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Does Your Pro-forma Still Work?
Developers, investors and landlords of commercial property routinely use a tool called a "pro-forma" for planning current and future developments. Done prior to a project, it serves as a financial model and forecast for an actual transaction in order to estimate and evaluate the terms, pricing and final costs of an asset.
By using a pro-forma, these owners get a better sense of the details of the project in order to gauge their ability to proceed and make a sound decision based on their personal investment goals.
Going into a development with a predetermined exit strategy makes the developer, and sometimes more importantly a lender, gain a higher level of comfort with the project as a whole.
But with a shift in today's commercial real estate investment market, what are some of the indicators that may play a role in today's pro-forma that were not in yesterday's? Additionally, how can the projects that were started a year or two ago with different market indicators and influences be affected today by the revised perception of investors?
The answer: an amalgamation of many factors including lending practices, retail sales, capitalization rate fluctuations, construction costs, county imposed impact fees, demographic changes and the psychology of today's investment climate.
For investors
Real Capital Analytics Inc. recently reported that overall real estate investment sales volume was at an all-time high of roughly $300 billion for transactions of $5 million or greater for 2007. It is estimated that if you count transactions under $5 million, then that total would increase by roughly two and half times.
It should be noted, however, that single-tenant, net-lease commercial transactions had their first slowdown in seven years, dropping roughly $6 billion in 2007 with retail assets such as Wal-Marts and bank locations showing a more prominent decline. This trend is mainly attributed to the commercial mortgage-backed securities market and the lack of availability for aggressively priced debt.
When capitalization rates trended downward, meaning an investor's yield declines, investors were forced to find a loan that would support the higher-priced, lower-yielding asset(s).
Over the last several years, conduit loans, or CMBS loans, provided that mechanism for investors as they were providing very low interest rate loans that allowed an investor's low CAP rate transaction to remain within their investment guidelines. However, now that the credit market "shakeup" has essentially taken away the CMBS option, there are different lending sources for investment real estate that comply with more conservative underwriting standards.
Therefore, aggressively priced assets are having a harder time being financed without access to CMBS debt.
There is no doubt that the media coverage being given to real estate today is heavily geared toward residential homes and foreclosures. While commercial real estate has fared considerably better -- only .5 percent of CMBS loans defaulted in 2007, as reported by Trepp LLC -- real estate is generally pooled into one category and is therefore seen as a considerable risk.
Commercial real estate data proves, to the contrary, that there are still sound intrinsic variables that allow investors, developers and landlords to make productive decisions about their assets. What they have to be more considerate of is the variability of market perceptions and conservatism within their pro-forma.
For Developers
Construction costs have always risen over time. However, today's market has seen a significant increase in construction costs in a very short period, which may drastically impact a developer's pro-forma.
David Cox, real estate manager of Opus South in Tampa, recently reported that the costs of diesel fuel, steel and copper all have international requirements and are therefore driving the prices up on those commodities. He states, "The end result is that we have to include those costs in our pro-forma because they are directly related to the construction of our projects."
When initiating a pro-forma, lenders are more closely scrutinizing the underwriting process of the developer's loan, placing additional emphasis on the strength of the tenant occupying the building, the experience of the developer and their ability to perform within this environment as well as the impact fees that are charged to the developer at the end of a project.
Brad Douglas, principal of HuntDouglas Development, said, "Less development is occurring in the Tampa area and municipalities are not receiving the influx of impact fees that they once were." He continued, "We foresee local governments increasing their impact fees in the short term in order to compensate for the reduced income from the lack of projects being initiated."
For landlords
Retail sales and demographic shifts are being closely watched. The overall sentiment of landlords states the stronger the economic market, the more viable their real estate investments become.
Claritas Inc., which tracks demographic and economic data, stated that from 2000 to 2007, the Tampa area, as defined by the U.S. Census, was ranked as the eighth city in the United States for demographic growth, taking into account household income, population growth and job growth. Tampa follows cities such as Las Vegas, Washington and San Diego.
With the macroeconomic perception of the United States taking an uncertain turn, strong locations help landlords with their future pro-formas in order to plan for potential vacancies and rental increases.
Overall, the Tampa area commercial real estate investment market will weather this period well. However, the pro-formas being drafted today may be slightly altered to comply with today's market influences.
David Sobelman is VP of Calkain Companies.
About the Author
David Sobelman is charged with the responsibility of managing Calkain Realty Advisors, the private markets division of Calkain Companies.
David focuses on single tenant retail, industrial, and office net leased transactions. He is instrumental in keeping the trends of the national and regional real estate markets in the forefront of Calkain’s client’s overall property evaluation.