Top 5 Factors to Close an Investment-Grade Property
- May 04, 2011
The decision to buy an investment property can be confounding. Here are the major considerations.
For investors considering buying a property, the decision can be confusing. Here are the five most important factors that will determine closing include the following:
A motivated seller: The question of why the seller is selling is important to an investor that requires a story. Sellers sell for various reasons, and understanding the motivation can help both parties during the negotiations. If the seller is selling due to a divorce, perhaps their major motivations are just to get out of the property. This seller most likely would prefer an all cash transaction and take a bit less on the purchase price in order to consummate a quick close. On the other hand, if the seller is looking for an income stream, perhaps they would be willing to carry paper at terms commensurate to the marketplace. There are many reasons a seller will sell and knowing those reasons is important.
Rent growth: Typically, investors (and lenders) are more attracted to rent growth of at least a fixed 2 percent or 3 percent or based upon the consumer price index rather than a flat rent. If rental increases are based upon the consumer price index, the buyer and the lender at least know they will be keeping up with inflation.
Length of the lease term: Typically, long-term investors are looking for a longer lease rather than a shorter lease, meaning that a 12-year term would be more desirable to an investor than a 5-year term. If there is a short-term lease, the investor would like to understand why the tenant may renew, or the location is in such a prime area that re-leasing it would not be that difficult. If the lease term is on the shorter side and the rents are well below market, the investor may enjoy the risk of having to re-rent it, yet at a higher rate in the near future.
Tenant Creditworthiness: Investors and lenders usually look for security and stability in their rental stream. One of the most accurate (although not guaranteed) ways is looking at the credit worthiness of the tenant. Does the tenant have a cash flow that has been consistent over time? Has the tenant been in this particular property for an extended period of time? And, is the likelihood of them staying great? Is the industry that the tenant occupies an stagnate, stable or growing industry? These all are questions that will help investors and lenders feel comfortable about the investment property.
Tenant’s lease: Is the lease that the tenant has signed considered a tenant or landlord favorable lease? Does the lease provide for any cancellation options which could put the investor and lender in a precarious situation if the option to cancel is exercised? Does the lease provide that the tenant needs to maintain the property or the landlord needs to maintain the property? Can the landlord pass through any of the operating expenses or is there some unrealistic cap on those annual pass throughs? The lease is an important document to understand when buying investment property.
While there are other factors to consider, these are the highest in my opinion.