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As always, I am on the hunt for information that will give real estate lenders insight into the minds, motivation and method of their investor/borrowers. Whether your bailiwick is residential or commercial real estate, this guest post by Rick Chess will do it. He is one of the very most knowledgeable people I know when it comes to CRE.

Purpose drives process

Residential real estate is ultimately driven by emotion.  Even those who buy-to-flip need consider that the ultimate owner will base their purchase decision on emotion.  How does this property make me feel? Does the neighborhood make me feel safe? How will my family react to my purchasing this property?  

But the surprise for today: emotion can also play a significant role in the commercial property acquisition process.

CRE: How professionals (should) approach the deal

Analysis – Analysis – Emotion

Buddy Scott was my counter balance for ten years at United Dominion Realty Trust, where we lead a 26-person acquisition department spread over 6 states.  We never would have been able to grow the company 10-fold in 10 years without his steady analysis.  I generally would avoid visiting a prospective apartment acquisition until Buddy had completed his initial projections.  I tended to love or hate a property immediately on my visit based on complexity (more the better, as it limited buyer competition) and whether I felt we could effectively reposition the property (to align it into the neighborhood in which it was located). 

Richard Giannotti would apply his architectural skills to point out detail we missed in our capital improvement budget.  Barry Kornblau, who could squeeze an operating expense dollar better than anyone, would lay hands on to improve our operating budget.  Jim Dolphin, as CFO, would force us to focus on the real cost of capital (factoring a reasonable growth factor). And John McCann, President and CEO, somehow balanced these many voices to lead us to a position on an acquisition which somehow almost always worked out.  

We dug for information, used detailed analysis to convert data into knowledge, got to a point where we knew we were close to the right price and terms; and then had to make a quantum leap!  In the end, emotion was the tie breaker.  Did we as individuals, and as a group, feel that this property fit what we said we longed to become?   Did it fit “clean, safe, and cheap”; our mantra for acquisitions and management?

Residential Real Estate: How homeowners approach the deal

Analysis – Emotion – Analysis

With residential, the process of acquisition of a home is narrowed by certain “absolutes” – bedrooms for all the children, near to work/school/groceries/church/golf, a yard in which to play, little in immediate renovation needs, and on and on. Many “absolutes” end up being wants rather than needs, or too expensive to justify.

Once in the right ballpark in size/price/location/amenities, residential acquisition becomes a matter of feel. Can you envision yourself living in this space? Does the neighborhood fit your concept of who you are…or who you want to become?  Will I feel safe/happy/rich owning this property?

There is then a switch which takes place to do the adult thing and obtain debt at a reasonable price and terms. How do you sell your current home in time to swing the purchase of the new residence? Must you move yourself to avoid breaking your checking account? In the end, logic often rules, as no matter how much you love the house, sometimes financial reality trumps the love.

The bottom line…

With a residential acquisition, at least for our own use, we first fall in love with the property and then use logic to justify the purchase.  With most commercial property acquisitions, the decision to offer comes only after detailed analysis. But the ultimate decision to purchase, once (hopefully) all the warts are revealed, is an emotional decision based on what the buyer hopes their team can accomplish…sometimes against all odds!

Rick Chess | Chess Law Firm | 804.241.9999|ChesslLawFirm.com

Nothing in this publication is be treated as legal, real estate, securities or tax advice. Please consult your professional advisors regarding the issues raised. The opinions are those of the author and do not reflect on anyone else. Thank you for considering our thoughts.

The lender’s take-away

When you are a CRE lender, you need to develop the ability to separate analysis from a love-fest. Has the investor followed the steps that Rick outlines in his team’s approach above? Can they answer your questions about needed capital improvements, leasing trends in the area, operating costs, and security? The icing on the cake is their genuine enthusiasm for the project.

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Linda Keith, CPA

Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis.
She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans.
Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.