Owners are concerned with several factors when it comes to analyzing stabilized properties. These factors include the NOI, Cash Flow, Net Cash Flow, Rent Roll, Types of Leases, and Operating Statements. Each of these factors are examined below:
The first step in underwriting any stabilized transaction is to understand the project’s NOI. The NOI is calculated as follows:
- Understanding the NOI – Is it Stabilized?
For the NOI to be stabilized, it must have the following characteristics:
- Building occupancy: needs to be at market, typically 90% leased.
- Building lease: rates need to be at current market rates (not below or above).
- Tenant rollover: the property should not have a significant amount of tenant rollover (expiring leases) in the short term, or at the same time.
- Cash Flow
Once the NOI is established, the investor will look at the project’s “unleveraged cash flow.” The unleveraged cash flow is the money available after the loan principal is paid.
- Net Cash Flow
Net cash flow is the real money that can be distributed to the owners. The investor should always understand the project net cash flow.
- The Rent Roll: A Key But Often Overlooked Document
Stabilized properties are driven by their rent rolls. All rent rolls are not created equal. The rent roll is the summary of the tenants in the building and their rental terms. This is important, as the rents paid by the tenants drive the cash flow of the property.
- Rent roll analysis will include:
- Percentage of the building currently leased
- Rate of lease (monthly payments)
- Lease terms: how long is the lease
- Lease expiration date
- Renewal clauses
- Extension options
- Contract rate increases
- Owner requirements over the lease term (i.e. improvements to space, building, storage, etc.)
- Credit quality of tenants
- Credit tenant: “A” rated company by Moody’s or S&P
- Strong credit: A company with a good balance sheet and income statement
- Poor credit: A “Mom & Pop” business
- Roll schedule:The investor/underwriter will spend significant time in order to understand the “project roll schedule”. Which means knowing if and when the tenants’ leases mature.
Lenders and investors seek out properties that have a “balanced” roll schedule. They don’t want the risk of all the tenant’s leases expiring at the same time. See Exhibit b for Rent Roll example.
- Types of Leases
There are two basic types of leases: a) full service and b) triple net leases. Most office buildings are full service, while most retail and industrial buildings are leased triple net. Details for each lease type follow:
- Full Service: Landlord pays all expenses, such as maintenance, taxes, and insurance.
- Triple Net: Typical charges in triple net include:
- Taxes: Paid by tenant
- Insurance: Paid by tenant
- Maintenance: Paid by tenant
- Operating Statements: The Window to the Property’s Performance
Operating statements are the profit and loss statements of the commercial real estate asset (i.e. the building). Operating statements show if the building is operating at a profit or a loss. These statements are the detail behind the cash flow formulas. This is the single most important piece of documentation when analyzing a stabilized real estate investment. Annual operating statements show the following information:
- Historical revenues
- Historical expenses
- Historical net operating income (NOI)