5 Ways to Juice your CRE Model (without actually juicing it)

Any deal done today should include unmodeled upside

There are times when pencil sharpening is needed to win deals.

Now is not one of them.

Any new CRE investment today should include "unmodeled upside," which sets you up to outperform expectations.

Here are 5 ways to "juice the model" without actually juicing it.

1) Tenant buyouts

Realizing the value trapped in below market leases is a great way to outperform the model, but including them in your base case creates tremendous operational pressure.

Because most of the time you can't suss out a tenant's willingness to accept a buyout during due diligence.

Make sure that you can fund the buyout though, since nothing dampens the benefit of a juicy buyout like having to do a capital call to come up with the cash.

2) Bedroom conversions

A tried and true move in multifamily investing is turning oversized studios into 1-bedrooms, 1s into 2s, etc.

These projects often have attractive ROIs, but can also be tricky to execute without ending up with awkward layouts.

We have underwritten many deals in San Francisco where owners were overzealous during the roommate boom of the 2010s, resulting in tiny bedrooms, tiny living rooms or both. These units struggle to lease in slow markets.

If you have to assume bedroom conversions to make a deal work right now, it's either the wrong deal or the wrong price.

3) NNN pass throughs

In states like California where an owner's tax basis resets at purchase, NNN (“Triple Net”) and other commercial leases allow a portion of the new tax cost to be passed through to tenants.

And while legally allowable by the terms of the lease, not all tenants can actually absorb the higher rent payments.

This is especially true for mom and pop retailers, where many sign NNN leases without fully understanding the terms.

Underwriting these passthroughs in your base case boxes you in, and you may end up with an unexpected vacancy if you push too hard for big passthroughs because the model says you have to.

Better to underwrite without these passthroughs to a) provide a clear path to upside if you can get them through and b) offer negotiating flexibility without being beholden to rosy-eyed modeling assumptions.

4) Operating Expense reductions

Its tempting to assume that you can out-operate a seller, shave some operating expenses off the P&L, and boost NOI.

Small savings can have a big impact on capitalized value, improving returns or allowing you to push your bid to win the deal.

But this is dangerous for two reasons.

First, most operating expenses are hard or impossible to control (taxes, insurance, utilities, etc), so the share of expenses you can actually impact are relatively small.

Second, if you run the building too tight, an eventual buyer may tack on expense cushion to their model, negating the benefit of your hard work.

Leave this in the "upside surprise" bucket.

5) Reserves

Good models start with healthy reserves, and good underwriters resist the temptation to shave down these reserves to eek out a few extra dollars of purchase price.

Stay sway from fine tuning reserve amounts and you'll be pleasantly surprised when you consistently beat the model.