Preservation of wealth is at the core of every investment decision made by the family office (FO). When it comes to commercial real estate (CRE) however, many family offices entering the world of CRE for the first time, at least on a direct investment basis, may still be risking losses through lack of due diligence.
Many FO investors will be experiencing unprecedented economic uncertainty and market volatility; quantitative tightening policy from the federal government continues to put pressure on profits and the closure of two UJS banks in the past week has heightened uneasiness. Geopolitical risks and strides towards digitalization are further challenges that also seem to be presenting risks for the family office simultaneously; effective due diligence then, is one thing that is actually within the control of investors aiming to minimize risk.
How is Due Diligence Important to Family Office Investment?
Due diligence allows family offices to thoroughly evaluate the risks associated with a potential real estate investment. This includes evaluating the property's condition, history of financial performance, market trends, and ensuring legal and regulatory compliance is covered from every perspective. Understanding the potential risks can help family offices make informed investment decisions and minimize the risk of losses.
Family offices need to verify the accuracy of information provided by the seller or broker. This includes financial statements, leases, and other important documents pertaining to the sale. Ensuring the accuracy of this information can help family offices negotiate the best possible price and avoid costly surprises after closing.
Undertaking due diligence can also help family offices identify opportunities to add value to the property or uncover ways in which to improve its financial performance. This includes identifying potential cost savings, negotiating better lease terms, or identifying untapped revenue streams. These opportunities can help family offices maximize their return on investment.
Legal and Regulatory Compliance
Due diligence is also important for ensuring that the property is in compliance with all relevant laws and regulations. This includes zoning laws, building codes, and environmental regulations. Ensuring compliance can help family offices avoid costly fines and penalties, as well as potential legal disputes.
Why Does Due Diligence Present a Challenge for Some Family Offices?
Although family offices understand the potential for CRE investment and most have incorporated it into their portfolios for some time, due diligence may not be as thorough as it could be still. Family offices often haven’t started out with real estate and as such they lack the expertise and resources to do adequate analysis but still the majority opt to undertake due diligence internally rather than recruiting outside professionals to manage the process. Without dedicated and experienced internal resources, it’s difficult to make informed investment decisions and mitigate potential losses.
CRE deals are complex, typically requiring the input of many professions across real estate consultancy, accounting, legal, engineering and environmental sciences. It’s doubtful that a family office would have all these skills in-house unlike a large institutional investor and as family offices manage multiple competing interests and a diverse range of assets, they can find the whole process very time consuming. Of course, many FOs are embracing software to assist them in their real estate due diligence, however as a standalone solution, it lacks the depth of scrutiny that commercial property investment demands.
Solid Due Diligence Negates CRE Losses
Family offices, like any other type of investor, can experience losses in commercial real estate investments for a variety of reasons; losses may arise from;
Changes in market conditions: Fluctuations in the real estate market can impact the value of a property, and investors who buy or sell at the wrong time can suffer losses;
Inexperienced management: inexperienced investors or property managers may make poor decisions that lead to financial losses;
Unforeseen events: natural disasters, changes in zoning laws, or other unexpected events can impact the value and profitability of a commercial property.
In many ways, due diligence underpins many of the variables that can make or break an investment and the investor's objectives, experience, and risk tolerance also all have an impact. However, careful due diligence, experienced management, and a thorough understanding of the market can help minimize the risks of commercial real estate investments. Clearly, no CRE broker can foresee a natural disaster, but they are the ones with an ‘ear to the ground’ on every other factor and are best placed to advise family offices on anything that may negatively or positively impact their investment. Real estate decisions need to be made quickly in a competitive environment and CRE professionals can help investors analyze a property swiftly and in detail including the unpicking of local development changes in the pipeline such as the proposed Ontario ‘More Homes Built Faster Act’ and what it could mean for developers and investors alike.
Investment Questions for the Family Office to Ask
As a start, family office representatives or their real estate advisors should be asking some basic questions about how location decisions are made, do they think a more pronounced downturn will happen and what will they be doing about it?
Further investigatory questions may be…what’s the demand in this market right now? And how many similar properties are there in the development pipeline locally?
Multifamily is typically the biggest real estate asset class in a FO’s portfolio and still a very appealing asset class for family office investors; somewhat shielded from the effects of a downturn and stable occupancy for the most part, but lack of supply makes it hard to come by. Questions that may be asked about a potential multifamily investment include:
How do you choose the type of multifamily asset?
How does the Toronto market compare to other regions?
Is the population increasing in the area?
Is the local economy growing?
Is the area already well established or ‘up-and-coming’?
What are the transport links like and what improvements are planned?
What’s the best and worst case scenario in terms of fluctuations in occupancy and CAP rates?
These questions may give a starting point for investment but evaluation should not stop there.
Evaluate, Then Some More
In summary, due diligence is critical for family offices to make informed investment decisions in real estate. While FOs are not neglecting due diligence completely, it can be lacking depth and a human touch. By thoroughly evaluating the risks and opportunities associated with a potential investment, family offices can maximize their return on investment while minimizing the risk of losses.
Lean on our commercial real estate expertise in the GTA, gained across 20 years’ of experience supporting family office investors in achieving their real estate goals - reach out today for a consultation.