In this article, we will be discussing the seven major reasons why good commercial real estate deals can go bad.
Let’s face it, there is always distress, but where and how much usually scales in density during poor economic times. But distress always exists for other reasons.
Understanding what causes distress allows investors to better understand risk. And it also allows us to discover exceptional opportunities.
Here are the seven main reasons good commercial real estate deals go bad.
Weak Operator/Borrower:
One of the main causes of a real estate deal going bad is the operator. The operator is responsible for sourcing, financing, and managing the day-to-day operations, including any key events that are essential to successfully executing the business plan.
Time:
Since time is the ultimate factor in the investment world, it is the ultimate reason why good real estate deals go bad. If a project gets ‘dragged along’ (for whatever reason) then it can lead to diminished returns.
Underestimated Costs:
Underestimated costs are another major cause of real estate deals going bad. Whether poor due diligence or lack of knowledge, having the right people and a conservative underwriting process is key to controlling this risk.
Key Events:
Key events are the events that need to happen in order to execute the business plan successfully. Depending on the type of deal, this may include events such as; entitlement, construction, rehab, lease-up, tenant renewal, etc. Understanding what events need to occur in order for the business plan to succeed will help you determine the risks associated with those events failing.
Property Overleveraged:
Depending on the project type, certain key events that are executed may result in a portion of the debt being paid off. In the case that those events fail, the property can become overleveraged.
Market Conditions Change:
Changing marketing conditions such as; softening demand, or tightening credit markets can greatly affect commercial real estate deals.
Interest Rates Rise:
When interest rates rise, the market tends to tense up. Floating rate loans are affected. Refinance loans are affected. And cap rates are affected.
Conclusion:
Good real estate deals can go bad. And when they do, there is usually a story to go along with it (which is very important). A good friend of mine calls this the “Country Music Story” because it usually ends with some sort of heartbreak.
Understanding why good real estate deals can go bad is crucial to understanding the risk.
Below are the nine major fundamentals that should be reviewed, verified, and personally aligned with in order to control the risk.
- Operator
- Market
- Asset
- Basis
- Business Plan
- Debt
- Equity
- Capital Sources and Uses
- Waterfall
Click here, to download the 9-Point Due Diligence Checklist for Passively Investing in Commercial Real Estate Syndications. The Checklist uncovers the nine essentials above that should be aligned with in order to control the risk.
