When you invest in large-scale rental properties, it's because you hope for large-scale returns. But when the reality is a lackluster return on investment, it might be time to self-assess.
Dan Bartell, president of Bartell and Company Real Estate Wealth Management, has helped many of his clients with real-life assessments.
"If you over-promise yourself higher returns, you're potentially setting up a negative self-fulfilling prophecy," said Bartell. "Chasing unrealistic goals can lead you to see what you want to see and not what is. It's important to utilize solid information from a trusted source and advisors who can put that data in context to assess real estate investment."
"There is a lot to be gained from performing an assessment of your property," said Cory Hensley, manager of the specialty assets group at BOK Financial®. "An asset performance assessment involves diving into your investment property and assuring it is performing at its full potential."
When determining if a real estate investment property such as a retail building, industrial warehouse or apartment complex is performing at its highest potential, investors might consider:
- Are there opportunities to subdivide/sell/lease space?
- Are there opportunities to build or develop custom-created spaces?
- Is there more capacity to a given piece of land than meets the eye?
- Is there a possibility of up-zoning to maximize use and value?
"It's a valuable assessment because you can be managing an asset the exact same way for the last 30 years and think you're just fine," said Brad Nelson, specialty asset manager for BOK Financial. "But you might be blind to your risk—or your potential for growth."
Room to grow?
As a property owner, it's important to have a realistic understanding of what you have and its potential.
"If you own an office building with a giant parking lot that sits empty, is there a way to do something else with it?" Nelson asked. "Can you go vertical and build an apartment complex or add another small office building? Or maybe you can pursue changing the zoning to allow for something else on the property—just to get the most return for your footprint."
Periodically assess what the market is telling you and how your properties can fulfill the market's needs, added Bartell. "The market may fib every so often, but it rarely lies. Is it time to add more of a product type to your existing portfolio? Or is diversification the smart way to go considering your season of life, and the present and near-term market? Perhaps it's time to take chips off the table. To go along merrily, hoping things will stay the same is a recipe for difficulties. Be proactive."
It's also important to have a sense of the property's current value and how that factors into an overall growth plan. In making those decisions, Nelson suggests keeping a couple of things in mind:
- Analyze land improvement ratios: Are there possibilities to yield new income, development or sales opportunities? Many properties are under-utilized and have excess land and space.
- Analyze reserves: How much capital is available for unforeseen capital expenses and budgeted expenses?
"Sometimes the only way to grow—is to grow," said Nelson. "If you want your return to grow, you may have to grow the property as well. And there are some creative solutions and options to explore on that front."
Brace for impact
When it comes to owning investment property, especially on a large scale, Hensley said there is a lot to be said for understanding your risk—then working to mitigate it.
"You never know when the economy, industry, weather or any number of variables are going to throw you a curveball," he said. "There's a lot out of the property owner's control—but there are still plenty of things we can take proactive steps to protect against."
Keep an eye out for deferred maintenance costs or capital expenses that may be looming around the corner, he said. He also suggests watching for any environmental or geographic risk associated with the location of the property.
"This could mean looking at historical use and surrounding property use," said Hensley. "Was there an underground storage tank that could have caused a pollutant? For example, it would be good to know if a property was previously occupied by a dry cleaning business because that is a high-risk hazard."
Another key element to assess is rent-roll risk. "Rent-roll is basically your tenant roster," said Nelson. "Mitigating this risk means really understanding who your tenants are and what position they're in."
Is your rent-roll exposure generally well-capitalized national tenants, or are they non-credit-rated small businesses with little to no cash reserves? It is important to understand the risks and financial situations of each.
Economic changes may impact the tenants' ability to pay and willingness to fulfill a lease agreement.
"It's helpful to know how industry changes, economic shifts and governmental regulations are going to impact your tenants and their budget," he said. "This may mean taking a closer look at who your tenants are, what they do and their long-term plans."
It's also important to keep a watchful eye on the overall market risk, Nelson said.
When it comes to assessing this risk, he suggested a few steps:
- Partner with an experienced real estate broker who has a solid background in the local market and micro-markets, as well as the specific property type to help you establish a plan to fit your property investment objectives.
- Enlist a professional to evaluate the right time to sell or refinance.
- Consider diversifying your real estate portfolio, both by product type and geographic location to mitigate portfolio risk.
"At the end of the day, remember that owning real estate property is an investment," said Hensley. "It's one piece of a larger, diversified investment portfolio. All of which should be working to get you closer to your investment goals."