Knowing When It’s Time to Switch to a Higher-Performing Asset in CRE
If we don’t have a predetermined exit plan for a particular property in our portfolio, we’re continually facing the decision to let our money ride or cash out and reinvest in higher-performing commercial real estate assets.
Indeed, there are other options and asset types, but for our discussion, we’ll focus on the disposition of a currently held property and the acquisition of a replacement asset.
When we have all the information available to make measured decisions, the choice is straightforward. However, without reliable data on the performance of our property and the regional market outlook, it’s unlikely we’ll know when it’s time to sell or exchange — or if it’s the best decision.
Accordingly, let’s talk about some of the factors to consider and how we can pull the data together to identify and support the best possible course.
1. Property data points for performance
Each of our properties has a story to tell. That narrative is coded into the asset’s operating and financial data. If we listen carefully, we’ll learn how well we’re attracting tenants, how efficient we’re operating, and how much we’re making or losing.
Of course, the principal metric we need to watch is NOI. However, we need to dig a little deeper. While it’s useful to know whether our NOI is positive or negative, it’s more fruitful to see how our NOI changes month-over-month, year-over-year, and how much margin we’re generating per unit and square foot.
With that insight, we can determine if we’re headed in the right direction, at what rate, and develop a baseline to compare with our other assets and potential acquisitions.
Operating expenses are also a top concern in evaluating a property’s long-term role in your portfolio and are an inherent component in calculating your NOI. Rising operational costs due to functional obsolescence associated with aging building systems and excessive Capex (significant maintenance costs) can be a solid signal to consider alternative assets. As with NOI, the data can tell us how much each unit costs in upkeep and facilitate comparisons with other properties.
We also want to know how competitive we are in the marketplace. Are our tenants boasting about the great deal they got by leasing our below-market units? Or are they paying fair market rates for what we’re offering? Property-level data can contribute to answering these questions as well.
Like NOI, it’s valuable to track how our occupancy rates are changing. The property data may not tell us why our vacancy rate is increasing or declining, but it will let us know if we need to look at external factors to determine the cause.
Suppose we find that our occupancy and NOI are falling despite our property being in top condition, running lean, offering the most desired amenities, and holding a prime location. In that case, it could be something beyond our control and it may be a good time to exit and seek assets and markets with more upside.
Potential or current delinquency is also something we need to monitor by tracking and reporting our loan data. If we’re headed for delinquency, particularly when it’s incurable due to circumstances, it’s a pragmatic choice to cut our losses, sell off, settle the debt, and move on to the next project — before our credit rating and reputation take a dive.
2. Staying on top of the market
Now, let’s look at data points for the external factors that can push us to exit. Prevailing lease rates are chief among these. There’s not much we can do when rents are sliding downward.
Sure, we can lower our lease rates if demand for our asset class prompts it. Yet, unless operating costs are also falling (not likely the case with inflation and rising supply and energy prices), we may be left to consider value-add assets in the same region or properties in markets with more favorable conditions.
Though not much concern for most asset classes today, falling property values also don’t bode well for an ongoing hold. Cap rate compression is a related factor that can influence our decision.
When rates are pushed down by excessive demand and valuations are rising, it may not be an optimal time to consider new investments where the potential income and margins will be restricted. In this case, the best course may be to hold and optimize our rents and expenses.
Other regional trends to consider include growth (or contraction) in labor supply, population, median income, industry inflow, and emerging regulation. Economic obsolescence or decline in value due to factors external to the property will also influence our strategies.
Here, we need to evaluate how our asset measures up to or aligns with tenant expectations, building codes, environmental standards, and other concerns that may erode value despite our property being in relatively good condition.
3. Making the data accessible
Being aware of all these data points is one thing, but bringing that information together and making it available to power quick-pivot decisions is another.
Even if you have a team or teams dedicated to collecting property and market data, it will be a time and money-consuming proposition to maintain the initiative and deliver prompt insights. For small and mid-market operators retaining this staff may not be practical.
Here’s where data management technology bridges the gap in creating a consistent flow of property- and market-level intel to power informed and rapid decision-making at a feasible expense.
When you want to know how each asset is performing across your entire portfolio to identify the laggards, automation via a data management platform delivers instant rent rolls, lease summaries, estimated net proceeds from a sale, and other vital operational and market data points.
Break the barriers to scale
In the history of commercial real estate, there was never an eight-figure portfolio consisting either entirely or in significant part of underperforming properties. Knowing when to let an asset go is among the most important decisions investors and operators make in scaling their portfolios.
Though an individual asset’s NOI may be positive, we may be losing out on the unrealized potential of our capital by not putting it to its highest and best use. Property and market data distilled with speed and efficiency puts us in the best position to recognize the right time to make our exit.