When looking at a commercial property of any type, you need to spend time on the property’s financial aspects before you form an opinion about the price you think you can achieve. The financial aspects of the property can have a major impact on the price and purchasers’ interest. The financial aspects of a building or a property can impact the asset for many years and, for this reason, must be analyzed and identified.
We have detailed some of the major aspects of financial concern in a property purchase or sale scenario. Whilst these are not the only categories of activity and concern, they are the major ones in most circumstances.
We recommend that you create a checklist for these items so that your property review and inspection process is suitably enhanced and professional.
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The Asset Schedules: The property will contain many fixed and moveable assets. These will normally be detailed on the asset register. A well maintained commercial property will have an up to date asset register for your review. Obtaining the asset register at the early stage of sale consideration is productive as it will tell you in detail what you are selling and later become part of the due diligence process.
Bank and Personal Guarantees: An investment property comprises leases and other documents that support tenant occupancy. A normal leasing process would involve and create some form of guarantee to be provided by the tenant to the landlord for the lease duration. This guarantee must have both strength and substance to reimburse the landlord in situations where the tenant defaults under the lease terms. At the time of property sale, these guarantee documents should have some form of an ability to be transferred or re-issued to the incoming purchaser. This process is called an assignment of the guarantees. You should consult with the landlord’s solicitor to identify the types of guarantees involved and the ease at which this can be achieved at the time of sale.
Capital Expenditure: Major items of plant and equipment replaced in a commercial property are usually regarded as capital expenditure and are separately itemized for taxation and depreciation over a period of time. Taxation laws in your location will stipulate the depreciation terms as they apply to different capital expenditure types. For example, a computer purchased for the building control system will depreciate far quicker than the air handling unit purchased for the air conditioning plant. Well maintained property records will include a detailed capital expenditure register and the date at which the capital item was purchased. Purchasers of the property will be interested in the depreciation that this register provides the cash flow in coming years.
Taxation and GST: Every country and property location has its own unique taxation laws and requirements relating to property and particularly investment property. It is important to understand that these matters have been correctly handled and are up to date in the sale process. It is sometimes necessary to view the property’s net returns for the last few years that were applied to the taxation statements and lodgement process. You can also seek written confirmation from the property owner that all taxation matters are up to date.
Income and Rent Analysis: The income for the property reflects the leases and occupancy licenses therein. It is essential to understand that the leases or licenses have collected the rent and that all rental matters are up to date. Part of this process will also involve checking the rent review profile and the expiry profile of all leases. A property with volatile leases or leases that are soon to expire is likely to impact the price or the buyer’s interest. When reviewing tenant occupancy against leases, you should review the original documents and cross-reference this to the landlord’s tenancy schedule and any discussions or information.
Independent Valuation: Many property owners will obtain a valuation regularly in support of their property financing package. It is not unusual for such valuations to occur annually. Importantly they are done by a qualified and registered valuer. If you view this documentation and consider the pricing process for the property, it is wise to consider the true independence of the valuation when it was done and its relevance to the current market. Some valuations for financing purposes may not be in parity with the existing market conditions. It pays to sometimes seek a truly independent valuation at the time of sale or in preparation for sale.
Land tax issues: Property land tax directly impacts the investment aspects of commercial real estate. In different locations, the recovery and payment of land tax are impacted uniquely by local legislation. In some circumstances, the land tax can or cannot be recovered from the property tenants. This will have an immediate impact on the bottom line and net return from the property, impacting the price. Consulting with the financial adviser for the property owner or the taxation office will achieve clarity in this taxation impact. Given that most agents and brokers are not taxation experts, you should involve other professional taxation people appropriately.
Lease disputes: Rarely is there a property that does not have an existing lease dispute or has been impacted by a previous lease dispute. For this reason, it pays to question the matters of lease dispute and resolution. If in doubt, seek a copy of the correspondence and any subsequent agreement between the appropriate parties. Unresolved lease disputes can jeopardize or slow the process of a property sale.
Mortgaged interests: Most commercial real estate properties will have a mortgage of some type to a financier. When a mortgage exists, it is necessary to understand how it will be handled or discharged in the sale process. The client should consult with the mortgagee to clarify these matters for you. In a situation of distressed properties, the property’s sale may need to realize a particular price before a clear title can be achieved.
Operational expenditure: The running of a commercial property will involve the operational expenditure attributed to running costs. Most of the properties of particular types in the same location will have similar operational expenditure. If the property has excessive operational expenditure above the averages in the area, then the property is likely to be difficult to sell. Most purchasers of properties understand the averages of property expenditure deemed to be realistic for each property. This also says that real estate agents and brokers should be well aware of the expenditure averages and analysis process that should apply in this situation. Operational expenditure is analyzed based on $’s per m2 or $’s per ft2 (depending on your location, monetary base, and country)
Statutory charges: These are commonly referred to as rates and taxes. These will involve water rates, land tax, council rates, and any other form of charge raised by the statutory bodies. Importantly the charges so raised must be analyzed for parity to similar properties in the same region. Part of the rating process involves a statutory valuation of the land on which the building and property are located. While some property owners like to think that their valuation is high and justifiable (and therefore gives substance to the sale price of the property), this valuation is the foundation for the charging and payment of statutory charges. The astute property investor will always question this statutory valuation undertaken by rating bodies in an endeavor to restrict or lessen the number of statutory rates and charges paid each year.
Rent reviews: A significant concern in the sale of a property is future rent reviews’ size and stability. The rent reviews underpin the cash flow and, hence, the attractiveness of the property to purchasers. It is essential that the real estate broker or agent read all of the leases before any assessment of price or method of sale is given. It is quite possible that the rent reviews projected and detailed in the leases can either hinder or attract purchasers to the property.
Rent arrears: Existing rent arrears should be identified with the owner of a property. Any matters of associated legal pursuit should also be identified. The property may have had a history of rent arrears and instability. Look for these matters and question the cash flow stability. A history of financial performance from the property over the last few years is the best way to achieve this.
Current building budget: This will involve a budget of income and expenditure as it applies to the building currently in the existing financial year. A good building budget will be written and supported by sound property strategy, projections, and controls. At the time of any potential property sale, it is important to understand that the current financial performance aligns with the expected building budget. If there are any shortcomings or overflows, it is necessary to clarify the reasons for such. If you do not do this, the purchaser of the property will.
The side agreements or deeds: Property occupancy and usage can involve supplementary side agreements and deeds. This can be with tenants or neighboring properties. Documents of this nature will impact the sale even though they may not be registered on the title of the property you are to sell. Aspects of the common law will usually support documents of this nature. If any such arrangements exist, you must seek further detail and clarity about how they will be handled at the time of sale. One of the common events here is the existence of rental incentives provided to tenants at the lease’s commencement. When these situations exist, the most common resolve method is the discharging of the landlord’s arrangement before settlement. This can become a term of the contract.
Sinking funds: It is not uncommon for sinking funds to exist on larger properties. The fund is essentially established to set aside money to cover the cost of major repairs and maintenance items. This would not normally include items of a capital nature. For example, sinking funds may be used to cover the cost of painting the exterior of a large building such as a shopping center every five years. If a sinking fund exists, it is important to understand how it will be handled at the sale time. Consultation with the client’s solicitor and accountant is essential to the process.
Taxation depreciation schedules: The property will have a taxation depreciation schedule. When correctly maintained, these schedules have the ability to lessen the net property income in forthcoming years. This is an immediate tax benefit to the property’s purchaser, who will assume the depreciation schedule as part of the sale and settlement. As the broker or agent in the sale, you should check the existence of such documentation and identify what benefits it brings to the sale process. A well constructed and detailed depreciation schedule will make the property sale more attractive.
Short term leases: Many properties have short term leases or casual occupancy active at any point in time. It is vital to know the mechanism under which this occupancy occurs and how it will be terminated. You do not want a short-term occupancy to jeopardize the stability and processes of the sale.
Un-documented lease occupancy: Some may call this a casual lease; however, a casual lease can create concern and uncertainty in the sale process. Some tenants may claim a long-term occupancy from a previous casual lease arrangement with the landlord. Claims of this type must naturally satisfy the law’s requirements to be sustained or upheld by the courts; however, you should be cautious in such circumstances, given that it can slow down or even jeopardize the sale process.
Warranties and guarantees: When properties are constructed, the normal process of warranties and performance guarantees apply from the construction process. At the time of sale, you need to know if any such matters apply or exist. Copy of the documentation is essential. Further to this, in an existing building where recent fit-out activity has created newly constructed premises, it is likely that warranties and guarantees exist for the tenancy construction. These will transfer to the new owner of the property in most circumstances; however, the documentation to allow this to occur must be suitably constructed. This is a matter for the solicitor acting for the client.
Utilities costs and supply: Every commercial property will be supported by the supply of water, gas, electricity, and communication systems. The process of supply needs to be understood together with the cost of the process. Obtaining copies of recent accounts for those services will help you here. Some utilities may be supplied direct to the tenants, and some others will be supplied directly to the building owner. Any differences in supply should be identified and documented. The costs of supply should be compared to the averages of other properties in the area.