Commercial RE: When Do You Make An Offer?

Question

Okay guys, this feels like a super-newbie/bordering on embarrassing question at this point.  I have two multfamily buildings under my belt, but I'm now looking at my first commercial apartment building, which will be out of state b/c I just don't have the money to play big time real estate in NJ yet and can't deal with sub 7% cap rates as "good".  So I've found a couple that are of interest, but obviously I don't know basic info about each of them (I've walked them and have initial financial numbers).  I've been asking more questions about the properties, specifically about some discrepancies with the numbers, and the broker I've been using has been somewhat hinting at the fact that nitpicking every little detail is more in the due diligence phase than the initial intro phase.

Of course I understand he wants me to make an offer so he doesn't feel like he's wasting his time and there is some money on the horizon for his work thus far, but I'm kind of stuck as to how to proceed.  I can freely admit that I am a chronic sufferer of paralysis by analysis and can get bogged down into over thinking, ESPECIALLY when it comes to major investments I'm going through for the first time (my first duplex took months).  But on the other side, I don't want to get pushed into making an offer without what I consider somewhat requisite information about a property.

So my question is when do you or have you made an offer on your commercial sized buildings?  Is there a certain checklist or thing you need to have and then you are ready to make an offer or do you just see it, run numbers, like it and offer?  I'm at the point where I know I like this property enough but there could be some issues with building permits that aren't clear and some issues with (I don't know what the technical term is) possible tenant ... stuffing(?) ... meaning it looks like he may have given incentives like no deposit required to some tenants in order to raise the perceived value of the property.  So there are things that could kill the deal or make my offer significantly less if found out, but is that info delving too deep before showing that I am serious?  I assume my offer is subject to inspections and due diligence, so if I make an offer, should the inspection period be on the longer side?  I don't want to lose the momentum on this, but I also want to try and minimize the potential for tripping and falling right at the starting line if possible.

Hopefully this all makes some sense, and thank you in advance.

Kevin Yeats · Answer

@Lou Ruggieri, You make an offer when you determine that the dollar price that you list (along with other terms) make sense from your perspective. Once you make the offer the seller can either reject the offer, counter or accept with the comment "when can we close?"  Expect to begin negotiating from your offer.

As for tenant loading, you should request 3 years financial rent roll AND copies of signed leases as part of your package. The Realtor may provide some of this.  Check for spikes in tenancy, and significant deviations in regular expenses.

Kenneth and Andrew made good comments.

Kenneth Reimer · Answer

@Lou Ruggieri Lou, you seem apologetic. Don't feel bad about inexperience; instead, feel good that you're asking the right questions before killing the deal (or killing yourself trying to get it!). Also, there are some brokers/agents that are unethical. Some of the facets I'm going to discuss might come off as distrustful for mentioning, but they exist in the industry and you will be at a disadvantage if you are unaware of them.

When speaking of the standard procedure regarding making an offer, conducting physical inspections, and working on removing your financing contingency, there are a few aspects to keep in mind.

First, some investors choose the route of wrapping up a deal in contract after very preliminary analysis. If you have a rent roll and operating statement or trailing 12, you should be able to do some reasonable analysis to see if the property is something that would fit well in your portfolio. Keep in mind that your financial analysis is done to find what the price you're willing to pay, not whether or not the property makes sense at the listed price. Making offers is not a didactic scenario, you shouldn't treat it as such. The threat of the aforementioned strategy of wrapping up properties and getting out of contract if they don't look good is the distrust of the broker. If you are working with a buyer broker/agent, and you go under contract multiple times without closing on a deal, the probability that the broker assigns to you actually closing a deal and him/her getting paid starts to fall significantly. Since time is of the essence with new deals that hit the market, along with the fact that we know humans work off of incentives, the broker/agent would then be incentivized to show the best deals to his or her clients that have the highest probability of closing. While most brokers will never talk about this, it is only human nature when you think about it. I wouldn't say it's right or wrong, but simply human nature.

Regarding your point of doing too much analysis before you make an offer, I would say this. If you're dealing with an experienced seller and listing agent, they know the drill. They will know what to expect, and when to expect it. If they've done things to the property, or adjusted the operating statement to reflect unreasonably low expenses etc., they should assume that those could very well cause a retrade while the property is under contract. However, you should be underwriting the property's financials to the way the market dictates it should reasonably be run. As for the timing, the length of your physical inspection and financing inspection depends on the level of competition you're up against. If it is a pride of ownership asset that people will run each other over for, obviously the seller would be incentivized to take the most competitive offer that has the highest probability of closing. If there is less competition, then it would be reasonable to lengthen your inspection period. As an example, I've heard of cases where the seller has accepted an offer with a 5% reduction on the purchase price, in order for the 2.5% earnest money deposit to go hard (nonrefundable) on day 1 of the contract. If the buyer were to decide that he did not want to proceed with the acquisition, the seller would keep the deposit and start to market the property again! This example highlights the trade-offs between price and terms. As the saying goes, "my price and your terms, or, your price and my terms."

All in all, I think the best guidance you can have is knowing that you can't possibly know everything about the property before you write an offer. That being said, I would make sure you assign a reasonable amount of confidence to your ability to close on the property so as to not build a reputation of being a lookie lou.

Again, speaking of the incentives of brokers and investors is inherently uncomfortable. But, this same information will be beneficial.

I hope this all helps you Lou! Please reach out if you have any questions.

Kenny Reimer

Kevin Yeats · Answer

Lou, for every answer that doesn't make sense, your price should drop.

It sounds like the current owner bought this property 12 years ago, made some improvements and repairs, then collected rents since them, basically ignoring items that would require periodic inspection.

Lou Ruggieri · Answer

@Kenneth Reimer Kenny, thank you for your insight and thoughts.  I agree with most everything you said and you basically clarified my initial feelings, albeit in a much more clear and concise way.  Funny enough, the broker finally tracked down the answers to my initial questions.  I'll list them at the end of this post.

@Andrew Johnson Andrew, oddly enough, it seems that a few of these tenants did kind of just appear due to the "incentives" they were given to move in.  I will say I never thought of it as being a better strategy to underreport expenses rather than showing an increase in income, but that does make a ton of sense.

@Kevin Yeats That is exactly the point I am at right now, which is deciding what dollar price make sense from my angle.  And from what I can tell, I think my initial offer is going to be well below what they're asking b/c as I will show from the answers I got to my questions, not only has there basically been a tenant "spike" but they also have no idea how old their HW heater or furnace is.

So here are the answers to my initial questions, which took almost three weeks to get:

1)  There are five tenants that don’t have security deposits.  Why is that?  Was this an incentive given in order to raise the buildings occupancy quickly?Yes it was an incentive to move in.

2)  Why are some of the security deposits one month’s rent, while another is half a months rent and yet another is almost double one month’s rent?  Double deposit was help for high rick tenants, that had a CHA voucher but a low credit score. Only one tenant has ½ month deposit and was an incentive to move in.

3)  What repairs were made with the $7,500 listed under “Repairs” in the expense report?

Tuck-pointing, porch and roof repairs.

4)  In the expense report, there is a listing called, “Utilities - Other” for $1,137.36  What utilities did this go towards?

Are electrical and gas , were just misplaced.

5)  Is the insurance on this property part of a master plan that also insures other properties?  I’m looking to find out if this number would be accurate when insuring the property on its own.

No

6)  How long has this owner had this property?  Why is he/she selling?12 years. We are a construction company and we are too busy to run property management for this building.

7)  How old is the roof?

2005

8)  Have there been any more termite issues in the last 12 months?

No, never had this issue.

9)  How long ago was the bathroom shower grout touched up?  If at all.

2005

10)  How old is the current furnace?

Do not know.11)  How old is the current water heater?

Do not know

Commercial RE: When Do You Make An Offer?

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