Top 5 Underwriting Mistakes in Commercial Property Transactions

Shopping Center Advisers | The Lagos Team | Top 5 Underwriting Mistakes in Commercial Property Transactions

We’ve all been there, staring at an offering memorandum or Excel Spreadsheet wondering why the numbers aren’t matching exactly. Or somehow a tenant’s actual base rent doesn’t quite match the Rent Roll. Many underwriting mistakes happen not intentionally, but rather through a variety of distribution channels. Understanding the economics of the real estate transaction is an essential part of the deal for all parties involved including, buyers, sellers, and agents and brokers. And when there are mistakes in the underwriting, it can affect pricing as well as the smoothness of the transaction. Even with a well-trained eye, mistakes do happen.
There are five common mistakes than can be alleviated to help your next transaction process with ease.

1. Valuation Timing Doesn’t Match Current Rents

As tenancies often have rental escalators the current rent maybe slightly higher or different than when the property was first placed on the market, or when the Rent Roll was prepared. Shopping Center Advisers (SCA) tip: ask for a current and updated Rent Roll to verify rents.

2. Property Taxes Aren’t Updated

There are many states that reassess the property taxes upon the sale of the property (such as California). However, the operating expenses can sometimes reflect the ownership’s current property tax amount, which can be lower especially if the property has not traded for many years. SCA tip: recalculate the property taxes as needed and verify the percentage rate.

3. Not Getting Leasing Updates

There are often moving parts with tenant leases, for instance, a tenant may be in the process of exercising an option (extending). Or, a vacant space may have an offer to lease. These timely updates can significantly impact the valuation of the property. SCA tip: inquire about any and all leasing updates.

4. Assuming ARGUS is Flawless

We would all like to think that technology is perfect; however, like most programs, the information exported is only as good as the information inputted. ARGUS is an intricate platform and one minor change can trigger a wrong calculation. For instance, having the rent show as $/Month (amount per month) instead of $/SF/Month (amount per square foot per month). SCA tip: check the ARGUS run against the Rent Roll.

5. Not Reviewing Specific Lease Clauses

One paragraph can change the entire economics of the deal. For instance, if a Big Box retailer has the right to terminate the lease early or is not responsible for paying their portion of the property taxes. SCA tip: ensure that the entire lease and any subsequent amendments are read in its entirety.

Paying close attention to these five underwriting mistakes will help you analyze the deal while minimizing some risk. With especially large transactions, it is helpful to have many eyes looking at the deal and determining appropriate procedures. As such, besides having an in-place analyst and acquisitions team, ask your real estate professional as well as third party vendors for a review. The more thorough the underwriting review process, the less likely to have avoidable errors.

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