Six Points That An Investor Should Consider When
Buying ICI Real Estate
By David Eger,
February 7, 2003
Altus Group Vancouver
It is often said that most of the
money to be made in real estate investment is made the
day you buy. There are plenty
of risks when buying real estate. By avoiding the six
common mistakes set out below, an investor will minimize
risk and maximize potential profit.
1) Paying too much for a
property. In other words, making an offer which is
greater than market value.
Prudent purchasers of
commercial properties should generally make their offer
to purchase subject to an appraisal.
An appraisal is a
supportable or defensible estimate or opinion of
value. It is an impartial, expert and reasoned
conclusion, formed by a trained professional based on an
analysis of all relevant evidence. It represents the
appraiser’s perception of the most likely and most
probable dollar value of the appraised interest(s),
subject to the qualifying conditions imposed. The
opinion is the appraiser's opinion based on perceptions
of the market as shown by the data in the report.
(Note that it is stressed
that appraisers estimate value, they do not determine
it. Courts determine value in case of a
A professional real estate
appraiser specializes in providing opinions of value of
various types of property. They charge a fee based on
the type of the property, complexity of the property,
and purpose of the appraisal assignment. This fee is not
based upon a predetermined value estimate and therefore
an appraiser can provide an objective, independent
estimate of value. All members of the Appraisal
Institute of Canada are required to conform to the
Canadian Uniform Standards of Professional Appraisal
2) Buying a property
without obtaining advice from a qualified building
inspector and/or an engineer.
Prudent purchasers of
commercial properties should generally make their offer
to purchase subject to a ‘Physical and Environmental Due
It is stressed that an
appraisal and a building inspection should not be
confused as serving the same function. An appraisal is
an opinion of a property's market value. While the
physical condition of the property is critical, the
appraiser also has to consider subjective issues such as
location, design/function, and supply and demand, all of
which have a significant influence on marketability and
A physical and
environmental due diligence is a thorough examination of
the physical condition of the structure and its
components. A building inspector or engineer should at
the very least provide an opinion of:
- The structural soundness of the
improvements and the services to the
- The condition of the roof and
electrical and mechanical facilities, including air
- The presence of any environmentally
hazardous substances (such as asbestos).
- The presence of any insect and rodent
- The presence of any soils
contamination (examples of this could include seepage
from an adjacent gas station or an old dry cleaning
- The overall type and condition of the
soils, and their overall stability with regard to the
existing improvements and any future
- Any potential of
The report provided should
provide realistic costs and time lines for repair,
replacement, and remediation of any of the above
3) Buying a property
without conducting a detailed financial
The price paid for most
income producing properties is directly related to their
current and expected income flow. Verifying the current
income flow and estimating the future income flow is a
time consuming but important process. Typically, for
larger properties, an estimate of cash flow over a 10
year period should be conducted.
Some of the important
elements of a ‘Financial Due Diligence’
- A review of all leases to identify
not only their financial terms but also any important
lease clauses, such as; options to terminate, options
to expand or downsize, options to renew the lease at a
fixed rent, options to ‘go dark’, future free rent
periods, and any outstanding tenant improvement
allowances payable by the landlord.
- An analysis of the tenant profile.
Personal tenant interview are a good idea as well as
some research into the overall strength of each
tenant's covenant. The strength of the covenant of a
tenant is determined by its financial stability and
general reputation in the business world.
- An analysis of the historical
operating statements (which should be
audited), the year to date
performance, and the current budget. Any budgets
provided should be reviewed to determine if they are
reasonable as well as to identify any possible
- An analysis of accounts receivable
and accountants payable as well as any contractual
agreements (such as with cleaning, elevator
maintenance, and security companies).
- An analysis of recovery revenue. The
majority of leases which are typically struck for
office and industrial buildings are on an a ‘net
basis’, whereby the tenant pays basic minimum rent as
stipulated in the lease, as well as its proportionate
share of operating costs and taxes. The tenant
therefore assumes the risk for potential increases in
operating expenses and taxes. A gross lease is a lease
in which the landlord receives a stipulated rent and
the landlord is obligated to pay all or most of the
operating expenses and real estate taxes. For most
retail properties, some tenants pay less that the
‘full recovery rate’. It is therefore vital that the
recovery or ‘additional rent’ section of the lease
agreement for each tenant in a property be reviewed
and fully understood in order to accurately estimate
both the current and future income earning potential
of a property.
- A review of property tax statements
in order to determine if there are any arrears in
unpaid taxes and utilities.
- A review of the property's tax
assessment. Is it over or under assessed, properly
classified, and will the assessment increase upon the
purchase/sale of the property?
4) Buying a property
without a full understanding of the market in which the
property is located.
A typical market analysis
will include the following:
- An Economic Overview. A brief review
of the main economic indicators, both historical and
projected, is required in order to determine if the
future outlook of the local market and surrounding
areas is positive or negative.
- A Competition and Leasing Market
Overview. In order to estimate the future earnings
potential of a property, an analysis of any competing
properties and the rental rates which are being
achieved in these properties is required. In addition,
a review of new and any proposed developments in the
area should be conducted.
- Investment Market Overview. An
analysis of investment demand, investor preferences,
and a survey of current valuation parameters will
assist in determining not only the price to be paid
but will also give an idea of the properties
‘liquidity rating’. In other words, ‘how difficult
will it be to re-sell the property in the future if
required to do so’.
5) Buying a property
without a ‘legal due diligence’.
A typical legal due
diligence will include the following
- A title search and a summary of
all charges registered on title.
- An opinion of any impact on value
with respect to the charges which are registered on
- A review of the heritage site
registry. A ‘Protected Property’ or a property which
is on the heritage list could affect the properties
future development potential.
- A review of the property's specific
zoning and official community plan designation, and
any other municipal regulations, is required in order
to determine if the property conforms to current
municipal requirements as well as to assist in
identifying the future development potential of the
- A review of the business licenses to
determine if the building operations on the property
are in good standing.
- A review of the most recent Fire
Marshall and Health Department inspections to
determine if there are any outstanding
A detailed and downloadable Legal Due Diligence
Checklist is available in the BCRELinks Build a Deal section.
6) Buying a property
without a review of the site survey and building
Are the building areas and site areas
stated correctly? The only way to determine this is
through either reviewing or obtaining a site survey as
well as a copy of the building plans and certified floor
For investors about to embark on a due diligence program
before acquiring a retail or office property, a detailed and downloadable
Property Purchase Due Diligence Checklist
and a Borrowers Checklist
are available in the BCRELinks Build a Deal section.