‘SWAT Team’ Approach to Confident Investing
- Jan 21, 2015
Institutional investors are increasingly focused on bringing real assets, including real estate, into their investment portfolios, a BlackRock study conducted in late 2014 reveals. Most investors buying commercial real estate will do their due diligence to identify asset risks, but when buying with “other people’s money” the importance of understanding and mitigating investment risks is magnified. In the physical due diligence world, the engineering report or property condition assessment (PCA) is one of the key tools used to identify asset risks as well as opportunities for ROI, but not all PCAs are created equal. With traditionally low risk profiles and many stakeholders’ eyes scrutinizing their decisions, many institutional investors will need to go beyond the standard ASTM scope for PCAs with a SWAT team approach to more comprehensively assess the building’s condition before closing deals. While it increases costs, adding specialists to the property condition assessment will add depth that can help protect investors from bad purchases, provide information for price negotiations and identify opportunities to improve building value post-purchase.
Why an Arsenal of Experts?
For investors putting other people’s capital at risk, issues like a leaking roof or curtain walls, leaky plumbing, faulty electrical systems or elevators, HVAC issues or structural distress are an extremely costly concern that can easily kill a deal. So you’d probably want to have a well-trained set of eyes on-site taking a close look at those building systems – or likely several sets of eyes. The standard ASTM scope for PCAs doesn’t call for a team of specialists; rather a single “generalist” assessor who is trained to assess all building systems and estimate what capital investments will be needed in the short and long term. Don’t get me wrong – there is a lot of value in this type of PCA, and it is a great tool for a large number of commercial real estate transactions. However, specialists are trained and certified to do what generalist inspectors typically are not – for example only a certified elevator inspector can enter an elevator pit. A faulty elevator can be upwards of a $1 million issue so spending more for a closer look is typically well worth it. An engineer who is trained in mechanical, electrical, or plumbing systems can give a much more in-depth understanding of those building systems, especially when a complicated issue arises. A roof specialist could provide a detailed drawing of the full roof measurements to facilitate future rehabilitation work on the roof. Specialists may also use advanced diagnostic tools like moisture meters and infrared imaging to identify hidden issues like moisture within wall cavities. For earthquake-prone regions a structural engineer can help you understand the asset’s conformance with building codes, insurability and likely performance during an earthquake. There are other specialists to consider depending on the asset or what you are looking to do with it.
From Risk to ROI
Bringing specialists on site may also identify opportunities to add value to a property. For example, a “green PCA” incorporates an assessment of energy efficiency and other green elements of interest into the PCA to identify low and no cost energy conservation measures (ECMs), more capital intensive ECMs, potential utility rebates or incentives to take advantage of, and ROI during your planned hold period. In case of faulty or aged equipment that needs to be replaced, upgrading to a more efficient model can reduce ongoing operational costs and the property’s environmental footprint. If equipment doesn’t need replacing but simply re-calibration, a retro-commissioning professional can restore it to optimal performance with typically a one to two-year payback. With many institutional investors under increasing external pressure from stakeholders to be socially and environmentally responsible in their investments, this kills two birds with one SWAT. (Sorry, had to).
Know What You’re Getting
Some PCAs are more equal than others, and understanding the level of certainty you and your shareholders need to get comfortable with an investment is key to determining the appropriate scope of due diligence. If your investments could use a few good men and women, the added costs of a SWAT team approach will pay off by protecting you against costly surprises and improving ROI through value-add solutions.