Deal Killer Blog Series #2
Commercial real estate acquisitions are modeled on spreadsheets or in fancy valuation software, often by analysts who have likely never had to hammer a nail a wall. That’s fine. Commercial buildings exist because some developer planned for them financially, and could rely on other investors who have also taken pains to map out strong financial plans.
But someone that has actually swung a hammer or two eventually needs to check in on the conditions of these properties to ensure they are in solid shape, or else the spreadsheets are relying on faulty assumptions — namely owning a building that is in worthy condition to rent out.
That person is a property inspector. Real estate deal parties (buyers, lenders, etc) rely on inspectors to visit a property and report on its physical condition. They’ll identify any problems and add value the acquisition discussion by explaining what needs to be fixed, and how much that will cost.
So, what can go wrong with an inspection?
If a roof needs to be replaced, that’s a big piece of capital expenditure. Likewise if there are major problems with a foundation. If no major capex has been accounted for when a buyer and seller negotiate a price, but then a big ticket item like this is discovered during an inspection, a buyer will often ask a seller to remedy the problem or at least offer a concession in price.Any re-trading on price or terms of a deal opens that deal up to risk. Maybe the seller would prefer to pull out and sell to another buyer, or they can’t come down on price because they need to cover other debts and investors. Either way, a major structural problem on the property can potentially be a deal killer.
Having some old copper wires or old lead pipes in a property doesn’t seem like something that can’t be remedied. But not only is that work potentially very expensive, but depending on the type of remedy utilized, you may see an increased property insurance bill.
We live in a day and age that is extremely health sensitive. If there is a widespread problem with mold or mildew within either rentable or common areas of a commercial or multifamily property, you’ve got problems.
HVAC stands for Heating, Ventilation, and Air Conditioning. It’s essentially the respiratory system of a building. An old boiler that needs to be replaced can change the cost outlook of a smaller commercial property pretty quickly.
If the pictures of a property look great, and you tour one or two nice looking units, you may think that it’s in great condition. An inspector may think otherwise if they walk through every single unit and note that kitchens and bathrooms are riddled with a long list of smaller maintenance items that have been ignored for some time.
It’s pretty common to deal with some level of deferred maintenance during an acquisition process — you can hope for the best, but plan for the worst. If not, this can be a deal killer.