3 Non-Metric Questions All Passive Investors Should Ask Before Investing In A Deal
Before funding a deal we always look beyond the metrics. There are 3 important questions we always need the answers to before pursuing an opportunity.
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Why is current ownership selling the property?
This one seems obvious, but when combined with question number 2, it becomes extremely powerful in vetting deals.
Some common reasons you’ll hear to current ownership selling could be the current group has hit their projections and is exiting, they’re offloading properties in the area or of the asset class, or looking to use that equity in another opportunity.
Some additional distressed signals could be balloon payments are coming due, or a split in the partnership that could be forcing a liquidation.
Overall distress signals tend to lead to better deals, but that’s not always a requirement.
What’s most important about question number 1 is how we use it to verify question number 2…
What are the obstacles to hitting proformas?
It’s common that brokers, and possibly inexperienced operators, can paint a very smooth picture to proforma.
While it’s common for investors to leave ‘meat on the bone’ for the next investor, generally the easiest value add strategies would be consumed by current ownership if it’s a sophisticated group currently running the property.
If the reason for sale is not a distressed reason, we may be more skeptical that the road to proforma is as easy as some may make it out to be.
Burning off loss to lease is a common answer to hitting proforma, but how quickly can it realistically happen? If the delta between current rates and market rate is high, can we realistically push tenants in year 1 to renew at significantly higher rates or will it take a few years to gradually push their rate closer to market without absorbing very high vacancy rates?
If renovations are required, has current ownership renovated any units or is it an unproven model? If select units have been renovated, we like to see a noticeable trend in renovated units leasing at proforma rates. If we see rates continuously increasing then decreasing, it could be a sign that the higher rates didn’t provide enough consistent traffic to the listing to be sustainable, so it would be tough to take the highest rate and assume we can duplicate that rate through the entire property.
Again, if it was that easy, why hasn’t current ownership leased at the highest rate every time?
Once we have a clear picture of the obstacles, make sure the business plan addresses the obstacles in a timely manner, accounting for higher vacancies if the timeline is more aggressive.
Is the property currently professionally or personally managed?
If a property is personally managed, we’ve generally seen more opportunities for increasing operational efficiency and reducing expenses. If the property is professionally managed, we want to know how can our team execute better than the current management team.
It’s possible current management wasn’t the best fit for the area, property size, or tenant base.
We want to know what the next management team can do differently than the current management team to push top line income, and decrease expenses that current management has not been doing.
There are many more questions that you may want to ask, but when it comes to analyzing a deal beyond the financials, these 3 questions will help give you a great glimpse into how viable the property and it’s future business plan will be. By understanding why current ownership is selling, you’ll be able to help validate what the true obstacles to the business plan are; then, by knowing what operational efficiencies are left on the table as opportunities for future management, you’ll be able to be more comfortable with how expenses can be adjusted in the future.