When it comes to asset management, every property falls somewhere on the buy-hold-sell continuum. During each phase of the property lifecycle, asset managers have different priorities and responsibilities but are ultimately responsible for ensuring that all aspects of the deal are going smoothly from acquisition to disposition as well as throughout the entirety of the ownership period.
To begin the acquisition phase, buyers start by establishing a comprehensive understanding of their target markets. Asset managers have their finger on the pulse of market dynamics and can provide acquisition teams with firsthand knowledge of trends, including rents, property taxes, insurance premiums, and other factors that affect real estate performance. Commercial real estate investments are typically evaluated by combining those market dynamics with the historical performance of a given property, and then comparing that to the purchase price.
Asset managers will often construct a business plan to increase the value of the property over time and generate stable cash flow for investors. A typical plan may include steps to assess local market demand, estimate the costs and revenue potential of certain property improvements, and evaluate opportunities for new management to enhance revenues or better manage expenses. As such, there are three main investment approaches that buyers employ when looking to acquire assets.
After a property has been identified and is under contract, due diligence occurs. Asset managers work closely with acquisition teams to ensure that assumptions about revenue, expenses, and occupancy are realistic based on experience and comparable properties in the market. Physical inspections of the property also occur.
Once the deal has closed, it falls to the asset manager to ensure a seamless transition from one ownership group to the next. Asset managers must ensure that the property is operational from day one. This includes getting the property management team up to speed and transferring ownership of all utilities and regular service contracts (or putting new ones in place).
Ownership is at the heart of asset management. It is the period in an asset’s life cycle where asset managers and property teams can have the most impact on improving performance and increasing NOI.
Operational Improvements
In a world full of macro-management, it’s easy to overlook the details, like operational costs in favor of the overall market or a building’s positioning. Small changes in operating costs result in large swings in asset value thanks to the way that net operating income affects value. The result is that a project that seems marginal, but that will reliably decrease expenses over the long term may result in important returns on investment across a portfolio.
Before you can begin executing any performance optimization program, you’ll need to collect building’s data for your portfolio. And for that data to be useful, it must be centralized, accessible, and accurate. Experienced property teams will be familiar with common energy optimization strategies.
Leasing Options
Leases serve as the primary income stream for properties and typically dictate who pays what expenses within a building. Asset managers are responsible for negotiating the terms with tenants and making strategic decisions about which tenants will ultimately be the best fit for a property. At the highest level, gross and net leases are the two main types you’ll want to be familiar with. With pros and cons to each, it’s important to determine which will be the more beneficial to all sides of the agreement, as well as your building itself.
A gross lease allows the tenant to pay a single flat fee for use of the space. Under this agreement, the landlord covers taxes, utilities, insurance, and, often, repairs. That is, they cover all expenses that may come with the property, while the tenant simply pays to use the space. Landlords who plan to make energy efficiency investments in their property may prefer a gross lease. Because the landlord is paying the utility costs and passing on a fixed cost to the tenants, he or she can easily recoup these costs. Because the tenant will continue to pay the same, agreed-upon rate even after the cost of utilities goes down, the tenant effectively subsidizes the cost of the upgrade.
On the other hand, a net lease is the opposite of a gross lease. Tenants under these arrangements will typically cover operational costs as well as the cost of using the space. A triple net lease, the most common type of net lease, dictates that tenants cover taxes, utilities, and operating costs in addition to renting the space itself. Triple net leases are often determined by square footage of the commercial building space or through submetering. What a tenant loses in control when leasing by square foot, they gain in the equitability offered by submetering, paying only for what they consume. Shouldering utility costs often motivates tenants to be more environmentally conscious; thus, a triple net lease can be a great choice for energy efficiency and the burgeoning green market.
There are several reasons to sell a property. The ownership group may want to free up capital for other investments or rid themselves of a property plagued by management headaches or partnership issues. With some properties, the internal rate of return may drop after a certain number of years, meaning there is greater risk in holding on to it compared to selling. Often, shorter hold periods can magnify IRR.
There are three main strategies when it comes to exiting a real estate investment.
While asset managers have an important role to play in all three of the scenarios above, selling a property outright requires the most operational savviness. Prospective buyers will look back at least 12 months of operating statements and make assumptions about how the property will perform going forward. Ideally, you will have been optimizing building performance throughout your entire hold period but if not, you must begin to 12-18 months before your property hits the market. Demonstrating that a property is operating efficiently is critical to securing a high valuation when you go to sell.