Don’t Make a Costly Mistake: When to Walk Away from a Commercial Real Estate Investment Opportunity

by | Mar 1, 2023 | Investing Advice

When considering investing in a real estate syndication, it’s important to know which deals are worth pursuing and which ones to avoid. This can involve being aware of potential warning signals and understanding the key metrics that underwriters use to assess the viability of a deal. In this blog post, we’ll provide an overview of the commercial real estate industry and offer insights into potential investment opportunities. Our team conducts extensive research on each investment opportunity and provides in-depth analysis of those that make it through our screening process. We’ll take you behind the scenes and provide a glimpse of our due diligence process. By the end of this post, you’ll have a better understanding of what it takes to make informed investment decisions in the world of commercial real estate.


Why Underwriting is Such a Valuable Component

Think of underwriters as the superheroes who safeguard you against bad investments by filtering out deals that don’t align with your goals. Our mission is to meticulously evaluate every detail, leverage our experience, and secure opportunities to acquire great assets for our investors. One crucial point to highlight is that we physically visit potential investment properties to conduct a thorough assessment.


The Negative Aspects of a Competitive Real Estate Market

It can be tempting to jump on a seemingly perfect investment opportunity with a great location, population growth, high incomes, good schools, and promising returns. Unfortunately, the competition for such commercial properties can become cutthroat, driving down cap rates and making the deal no longer viable. Additionally, investments always carry some level of risk, including rising expenses, inflation, interest rates, and unforeseen challenges like plumbing problems. But fear not! We’ve got you covered with some insider tips on how to carefully evaluate these variables and avoid wasting time and money on commercial real estate that doesn’t meet your needs.


How to Recognize When It’s Time to Pass on a Property: The Details

Investing in commercial real estate involves multiple goals: earning money, minimizing taxes, and having a hands-off investment that is also protected from losses. To avoid losing money on a bad deal, it’s essential to choose the right investment option from the start. Regardless of the property type, you’ll want a deal that offers the returns and financial security you need within your desired time frame and with minimal risk. We typically seek out value-add transactions that offer at least an 18% IRR over about 5 years. While some syndications have shorter business plans, such as three years, these deals often come with high upfront costs and risks similar to fix-and-flip properties. While they offer significant potential returns, they require extensive remodeling and are high-risk investments. If you prefer to lower your risk and maintain long-term cash flow, consider investing in a property that already generates monthly or quarterly profits, such as a new construction Class A or B+ apartment complex in excellent condition that requires no repairs.


Red Flags for Real Estate Investors:

  1. Property management appears unaware or unsure about issues.
  2. Debris, defective paneling or roofing, or unkempt landscaping.
  3. Properties that have been on the market for a long time or priced well below their value.


How Seasoned Commercial Real Estate Investors Look At A Potential Investment Deal

To determine whether to invest, look at the T12 financials and make necessary tax rate adjustments, then analyze the going-in-place cap rate. Expect the cap rate to adjust slightly after year 3 when taxes are assessed. Anticipate changes to expenses and how they will impact cash flow. Calculate month-one income based on the cap rate and compare rents and unit mixes to similar assets in the region to determine potential value. Seek comparable renovated units to estimate commercial property lease rates.


I. The Underwriter’s Sample Numbers

  • Renovations cost $17,000 per unit and result in an extra $337 in monthly income.
  • The return on investment is 22.5%, which justifies the renovations.


II. Examining the Various Financing Choices

  • Bridge debt lender is an excellent choice due to current cash flow limitations.
  • Consider the going-in cap rate, potential rent increase, and property’s existing cash flow when choosing financing.


III. The Advantages of Using Bridge Debt

  • Floating rates, non-recourse money, and higher leverage opportunity are advantages of a bridge loan.


IV. The Downside of Taking Out a Bridge Loan

  • Higher fees, up-front and back-end costs, and higher interest rates are disadvantages of a bridge loan.


V. Exploring Profits at the Sale

  • After renovations, the property may sell for more in approximately 5 years.
  • Check with brokers to determine limited partner investors’ 12% IRR after factoring in property sale, purchase price, renovation expenses, and increased rent.


All Considered, Are the Returns Worth It?

On this occasion, we have decided to decline the investment opportunity. The potential profits do not meet our investors’ expectations, and there are other commercial real estate investments that offer higher returns with lower risks. As the market, economy, and other factors are constantly changing, there are no set standards for what constitutes an “excellent” return. To evaluate a commercial property’s investment potential, risk-adjusted returns should be considered based on the property’s class, location, and business plan. Higher returns often come with higher risks, so it is important to compare the two when making investment decisions.


When Preferred Structure Deals Are in Your Favor as a Commercial Real Estate Investor

Preferred structure deals offer a preferred return for limited partner investors before the sponsor team profits, aligning their interests. Due diligence is crucial to avoid potential losses due to external factors, making preferred structure deals advantageous for commercial real estate investors.

When Is It Time To Say No To A Commercial Real Estate Investment?

Now you know the basics of commercial real estate investing, allowing for a simple yes or no decision to proceed. The same analysis applies to all property types. Village Capital Partners completes extensive due diligence, including sensitivity analysis and number-crunching, to win contracts and seal deals. Join our Investor Club to learn more and achieve your investment objectives!