How I underwrite a commercial real estate deal

— When I’m looking at a new prospective deal, the first thing I ask is how much money can I make on that project?

Or I’ll ask it to a broker who’s presenting a new deal to me. Hey Sean, do you like this deal?

Well, how much money can I make?

So what I’ll look at first is the proforma value of the property.  That means at market rate, with it fully leased up, how much is the net operating income going to be, best case scenario. From there, I’m going to back out whatever costs we need to put into it to get it there.

A lot of times that’ll be filling a vacancy, fixing problems on a property, doing capital improvements like a new parking lot, a new sign, a new roof, HVAC, whatever it is we need to do to improve it to get it to the point where we can lease up that vacancy. Then we can also specifically calculate leasing commission.

If I’m leasing up 20,000 vacant feet, I know what I’m gonna pay my leasing brokers to fill up that space. Then I’ll ask them, what’s the market rate for the tenant improvement allowance on a space like this, in an area like this? And they’ll usually say five bucks a foot or 10 bucks a foot or something to that effect. We can get pretty specific with what our proforma value is, how much improvements need to go into it, including tenant improvements and leasing commission and then I’m gonna say, well, what can I buy it for, or what’s the whisper price?

You’re telling me your broker or your seller wants a seven cap, on, in place.

Okay, I can see what that number is. And then is there some spread?

Is there some margin or some room between those two and is it enough where actually compelling to write up an offer?

I like to see that 50% upside. So if you’re telling me, hey, you know, it’s pretty tight or thin margins here or this is more of just a straight cap rate deal, I’m probably not gonna get terribly excited.

If we’re looking at a deal where we can buy it for almost half of what it might be worth in the future, that’s pretty interesting. I know it’s gonna take a lot of work and heavy lifting to get it there but that’s generally the first thing I’m gonna look at and then all the basics and fundamentals. So does it have the car count that we’re looking for? Does it have the visibility?

Does it have the access coming in and out of the building? Is it a place where a national, name brand, credit tenant retailer would want to open another location? Or if it’s a mom and pop, would they want to choose this location over all the other locations around it?

I want to make sure that I’ve got the most compelling value in the immediate area, where I can deliver a nice box, in a good condition at a competitive rental rate with good signage, with good visibility. If we have all those things, high probability that I’m gonna be able to lease up that space and then make that property achieve that proforma value.

It’s never guaranteed but if I have all those things, we’ve been able to do that consistently in the past because I’m looking at all those things when we’re buying, when we’re writing the offer, I know going into the deal that there’s a pretty clear path to achieving those results.

So that’s what I’m looking for. You know, again, first question that comes in, how much money can I make on this deal?

Why should I buy this over all the other deals that are out there? And is there a clean, clear path to being able to accomplish that proforma value on the building? Hope that helps. So let me know if you’ve got any questions on that. And if you have any deals that you think meet that criteria, would love to take a look.