Over the past several weeks, I’ve been deep in a new value-add multifamily transaction. Acquiring real estate is cumbersome, complex, and opaque, yet we continue to complacently accept this reality. Part of the issue is that acquiring real estate is very fragmented, with different players collecting disparate data, requiring 3rd parties, and all profiting from different elements of the process.
This complexity is exactly where opportunity lies. Based on my recent experience, here are a few of the aspects of the acquisition process I find most frustrating.
The deal sourcing process remains local in nature and relationship-driven. Given our local connectivity, micro market knowledge, and proven track record of successful execution, we tend to see off-market deal flow through brokers, owners, and various real estate participants.
We don’t have a novel business plan and we’re not doing anything particularly special to source deals, but through relentless networking and active participation within the real estate community, we have consistent deal flow.
This rewards the experienced players and makes it challenging for newcomers to compete within the market. While nothing has been widely-adopted, there is innovation in the deal-sourcing space.
Global Marketplace for Deals: Real estate listings remain fragmented and controlled largely by brokers. There are several start-ups attempting to create the global marketplace for real estate deals, but there’s been little traction. While everyone knows of Loopnet, there are several other players in the space including Ten-X (formerly Auction.com), CREXi, and RCM. There is no Zillow for CRE and investment sales remains dominated by brokers who are incentivized to control their relationships. I’m not sure this will change any time soon.
I’ve run into groups such as Institutional Advisory Group, which cold call all owners on your behalf based on a target deal profile and market. If they successfully identify a deal, they’re paid a market-rate broker fee. It’s an added service provided by a brokerage which is interesting given today’s landscape, but hardly novel.
Data-Driven Acquisition Process: Most groups, Atlas included, are not using data to determine target markets or devise unique, niche investment strategies. Instead, we’re largely value investors, focused on identifying mispriced opportunities in the markets we’re familiar with, where we can add value at the property-level and we’re not reliant on market rent growth.
Deal Underwriting: When a deal comes through a trusted source, we’ll run it through our deal-screening checklist and do a quick and dirty BOE underwriting. We’ll use a tool like redIQ to slice and dice the rent roll to help us get a clearer picture of current performance, look at 2-3 most relevant post-renovation comps to determine upside in rents, and use a combination of the T12 and performance of other, similar deals, to underwrite the expenses. It’s a rough process that enables us to determine if we should spend more time on the deal. Is there a better and more efficient way to underwrite deals using data and software?
Modeling: Like most firms, we have our proprietary underwriting model in Excel which we use for all multifamily deals. We’ve used it for years and we’re comfortable with it. However, the modeling process can be time-consuming and error-prone. There are several start-ups creating software to improve the multifamily modeling process such as Valuate, Enodo, redIQ and Assess RE to name a few. While software should improve speed and accuracy of underwriting, what I find most interesting is the ability to layer in data sources enabling firms to better identify market comps, underwrite expenses, and more accurately predict rent growth, expense growth, and sale and refi assumptions. What will it take for underwriting software to become more widely-adopted?
Debt Sourcing: Debt sourcing is another fragmented, relationship-driven process. Once we identify an opportunity, we reach out to our contacts across banks, DUS lenders, and insurance companies. After we determine the right type of debt for the deal and investment strategy, the lender who wins the deal is the group who gets most aggressive. Why isn’t there a transparent and efficient debt marketplace?
PSA Negotiation: Another frustrating aspect of the acquisition process is the negotiation of the PSA. It consists of a lot of email, calls, attorney’s, red-lined agreements, and negotiation over closing fees, prorations, reps & warranties, extension options etc. There is little clarity into what is ‘market-rate’ and rarely is the PSA fair to both sides. Does it need to be this way?
Property Assessment: Once a deal is under contract, it’s a mad sprint to review the diligence items, complete 3rd parties, raise the capital, finalize loan docs, and close the transaction. There are many small, annoying steps along the way:
- Due Diligence: The due diligence process is cumbersome and includes reviewing historical financials and ensuring the income ties to the bank statements, reviewing service contracts, utility bills, work orders, property tax bills, and delinquency reports just to name a few. Documents are shared via Dropbox or some other online doc sharing site and often requires back-and-forth just to determine all files have been received.
- 3rd Parties: We work with 3rd party firms to complete an appraisal, property condition report, environmental site assessment, unit walks and lease audits, survey, and zoning report among others. It requires a lot of coordination and at the end of the day, the reports typically aren’t worth the paper they’re written on. Why isn’t this better?
- Site Visits: While under contract, we coordinate various site visits including subcontractors, 3rd parties, the property management team, and lenders, just to name a few of the groups. This is all done while the Property is fully occupied and the current onsite team is overseeing the asset. It’s hectic.
Every aspect of the property assessment is a pain, and at the end of the day, there’s no way to be certain that you didn’t miss something. Could there be one central software to coordinate every moving part?
Closing & Legal
Once due diligence is complete, debt/equity secured, and new management in place, we’re finally ready to close. The closing process is complex; the buyer/seller finalize prorations, Title prepares a settlement statement (typically HUD-1 for multi deals), funds are sent to Title and held in escrow, closing documents are executed, and finally funds are disbursed via wire. Shortly after closing the deed is recorded. Settlement statements often require several rounds of revisions, the wire cut off is commonly missed, and signing paper docs is a pain. The closing process is opaque, expensive, and rarely runs smoothly. Does it need to be this way?
Tackling aspects of the CRE industry is clearly been a daunting challenge, but it’s also where the opportunity lies. While many recognize the inefficiencies of the CRE business, it’s naïve to think they’re easily fixed. Many outsiders, who don’t understand the nuances of the business, have tried and failed. But ultimately technology will be adopted and the commercial real estate will be disrupted, it’s just a matter of when.
There are so many aspects of the CRE acquisition process ripe for disruption. Where do you see the greatest opportunity?