset?
• Is the current lease above or below the current market rental rates?
• Is there any capital expenditure or major maintenance needed?
The answers to these questions will give you an idea of the condition of the property, its current leasehold situation and whether a rental review can or should be carried out. If the property is in poor condition or the current lease is set to expire, you can use this information in your negotiation tactics or perhaps it is a sign you should steer clear of the property all together.