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Important Lessons Blue Water Capital Has Learned About CRE Investments



Having spent most of my adult career analyzing and underwriting debt and equity investments in income-producing Commercial Real Estate (CRE), there are a number of important lessons that I have learned. Although I have financed all CRE property types, I will focus on apartment community investments in this Blog. 

Investing in apartment communities involves a multi-step process to analyze, inspect, finance, lease, manage and ultimately sell the assets. Starting with a Broker Package, the typical acquisition analysis steps include analyzing and understanding the local market where the Property is located, touring and inspecting the property unit-by-unit, verifying the historical and current operating numbers and the accuracy of the rent roll (especially vacancies), having third-party reports (property condition, environmental assessments, surveys, etc.), securing the appropriate capital stack to acquire the property, closing the transaction and then managing and leasing the Property.

 

  1. 1. Analyze the local market carefully. Above all else, CRE investments are local by their very nature unless a portfolio of assets is being acquired in which case this is even more important. Understanding multifamily inventory (existing, as well as those units in the planning process) is critical. While there may be an extremely low vacancy rate at the moment, what would happen if all of the projects in the various stages of the approval process were to come online? This has happened more than once over the past few decades.

  2. 2. Be careful about acquiring CRE assets, including apartment communities, at low Cap Rates. We are currently experiencing a low cap rate environment. I have learned it is far more important to buy a good property at a great value than a great property a good value. For value-add investors and lenders, buying an asset at below its intrinsic value has always been the “Holy Grail” of CRE investing. Acquiring a CRE asset above its value, or at a value based on artificially low cap rates, rarely ends up being a good deal in the long term. As an example, if interest rates increase (which has historically been the case), then so will cap rates, resulting in a reduction of asset value. A rise in a cap rate from 6% to 7.5% would results in a 20% decrease in value.

  3. 3. Poor Due Diligence. Nothing ensures failure in CRE investments more than poor Due Diligence, especially in a frothy market as we are experiencing now. Sellers are trying to shorten the closing process thereby shortening the Buyer’s time to complete a thorough due diligence process which could easily impact investment returns and cash flow. One negotiating tactic I have used in the past when acquiring CRE assets is to offer the Seller the results of my third-party inspections and reports if I were not to close. This can help mitigate a too-tight Due Diligence time frame.

  4. 4. The need to put idle cash to work. According to Preqin, as of the end of December 2018, global real estate investors and funds had $298 billion of “Dry Powder” available for real estate investments, primarily in North America. The pressure to put these assets to work at almost any return to drive AUM (Assets Under Management) fees of 1-2% is intense. 

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  6. 5. Excessive Leverage. History has a nasty habit of repeating itself. This is especially true when it comes to leverage. When I started in this industry back in the mid 1980’s, the Prime Rate reached a high of 20.5% during that decade. Yet the demand for permanent debt was still strong, especially for refinancing floating rate Prime Rate construction loans which led to creative deal structures like the CRE “bow tie” accrual loan and senior participating mortgages. 

  • In many cases the deal you Do NOT do is sometimes the best deal of all.

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