The Anatomy of a CRE Deal

Disclaimer:  The below essay is for informational purposes only.  It should not be relied upon in any respect, but especially as investment or legal advice.  This document should not be copied or disseminated without the author’s written approval. © William M. Barres, 4/1/20.


This essay follows the typical linear steps (Marketing Period, Bidding Period, Contract Negotiation, Due Diligence and Closing) of an institutional acquisition process for a publicly marketed property, making note of work often occurring across steps.  Each acquisition step begins with an estimated timeframe; cumulatively, the overall acquisition process should require 3 months or less.


Buying a commercial real estate asset requires expertise in many areas, much of which will be discussed in this essay.  As an accredited investor considering a potential syndicated investment, it is helpful to understand: 1) the anatomy of a commercial real estate transaction, 2) the risk-reward dynamics of the specific investment being considered and 3) the “structure” of capital and return distributions (related essay forthcoming).  Then, an investor can ask intelligent questions that reasonably vet the transaction, its structure, as well as the sponsor’s competency.  Afterwards, if an investor is uncomfortable with his/her findings, walk away.  There will always be another deal and/or another sponsor.  Further, while deals may stand on their own merit, not every transaction is right for every investor; the nature of real estate results in every potential purchase having a different set of risks and range of reasonable returns.  This is the core reason why investing in multiple single assets separately is arguably preferable to real estate funds or other pooled equity investment formats; the educated investor can get comfortable that each particular deal matches up with their particular investment return, structure, sponsorship and diversification goals.


When engaged by a seller, an investment broker will distribute a “teaser” marketing flyer to potential buyers, providing a synopsis of the property investment opportunity and an invitation to receive more detailed information upon execution of a confidentiality agreement.  That detailed information comes typically in the form of an Offering Memorandum (“OM”) and financial cash flow files prepared by the broker.  The quality and extent of the information contained in the OM varies significantly.  These are marketing materials meant to shed the property in the best light, in order to encourage buyers to create positively skewed cash flows for valuation purposes.  While much of the data can be relied upon, it should be analyzed with a discerning eye.  It’s important to understand that the OM and accompanying financial analysis is the fundamental information provided to buyers, in order for an assessment of the property investment to be made and a valuation model to be constructed.  The buyer usually doesn’t have time to review exhaustive due diligence materials prior to winning the bid, but frequently brokers will provide access to it (by war room link) after receiving a confidentiality agreement.

Now, lets review the sections of an Offering Memorandum (“OM”) and what a typical acquisition professional will consider when reviewing it:

Confidentiality Statement and Disclaimer: Usually at the front of an OM, this page will tell the reader that nothing contained in the OM should be relied upon and all non-public information disclosed is confidential

Executive Summary: With a positive slant, this section provides a summary overview of the property, market, tenancy, and financial returns. Particular focus will be paid to positive distinguishing features of the property and value-add opportunities, such as below market rents in place, vacancy that can be leased up, low lease expiration exposure, etc.    Review Commentary: Typically, an acquisition professional will spend time reviewing this to make a first cut determination if the particular deal is worthy of a deeper dive review.

Physical Description:  In some manner, the following information will be shared and each topic will elicit considerations for the acquisition professional:

  • Site Plan (showing acreage, parking field, building footprint, property’s borders, curb cuts, etc.)
  • Structure (describing square footage, stories, roof, structural frame and foundation, exterior skin, window systems, etc.)
  • Plant and Equipment (describing HVAC system, elevators, etc)
  • Floor-Plans (showing location of demised tenants spaces, stairwells, common hallways, bathrooms, elevators, etc).
  • Amenity Improvements (describing public conference facilities, cafeterias and gyms, etc).
  • Recent Capital Improvements

Review Commentary: An acquisition professional will spend time reviewing this for three important things. 1) The buyer will determine whether the asset is appropriate for the investor’s needs and acquisition criteria. If the property passes that litmus test, then the buyer will look more closely at the information discussed below to ascertain 2) what capital costs during the investment time horizon should be projected in the financial model and 3) whether there are any negative aspects to the property that would impact marketability.

  • On the site plan, the buyer will want to know about the adequacy of parking, traffic flow, garbage disposal and access (restrictions to ingress/egress?). Further, the buyer will look at the potential for capturing expansion opportunity. (i.e. development)
  • With the structural, plant/equipment and recent capital improvement information, the buyer will be considering the remaining useful life of the improvements and whether his/her financial analysis should incorporate capital replacement costs for some of these improvements.
  • With floor-plans, the buyer will be considering whether a floor-plan can be reasonably demised into highly functional, market appropriate spaces that today’s tenant will be find attractive. Amongst other things, the buyer will usually review: a) the depth of building spaces off common hallways/doorways, which meaningfully impacts an owner’s ability to configure marketable tenant spaces; b) the location of stairwells, access points, product loading points/docks, columns, elevators, bathrooms, etc.   All of these things impact tenant space layout and marketability; c) the rentable versus useable square footage. The goal is to have a highly efficient building, but in no event less efficient than the “market”. (Price per rentable square foot is an oft cited and highly useful metric but does not tell the whole story); d) the window lines and light access.
  • With amenities, today’s office tenant demands higher levels of common area amenities, such as dedicated conference centers, gyms, cafes, etc. The key for potential buyers is to make sure the proposed purchase has market competitive amenities or can be improved to have them.

Market Review: In some manner, the following information will be shared:

  • General Metropolitan Statistical Area (MSA) economic discussion highlighting local economic drivers, including larger area employers.
  • General real estate market information, highlighting current supply in each metropolitan submarket, vacancy, Class A and B rent levels, construction pipeline statistics, etc.
  • Deal specific competitive cohort statistics, including rent and sale comparable transactions used to support broker’s underwriting.

Review Commentary: An acquisition professional will review this information, but should not rely too heavily on the rent and sale comparable transactions.  It is better to supplement this information with independently sourced comparable transactions and gather the opinion of a few local market brokers.  Meaningful time will likely be spent considering the competitive cohort and whether the subject property can compete well over the long term.

Tenant Information: While often this section is included in the Financial Analysis, for our purposes, we will discuss it separately.   The following four tenant-related informational pieces are typical:

  • Rent Roll: This is a table of key financial tenant information and for each tenant usually includes: Lease Start/End Dates; Rentable Square Feet; Annual Rent and Annual Rent Per Square Foot of rentable space; Operating Expense Reimbursement Information; Tenant Option Rights (renewal, expansion, termination, etc).
  • Tenant Rollover Schedule: Graphically depicts the amount of space expiring per year until all expirations have occurred.
  • Tenant Lease Abstracts: These provide more detailed information than what’s provided on the rent roll, and often are limited to the larger tenants.
  • Tenant Company Descriptions: These provide an overview of a Tenant’s primary business, often providing credit information.

Review Commentary: In reviewing this information, an acquisition professional develops insight into the tenant related investment risks and the expected nature of the rental revenue over the course of time (credit quality, lease expiration rollover, exposure to option rights (termination, etc.)).  This review will strongly impact how an asset is valued.  By way of example, high credit, long-term tenants will result in considerably higher valuation.  Conversely, buildings with high vacancy, short-term leases or low credit tenants (without credit enhancement) will be impacted by downward pricing pressure.

Financial Analysis: This section is provided so that a potential buyer can intelligently project their property cash flow and derive an asset valuation. To enable this, the broker will present the following information:

  • Rent Roll and related tenant information (Discussed Previously)
  • Historical Property Operating Cash Flow Information
  • Broker’s Stabilized Cash Flow (This is a projected year-end cash flow statement, based upon the market-based assumption that the building was leased at 95% capacity throughout the year)
  • Broker’s Projected 10 Year Cash Flow Statement (Argus Model)
  • Recommended Argus Valuation Assumptions

Although many buyers use EXCEL to project cash flows, most “institutional” acquisition professionals today utilize “Argus” software; it is the present industry standard.  Argus enables the creation of projected year-by-year cash flows ending with the sale at the end of a chosen holding period, which can then be discounted back to a net present value.  The model enables the detailed input of the contractual rent roll in place and then allows the analyst to determine what happens with each tenant space after each tenant’s obligation ends, so that a projected cash flow may be created.  Argus’ real power as a projected cash flow tool lies with its ability to create “speculative renewal” assumptions, which are probabilistic weighted averages of the deal terms for two mutually exclusive outcomes: 1) the tenant stays, or 2) the tenant vacates the space and after a period of downtime a new tenant leases the space at market terms. (For greater detail on Argus model assumptions, see the attached exhibit).

After the acquisition professional has read the OM, he/she must next set out to build a new Argus valuation model or revise the broker’s model provided with the OM – either is fine, but a broker’s model likely will be somewhat positively skewed and thus may need to be revised. These models are meaningfully impacted by numerous market-based assumptions, which in each case must be set by the acquisition professional building the model.  That person may have sufficient market knowledge to do this, but usually will call local professionals (leasing and sale brokers, appraisers, principals, etc) with the goal of determining a reliable number for each key market assumption (rent, downtime, vacancy, free rent, tenant improvements, cap rates etc).  An iterative process of model assumption revision will occur until the model is satisfactorily adjusted for the acquisition professional and a valuation is derived.  Nevertheless, as the saying goes, “All models are wrong; some are useful.”  Review Commentary: Some investment professionals become myopic due to the mesmerizing affect of developing an Argus model; they become model jockeys determined to tweak assumptions until they drive the model to a winning valuation. Consequently, as an investor, its important to hear a sponsor discuss the differentiating aspects of the asset and/or the relative pricing, not just projected returns.  In this way, you can be somewhat more comfortable that the sponsor has maintained his/her perspective on the property while developing financial projections.

Market/Property/Site Tour (Most likely during Marketing Period, but often later):  The purpose of a market and property tour is to learn things that weren’t disclosed (or disclosed fully) through the Offering Memorandum. (Remember, the OM is a marketing document created by a broker). Here are the key things a prospective buyer might learn from a market, property and site tour:

  • A market tour will help the buyer understand the relative competitive advantages and disadvantages of the property versus its competitive cohort.  Primary considerations will include: a) highway access; b) proximity to executive and worker communities; c)“walkable” and property amenities; d) proximity to public transportation.  Review Commentary:  Stop a moment and think about being a tenant.  You are choosing between 5-20 spaces shown to you by a leasing broker.  In the end, you are going to choose space that has the best combination of positive factors (location, layout, amenities, etc.) within your price range, appears to be in good physical condition and is managed by a responsive management company.  This is the secret sauce moment of leasing real estate and is best understood by professionals with deep asset management experience.  Most commodity product will lease during strong leasing cycles when little available competition exists.  However, when an economic downturn occurs, commodity real estate will be much more likely to suffer high vacancy.
  • A building tour will reveal the following: a) tenant space condition; b) subleased space; c) empty or minimally occupied space; d) potential floor-plan marketability issues (heavy column use, poor hallway accessibility, excessively deep space, poorly demised space, etc); and, e) visible building physical obsolescence.  Review Commentary:  Each building tour finding will likely result in assumption changes.
  • A site tour will reveal the following:  a) pragmatic use issues of parking field and access; b) parking field/garage/sidewalk/landscaping condition; and, c) pragmatic expansion capability issues (such as grade).  Review Commentary:  Each site tour finding will likely result in either assumption changes or overall competitiveness assessment changes tied to chosen valuation metrics (cap rate, ire, etc).  For instance, many property’s access appears great until rush hour, when it becomes clear that without a traffic light no one can take a left hand turn out of the property.


At the end of the Marketing Period, the sales broker will call for offers in a blind bid format.  In a “hotter” market, the bidding pools can frequently number well over 7 bidders.  This, in turn, often results in a second (and even third) round of bids, as the bidding pool is whittled down. The broker’s most important job during this process is to help the owner to choose the highest offer from a qualified bidder.   Either price or buyer reliability/ability to close can influence who wins the deal.  The broker seeks to fan the competitive flames of the bidding pool and at the same time assess each bidder’s reputation, partially through interviews.  The following four interrelated factors distinguish the competitive bidders: a) likelihood of deal closure; b) risk that buyer “re -trades” price; c) reliability of funds available; d) deal terms, beyond price.

While often a completely above-board process, it can be filled with gamesmanship.  Most bidders will seek to create a stronger relationship with the broker and/or owner to gain insight.  Some bidders will do a comparatively more thorough pre-bid review of the transaction and attempt to woo the owner with assurances that they will honor their bid level; a buyer who evidences deep consideration of the transaction prior to bidding should be taken more seriously.  Others will purposely win the bid based on price and then negotiate the price downwards (or “re-trade” it, for any or no reason) after largely completing the due diligence process.  Compelled by “bird-in-the-hand” realities, especially as a potential buyer is ready to sign off on due diligence, many sellers will choose to accept a lowered price for the security of knowing the deal will close shortly thereafter.  Lastly, it is sometimes suggested by buyers (perhaps by the bid losers) that brokers will nudge the process in a self-interested way.  For instance, the broker might coach a buyer towards a winning bid if the buyer is a well-established client or promises the broker’s firm future management and leasing contracts on the subject property.  Each sale and circumstance is different.

Non-Binding Letter of Intent:

The bidding document issued by a potential buyer is called a “non-binding” Letter of Intent. This document covers the following key elements of the transaction to allow the Seller to reasonably assess the offer:

  • Names the asset and all related improvements clearly
  • Price
  • Underwriting details – where supportive to buyer
  • Buying entity
  • Security Deposit and related terms
  • Financing contingency (in today’s market, this is rarely utilized).
  • Source of equity
  • Due diligence period and terms
  • Closing period, usually after going “hard” with the deposit.
  • Lease and estoppel requirements
  • Survey and title requirements.
  • Approval process/contingency

While “non-binding” and often never signed by the seller, when the buyer is chosen, the non-binding Letter of Intent document is usually utilized by the appointed lawyer to draw up the Purchase Agreement. In addition, the review of this “offer” is when the parties may hash out more meaningful details of the transaction.

Pricing Decision:

As a passive investor, one should ask what drives the pricing decision made by an acquisition professional.  The truth is that the final pricing decision is an intuitive conclusion driven by many considerations. All of the following are potentially impactful pricing considerations:

  • Property Specific Issues: Between capital requirements, tenant credit issues, rollover schedules, etc, there are many issues that can impact pricing.
  • Commodity Versus Generational Asset: Much of real estate is a commodity asset without meaningfully distinguishing features.  Investment professionals often fail to calibrate pricing appropriately, based on realistic future leasing assumptions through cycles.  Nevertheless, there are many cases where buying a commodity asset is justifiable. For instance, where a buyer intends to improve that asset and sell it into a strong market or the asset is part of a “portfolio play”, where aggregating assets into a portfolio sale creates pricing arbitrage. High quality real estate in irreplaceable locations costs more for a reason. For an investor with a long time horizon, often the best way to create wealth is by letting the value compound over time. Indeed, it is this sort of asset that savvy local entrepreneurial investors hold onto for generations; hence the term “generational asset”.
  • Core, Core+, Value-Add, Opportunistic Risk Profiles: These are the accepted deal risk profiles, each with an expected return range. Generally, each higher step in this risk/return spectrum (Core to Core+ to Value-Add to Opportunistic) delivers a higher portion of its overall total return from the sale, after the property or capital structure is improved. For the acquisition professional in tune with the market, investment pricing will fall within a range based on the relative risk assessment ascribed.
  • Product Type: Especially since the advent of internet shopping and its impact on retail and industrial product, product types fall in and out of favor and consequently develop separate pricing ranges.
  • Asset Size: Different size assets are attractive to different types of buyers. For instance, a $100M asset will mainly be attractive to “institutional” buyers, who may or may not be heavily in the market.
  • Market Size: Gateway cities recognized by foreign buyers always garner a relative premium. In the same way, second-tier cities (e.g. Denver) are going to garner a premium over third-tier cities (e.g. Omaha).
  • Debt Availability: During recessions, debt scarcity can remove leveraged buyers out of the market. Alternatively, when debt is readily available at low spreads, leveraged buyers become more aggressive in their pricing.
  • Equity Capital Sources: In more recent years, alternative capital sources such as private equity and foreign funds have impacted pricing, and acquisition professionals need to be aware of this and related impacts.
  • Capital Market Alternatives: Money flows to real estate are largely dictated by capital market alternatives and the cost of financing. If institutions believe real estate is more attractive than the stock market, than it is reasonable to believe more real estate demand will exist, thus driving down cap rates.

Intuitive Pricing:  Along with the aforementioned factors, acquisition professionals consider the following: 1) conversations with other market participants, including brokers, leasing agents and other acquisition professionals; 2) their own recent acquisition reviews, and how pricing and terms were finally agreed to; and, 3) directly relevant recent sale comparable transactions. These more timely market touch points enable the acquisition person to develop a “sense” of pricing for its target asset. That risk-adjusted sense of pricing is then applied to an acquisition financial analysis, and distilled down to certain comparative cash and leveraged return metrics: Total Return (IRR), broken down by contribution coming from cash flow and reversion; Cash on Cash Returns; Cap Rate; Equity Multiples; Contractual Rent/Price Coverage. In the end, the acquisition professional is going to consider all of these issues and return metrics and make a very subjective, intuitive judgment on perceived value relative to risk. Review Commentary: Two pricing perspective thoughts to keep in mind: a) a winning bid in an auction sale means an investor paid more than any other bidder (while very rare today, this should illustrate the value of an “off-market” acquisition); b) generational and other assets with secure cash flow enable owners to comfortably sell at strategically opportunistic moments.

Objective Reality Checks:  Many acquisition professionals consider objective reality checks of their intuitive pricing decision. Any of the following may be considered:

  • A “back of the envelope” analysis can be one’s best reality check, and often is a first step valuation in the review process. The format can be a pencil and paper analysis or an EXCEL spreadsheet. Regardless, typically the analysis is a capitalized NOI valuation, reduced by appropriate “costs” required to stabilize an asset. (For instance, clear and present capital costs would be an appropriate valuation deduction).
  • Broader, more thorough review of the body of comparable sale transactions, beyond what the sales broker provides.
  • Consideration of national/regional cap rate pricing reports, subjectively calibrated for the specific circumstances of the asset and other impactful factors, such as those discussed above.
  • Rates have dropped so low that leveraged buyers can be very aggressive and competitively impactful in the bidding process. For some transactions, a professional may consider where cap rate pricing enables sufficient positive leverage to entice private equity buyers. To understand this perspective better, consider the following example:

10 year Treasuries:                                                              2.50% +

Lender Spread:                                                                     1.50%  +

Amortization Rate                                                                0.50% (30-Year Am)  +

Total Loan APR or Constant                                               4.50%  +

Equity Premium (Positive Leverage) Required               2.00%   =

NOI Yield or Cap Rate                                                             6.50%

INVESTMENT APPROVAL (Throughout Process):

Preamble Commentary: Every company has a different investment approval process, dependent largely on its’ size, client sophistication and possible conflicts. Arguably, this could be placed anywhere along this timeline/process discussion. The investment approval process has essentially four steps:

  • Initial review to determine whether the deal is worthy of chasing and to allocate to appropriate client (where potential conflicts may exist).  This first step can occur as early as post OM review by the acquisition professional.
  • The pricing/bidding decision is usually a collaborative agreement made by the investment committee or particular members of it.
  • Conditional investment approval is usually agreed to by the investment committee sometime just before or after contract execution, but is always subject to successful due diligence closure.  By that time, the acquisition group has usually gathered the key facts and assessed the transaction.  Further, the investment professional has written up an executable (for internal purposes) Investment Recommendation, which the committee has reviewed prior to meeting and got verbal approval from any other required stakeholders.
  • Lastly, final committee investment approval is issued just prior to the due diligence expiration (or the deal is killed or “re-traded”), based upon satisfactory due diligence findings.

Investment Recommendation Document: 

  • Recommendation: Price and terms
  • Asset Description: Repackaged information from OM.
  • SWOT Analysis: Some sort of higher-level strategic discussion about the property’s strengths, weaknesses, opportunities and threats.
  • Tenancy discussion: Usually reviewing larger tenants’ credit, business and any critical lease terms, particularly options which pose a threat or complication.
  • Market Analysis: Usually this will look at competitive cohort and how the asset compares for rent, comparable sales and replacement cost.
  • Financial analysis: This will be the product of an Argus (and/or EXCEL) sensitivity analysis, incorporating validated assumptions, with appropriate commentary.


Negotiations range wildly based upon certain factors: a) deal size; b) the sophistication of the parties and their legal representation; and,c) the frothiness of the market and particular bidding pool.  With a broad brush, consider the Purchase Contract as a rules-of-engagement document, where the seller and buyer establish what will happen during the due diligence and closing process, as well as how ownership will transfer. The seller should reasonably facilitate a buyer’s orderly due diligence, as they share a mutual goal: to transact. Nevertheless, Purchase Contracts get negotiated heavily, often times beyond a reasonable standard.

Since the seller more frequently will issue their contract for review, nearly all the negotiation will occur to meet the buyer’s needs and cut back on overreaching seller oriented clauses. Not surprisingly, what seems rather simple can get very complex. The “devil is in the details” and those details are being documented by risk-adverse lawyers, who get paid by the hour. The result is that I’ve seen Purchase Agreements over 100 pages long and some less than 20 pages long that were just as good, pragmatically.

Over the course of the last three decades, institutions and other sophisticated owners have gained a larger presence in the commercial real estate world. Consequently, Purchase Contracts have become more complex and seller friendly, somewhat reflecting a heightened sensitivity to risk and “sophisticated” legal representation. Nevertheless, most seasoned market participants strive to maintain an approach that gives a buyer reasonable assistance in getting a due diligence completed and a balanced document that benefits all parties. They understand the parties share a mutual goal and relationships matter.

With that in mind, let’s quickly review what should be the primary goals of each party:

  • The Buyer’s Goals: The buyer will endeavor to negotiate terms that enable: a) transmission of all due diligence information from the Seller (and Tenants); b) assurance that the financial underwriting is accurate; and c) sufficient time for due diligence and the raising of equity/debt funding.

The buyer has a meaningful complication; he or she must manage parallel processes. In addition to his or her own work, the buyer relies upon the successful work of many 3rd party consultants, and needs to allow for sufficient time to review these external reports and resolve issues. Most “institutional” acquisition due diligence includes the following reports: Physical, Environment, Title/Survey, Zoning/Compliance, as well as in certain circumstances an appraisal. Moreover, the buyer is often challenged during the process with raising money (debt/equity) and making sure the lender has reasonable time to complete its own work.

  • The Seller’s Goals: Sellers will endeavor to minimize their liability, tie the buyer tightly to the transaction and limit time. Their goal is to simply transact quickly and cleanly, and minimize the likelihood of getting sued.

Purchase Agreement:

A Purchase Agreement will contain many important sections laying out legal/ministerial elements of the transaction, that won’t be addressed here. Accordingly, it’s important to note that the following synopsis can’t possibly be comprehensive; the purpose of what follows is to provide the reader with greater familiarity with Purchase Agreements. The following are the more important business areas of a Purchase Agreement to understand/negotiate:

  • Deposit: The deposit is frequently posted in two stages: 1) contract execution; and, 2) at the end of Due Diligence. The first posting is to show the buyer’s good faith, although 100% refundable until the Due Diligence period has expired. The second deposit is posted at the end of due diligence for the purpose of more firmly tying the buyer to the transaction, by becoming 100% non-refundable and sufficiently large to dissuade a buyer from walking away from the transaction after due diligence is completed. Should the buyer default after the deposit is “hard” or non-refundable, in most cases the buyer’s liability is limited to the deposit. Conversely, should the seller default, the buyer can choose to either: a) get their deposit refunded, or b) elect to sue for “specific performance” – i.e. the right to sue to compel the sale.
  • Title and Survey: Although a part of the work of “Due Diligence” during an Inspection Period, generally Title Commitment (mostly paid by the seller) and Survey (payment negotiable) review will have a separate negotiated process and timing laid out in the Purchase Contract. In short, this is because after a Title Commitment and Survey are completed (usually much sooner than other 3rd party reports), it may be found to contain issues objectionable to a buyer, but repairable (or not) by the seller. The Title Insurance Company will issue a Title Commitment (a preliminary agreement to insure Title), subject to “exceptions” that will not be insured and conditions after which a particular exception(s) will be waived. This is not an uncommon occurrence, and may be as simple as a filed mechanic’s lien or a minor encroachment. Consequently, the Purchase Agreement will lay out a clear process for the buyer to raise objections and for the seller to respond to or repair them, within a reasonable timeframe. (In the meantime, there will be some pressure on the Title Company to make sure the exceptions posited are reasonable, as fees for the Title Company hinge on there willingness to facilitate transactions in a reasonable manner).
  • Representations and Warranties: Often this is a highly negotiated section that legally is important in theory, but rarely forms the basis for a lawsuit, when dealing with reputable organizations. For the most part, the representations and warranties affirm facts, such as: each party is legally empowered to sign the document; the seller is unaware of any compliance or governmental notices that may change the marketability of the asset, etc . That said, the buyer does have two important seller representations that it will likely require: 1) the accuracy of a rent roll and general contract exhibit(s) (content highly negotiated); and, 2) no actual knowledge of undisclosed events or notices (including environmental compliance). These are two things that arguably a buyer cannot discover through due diligence and hence a buyer must rely on honest disclosure from the seller.
  • Due Diligence (or “Inspection”) Period: This period (most typically 30-35 days, but often negotiated downwards) allows the buyer to engage and leave time to review third-party reports (often: environmental, physical, zoning/compliance, appraisal) and perform in house due diligence. The two critical related negotiated issues are timing and complete delivery of (or access to) all due diligence materials (ALL property/tenant files, former third party reports, etc). With these two things satisfactorily in place, then the way is paved for an orderly due diligence by the buyer. (This section will be discussed in greater detail below).
  • Preclosing Operation: Most importantly, this section dictates how leasing and other property contractual matters will be negotiated and executed while the property is under contract. Both parties want some level of control. In addition, it should dictate that the owner shall continue to manage the property at a high quality level, presumably as if ownership would continue beyond closing.
  • Prorations and Adjustments: This dictates how expenses and revenues will be apportioned at the time of closing. It is important to understand local conventions and underwrite and negotiate accordingly.
  • Closing Period: Generally, this period is negotiated to somewhere between 5-to-30 days. With all-cash buyers, this is almost a meaningless period of time. For buyers raising equity and debt capital, this is an important period of extended time where the buyer still is trying to button up its capital raising, despite having gone hard on its deposit and finishing due diligence. The key negotiation issue is simply time allowed.


As mentioned above, the two critical issues are timing to get work completed and complete delivery of (or access to) all due diligence materials (ALL property/tenant files, former third party reports, etc.). Fundamentally, this work takes 30-35 days. However, sometimes a buyer agrees to a shortened due diligence period, as an enticement to the Seller. The buyer accomplishes the shortening by agreeing to begin due diligence while negotiating the contract and pressing 3rd party advisors for quicker turnaround on their reports. Now let’s dig in a bit to what actually happens in due diligence.

Almost immediately, the buyer engages his third party reports, which may require more time than internal due diligence work. As a process responsibility, the third-party reports are somewhat simple. The acquisition professional must contractually engage the service provider and provide them access with all appropriate due diligence materials, which generally should include all related correspondence and old third party reports. Thereafter, the service provider must be cajoled into meeting time deadlines. Once received, the acquisition professional will review the reports for any issues, working with the service providers to assess these issues and respond to them, as appropriate.  The in-house due diligence should include the satisfactory review of the following:

  • Financial analysis validation.
  • Property and tenant file review.
  • Review of third-party reports.
  • Tenant interviews.
  • Lease review and abstracting.
  • Review of tenant (or seller) estoppels. (defined below)

Pragmatically, whether from the third-party reports or in-house due diligence, issues will be surfaced.  Then, an acquisition professional must achieve investigatory resolution, which may result in: a) satisfactory understanding and acceptance of the issue, b) a price adjustment, or c) walking away from the transaction.  The lifeblood and quality of this process is found in the focused tenacity of the acquisition professional to surface and resolve appropriate issues.  The work related to the review items is straightforward, but it’s good to keep in mind:

  • The proverbial smoking gun can often be surfaced through file review and tenant interviews.
  • A good scrubbing of expenses (and expense reimbursement revenue) by comparing historical performance to what was modeled is an important component of a sound financial review.
  • The lease review/abstracting process fulfills two key goals: 1) validation of base rental revenue; 2) full understanding tenant rights and how they interrelate.
  • The tenant estoppel process validates the findings of the lease review/abstracting process.

There are two due diligence topics worthy of further discussion:

Lease Abstracts:

First and foremost, lease abstracts document the financial terms of the lease obligation. However, the lease also documents the tenants’ and landlord’s rights/obligations beyond the boilerplate lease terms. During the lease negotiation process, the landlord will have proposed a standard lease with terms that generally are “market”, but also (at some level) lean in the landlord’s favor.   The tenant will have negotiated (at some level) those boilerplate terms and also possibly added other terms. For instance, the tenant may have negotiated for option rights (renewal, downsizing, growth, termination, ROFO, ROFR, etc), expense caps, etc. For this reason, it’s important for the abstractor to review leases more thoroughly and abstract terms, not just pick out financial terms from a lease. Further, in some cases the abstractor may need to take an additional step by tabulating all tenants’ rights (expansion, ROFO/ROFR, etc), to make sure that there are no unmanageable tenant right conflicts in the building. As with most due diligence, the quality of the abstracts is largely related to the conscientious tenacity of the acquisition professional.

Tenant Estoppels: 

If lease review/abstracting is the “belt” to financial revenue review, its’ “suspenders” are the tenant estoppels. In short, this legal document is a synopsis of the key financial terms of a tenant’s lease. In most cases, the tenant is obligated to “estop” (or acknowledge legally) to those terms discussed in the estoppel; the obligation to sign a tenant estoppel is established in their lease. By receiving a “clean” tenant estoppel, a buyer (or lender) has legal surety that a tenant acknowledges the terms (and the actual lease provided by the owner) shown on the Tenant Estoppel, as well as that there are no other agreements (verbally or in writing) conditioning the tenants’ or landlord’s obligations. Upon receipt, a Buyer reviews carefully the Estoppels against their financial underwriting. If all this information ties out, then the buyer will sign-off on this due diligence (or closing delivery) condition.

Pragmatically, the seller does not want a deal held up waiting for each and every estoppel to be signed by each and every tenant; further they don’t want tenants balking on execution because of overly intense estoppel documentation. Consequently, many things can be negotiated, including the Tenant Estoppel form/content/requirements, the percentage overall of Tenant Estoppels satisfactorily received, and required specific Tenant Estoppels regardless of percentage received (almost always the biggest anchor Tenants). Lastly, although often after failing to receive the required tenant estoppels, a seller may request the ability to provide a “seller estoppel”. In short, this is usually a short-fuse estoppel signed by the seller on behalf of a tenant who has not provided their estoppel in a timely fashion.


Presuming a successful conclusion to due diligence, the parties reorient their focus towards closing. Generally, an all-cash buyer will require about 5 days for the lawyers to prepare the closing documents and for settlement statements (pro-rations) to be prepared. During this period there may be a few estoppels coming in that remain a closing contingency.

Leveraged buyers, and especially syndicators, typically require more time.  Likely, they need time to button up documentation and lender diligence, including appraisals. Further, they are reliant on the performance of their equity money sources. Especially with syndications, herding committed investors to timely post their money can be problematic.  For these reasons, some leveraged buyers establish “bridge” facilities or maintain balance sheet flexibility for acquisition purposes.  In such cases, buyers can close more quickly and sort out debt/equity funding post closing, in a more orderly fashion.

In any event, when the funding is placed in escrow, legal documentation and settlement statements are signed the deed documentation will be brought to the registry for filing. Once deed filing is confirmed the escrowed money will be given to the seller and the transaction is complete.

Author’s Note: The author is happy to spend time on the phone or through email explaining any concepts discussed in this essay.  He can be reached through Arrow Realty Partners website:


Exhibit: Argus Model Assumptions

The Argus model is based on numerous market-based assumptions that primarily fall into four buckets, discussed below:

Primary Tenant/Market Leasing Assumptions:

  • Expected Market Rent Grown for Future CF Years
  • Expected Credit Loss Percentage (due to tenant defaults)
  • Expected Tenant Expense Reimbursement Methodology
  • Expected Length of Leases: ie 5 Years.
  • Expected Free Rent – a Tenant Incentive to Lease
  • Expected Commissions (%) Paid on New and Renewed Leases
  • Expected Space Improvement Costs for New and Renewal Leases – also known as Tenant Improvements or “TI”.
  • Expected Time Space is Vacant Assuming an Existing Tenant Moves Out – also known as “Downtime”.
  • Renewal Probability: Renewal Probability is the likelihood on a percentage basis that a tenant in the building will renew, as opposed to vacating their space. While an Argus model allows for each tenant to have explicit assumptions, such as the assumption that a tenant renews or vacates, most tenants will have a Speculative Renewal assumed. The Renewal Probability is the key assumption that dictates the weighting of the Speculative Renewal.
  • “Speculative Renewal”. When we project a 7-10 year cash flow, there is a strong likelihood that most, if not all of the tenants’ leases will expire during that timeframe; hence, the potential buyer must project costs and future cash flows related to the space that is expiring (or “rolling”). This is a weighted average projection of two mutually exclusive outcomes (new tenant or renew sitting tenant) that has a solvable result, which can best be seen by the table below. For illustrative purposes, we’ve based this upon a 5 year lease at $20/RSF rent with a 70% “renewable probability”:
70% Prob Downtime Free Rent Commission TI/PSF
New Tenant 10 Months 6 Months 6% $30/PSF
Renewal Tenant 0 Months 1 Months 2% $10/PSF
Speculative Renewal 3 Months 2.5 Months 3.25% $16/PSF

When we don’t know a tenant’s intention upon their lease expiration, we project a notional lease that has a 70% probability of renewal and a 30% probability that the old tenant moves out and afterwards we lease the space to a New Tenant. Hence, based upon the above weighted average table, we would “speculatively renew” a notional 5-year lease at $20/RSF rent to commence 3 months after the previous lease has expired (“Speculative Downtime”). We would give that speculative tenant 2.5 months of Free Rent and $16/RSF in Tenant Improvement dollars; we would pay the broker a 3.25% commission on the deal. In essence, this cash flow projection makes sure that the model isn’t too aggressive (assuming all tenants renew) and too conservative (assuming all tenants vacate), but instead projects a reasonable compromise.

Operating Expense and Expense Reimbursement Assumptions:

Operating Expenses should be based on historical operations, grown for future inflation and adjusted for known, or expected changes; by way of example, a typical expense change might be for taxes, based upon expected adjustment to a property’s tax assessment after a sale.

Operating Expense Reimbursements are paid by a tenant to the Owner, and are based upon complicated nuances and terms that can be input into the Argus model. Despite often having some underlying complexity, they typically fall under two general operating expense reimbursement methodologies:

  • Gross Rent with Base Year Expense Stop: This lease format calls for the Tenant to pay a negotiated monthly “gross” rent that includes the full amount of operating expenses for the first full year. The amount attributable to operating expenses (including taxes) for the first full year is called the “Base Year Expense Stop”. In future years, a tenant will pay the amount of expenses that exceed the original Base Year Expense Stop.
  • Net Rent: Rather than utilizing the convention above, the Tenant will pay from day one it’s full pro-rata (percentage share of building based on square feet) portion of the building expenses, along with a negotiated Net Rent.
  • Demystifying the two: Spend a moment to consider these two rent-paying methodologies. Conceptually, they should be a mathematical identity. Said another way, Gross Rent minus its Expense Stop should equal Net Rent. However, in reality, a Net Rent is negotiated and notionally provides an owner the surety of being reimbursed for all operating expenses attributable to a tenant space above the Net Rent. The Tenant takes the risk throughout the lease term that expenses are higher than the Owner’s originally provided estimate. If expenses are higher than expected, then the Tenant must pay for that surplus. Conversely, with a Gross Rent, if the Base Year Expense Stop is higher than expected at the time the Gross Rent is negotiated, the Owner will “net” less rent. With Gross Rents, the Owner takes on the risk that expenses will be higher than expected, in the first year of the lease, but thereafter the Tenant pays for any expense growth.

Valuation Assumptions:

Valuation in an Argus model is accomplished through a Net Present Value (NPV) calculation, driven by a Discount Rate (or Total Return Rate) and an Exit Cap Rate. Typically, valuation will be presented in a sensitivity table, showing how value changes with various combination/ranges of Exit Cap Rates and Total Returns.

  • Cap Rate: A cap rate is the inverse of an “earnings multiple”. Valuation is calculated by dividing a property’s stabilized Net Operating Income (“NOI”) by a cap rate to derive a valuation, which should be reduced by the estimated cost to get to a stabilized NOI. The choice of an appropriate cap rate is a market-based decision, which is strongly impacted by interest rate levels, money supply available for investment in real estate (equity/debt) and the particular product type being considered. A stabilized valuation utilizes a Cap Rate.
  • Exit Cap Rate: An exit cap rate is the cap rate applied to the last (or the year after) annual Net Operating Income for an investment holding period, in order to calculate a projected sale of an investment. Typically acquisition professionals derive an Exit Cap rate by adding 10 to 50 basis points to the entry cap rate. This more conservative number theoretically reflects the risk of unknown future changes to valuation metrics and the property.
  • Total Return Rate (or Discount Rate or IRR): Total Return Rate is the expected investment return based on the stream of cash flows generated by the investment and reflecting the original investment cost and proceeds from sale.

Property Related and Growth/Inflation Assumptions:

  • Stabilized Vacancy: Many investors choose to utilize a notional stabilized vacancy rate, which means the cash flows will be reduced to reflect lower revenue for a certain portion of the building always being vacant. (Although usually set at one figure for the investment time frame, it can be set differently for each year).
  • Capital Reserve: Most investors will charge the property an annual capital reserve amount to provide for future, but presently unknown costs (or costs expected to be paid after the investment time horizon).
  • Capital Costs: An investor will usually charge the property for all capital replacement costs expected during the investment time horizon, or at least the earlier years of the projected holding period.
  • Revenue Growth: Typically 2-3%. However, investors will often project meaningfully stronger market rent growth, based on positive market dynamics.
  • Expense and Tax Growth: Typically 2-3%, except where tax assessments are expected to increase based upon the purchase.

Review Commentary: The author provides this review of Argus assumptions for two reasons: 1) to act as a future resource; and, 2) to help the passive investor to understand that projected returns generated by an Argus model are only as good as the input assumptions . The goal of every “base-case” model should be to have achievable assumptions – neither too positively or negatively skewed.  From there, sensitivity analyses can be run.


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