Transaction volume and international investment in US commercial properties remain strong, and several sectors may see an
increase in 2019, but many economists think that CRE property and
lending metrics indicate that we are at the top of the market, poised
for an eventual down cycle. While no one can say whether this is so
with absolute certainty, here are three essential late-cycle due diligence considerations that can help minimize risk for investment
and development strategies.
1. Construction Risk Management. Construction faces some significant potential headwinds. The 2019 Dodge Construction
Outlook predicts a steady 2019, relative to last year’s US construction output, staying at an essentially even $807 billion. However,
labor shortages, an overall increase in
construction cost compounded by
recently imposed global tariffs, and geopolitical uncertainty around trade agreements. The effect this has had on construction is to drain cost from project
profits, project scheduling delays and projects running over budget.
To decrease the likelihood of contractor or subcontractor failure,
construction risk management tools for project oversight and funds
control are more crucial than ever. Necessary raw materials can be
purchased at the outset of the project (thereby avoiding sudden
price spikes later), price increase provisions can be drafted into
contracts ahead of time, and a range of engineering and project
contingency mechanisms can be implemented. These include contractor evaluations to engage with capable personnel, budget
reviews and funds control for disbursing money and keeping payments in line with progress, document and cost review and construction progress monitoring to keep projects on schedule and
construction completion commitments to keep projects on track
and lower the risk of loan default.
2. Adaptive Reuse Can Be a Smart Investment. During the late
stages of a robust CRE market, investing in ground-up develop-
ments and assets incurs investment risk. For blighted, abandoned
buildings in derelict or industrial areas, adaptive reuse can give a
new lease on life. Additionally, as prices of raw materials remain
uncertain in the future, adaptive reuse of historic properties is an
attractive (and profitable) alternative to new construction.
Renovating, remodeling, and repositioning existing assets is faster
and a terrific value-add proposition, but maximizing profitability is
contingent on avoiding delays and minimizing risk.
Can you physically make your business objectives work on the
property? Conduct a feasibility study to find out. For example, can
you get a zoning exception for parking requirements because the
proposed commercial asset would have a different capacity than the
previous one? Avoid entitlement delays by understanding the zon-
ing requirements and what changes you can make “over the coun-
ter” without triggering a lengthy entitlement process. Will the new
use of the property require a conditional or special use zoning per-
mit? Get a Property Condition Assessment or Facility Condition
Assessment to understand the building’s current condition and the
remaining useful life of the major building systems. Conduct thor-
ough environmental assessments to determine risks or liabilities,
and how a remediation or underground storage tank removal may
be navigated to not derail the transaction. All construction can be
risky, but can be even more so for adaptive reuse projects.
3. Warehousing and Last-Mile Logistics. Strong demand for ware-
housing facilities is expected to remain buoyant in 2019 despite a
rise in rents, with demand from e-commerce outpacing warehouse
supplies. The warehousing trend is expected to expand to construc-
tion of multistory warehousing facilities, as developers continue to
look to meet demands from the industrial real estate sector and
skyrocketing e-commerce growth while maximizing space and stor-
age footprints. Five multi-story warehouses have already been built
this year in major urban markets, and could set a blueprint for
developers in other cities with high-density populations.
Whether you are an institutional investor looking to expand your
warehousing portfolio or a developer looking to capitalize on the
e-commerce boom, you must first determine whether the building
of interest is in an ideal location, if it is suitable for storage needs
and loads, and can handle parking needs of distribution vehicles.
A Property Condition Assessment will help identify building defi-ciencies and sub-systems for warehousing, particularly ceiling
heights, loading areas, HVAC and electrical systems and floor load
capacity. Certain changes of use may necessitate seismic reinforcement or retrofitting for building safety. Consult with a seismic
expert to perform a Probable Maximum Loss assessment. If the
warehouse is a former industrial property or Brownfields redevelopment site, or will use hazardous materials, a Phase I Environmental
Site Assessment will identify and quantify potential risks.
Jenny Redlin is a founding principal at Partner Engineering and
Science Inc. She may be contacted at jredlin@partneresi.com. The views
expressed here are the author’s own and not those of the ALM Real Estate
Media Group or its publications.
Three Key Late-Cycle Due Diligence Considerations
RISK MANAGEMENT
By Jenny Redlin
The end result has been a 31% increase in national rents since
January 2011, according to Yardi Matrix. Last year was a solid one
for the multifamily sector, and the 3.2% rent growth slightly
exceeded going-in expectations. Las Vegas ( 7.3%), Phoenix ( 6.5%)
and the Inland Empire ( 5.5%) are the top three growth metros,
highlighting a trend of outperformance among secondary markets.
Rent growth in 2019 is expected be led again by metros in the
Southwest, West and South regions. “Despite the recent volatility
in the financial markets, we foresee more of the same in 2019,
with strong demand producing rent growth just shy of 3% nation-
ally,” say Yardi Matrix analysts.
On the other end of the spectrum, Dallas, Denver and
Nashville—submarkets in the urban cores of secondary markets—
are likely to see growth stymied in the short term. That is because
of the supply pipeline, with the market about to embark on
another year of about 300,000 deliveries.—Erika Morphy ◆
