Asset Due Diligence on Rental Properties

A former real estate asset management intern at Henderson Global Investors Ltd., Maxine Marie Hepfer currently serves as a senior in Ernst & Young’s Transaction Real Estate group. The group provides a variety of real estate advisory services, not limited to strategy and feasibility advisory, transaction advisory, and asset due diligence.

Due diligence in property transactions encompasses multiple activities, the most important of which is the business and legal review. Here, the buyer should evaluate all of the property’s essential financial and legal ingredients before finalizing the sale.

The first element to review is the tenant leases. Ensure the rent roll reconciles with the tenant leases. A review may expose glaring discrepancies such as a misstatement of base years and a difference between the recorded current income and the actual income.

Tenant interviews should follow. Here, the aim is to find out the tenants’ needs as well as their leasing expectations. This will reveal any repairs needed to be done on the asset.

Third involves obtaining tenant estoppel certificates. Tenant estoppel certificates harmonize the facts of the lease according to the buyer and the existing tenants. They state the economics of the lease such as rent and future escalations, the amount of the deposit, terms for lease renewal and termination, and a statement absolving the buyer of any amendments to the lease of which he or she was never informed.

The Impact of Increasing Interest Rates on Commercial Real Estate

A senior at Ernst & Young, Maxine Hepfer has been a member the company’s Transaction Real Estate (TRE) group in Dallas, Texas, for several years. At the direction of Partner Steve Rado, TRE published an article in late 2015 that discussed the effect of rising interest rates on the commercial real estate industry in the face of imminent rate increase by the Federal Reserve (Fed).

When the Fed considered raising interest rates at the end of 2015, people generally assumed that lenders, investors, and developers in the real estate industry would suffer. This made sense, at least intuitively, because any boost in benchmark interest rates, such as Treasury bonds, typically makes all yield-oriented investments considerably less attractive.

Ernst & Young thought leaders Steve Rado, Thomas Dudney, Dan Jensen and Peter Brogan, however, determined that rising interest rates should not immediately threaten commercial real estate values for a number of reasons. Firstly, there has been no strong historic correlation between the yield on 10-year Treasuries and commercial real estate cap rates. Secondly, any federal rate hike will improve economic conditions, and improved economic conditions should drive stronger commercial real estate fundamentals. Thirdly, an increase in the federal funds rate may not have a significant near-term impact on many types of commercial real estate debt. And finally, current capital flowing into domestic commercial real estate continues to be strong.