Acquisition Due Diligence
First Rule-of-Thumb: Don't Buy the NOI
This is why you should buy Rental Revenue and Cash Flow instead.
Second Rule-of-Thumb: Buy Rental Revenue and Cash Flow
In order to evaluate the income producing potential of the asset it's necessary to examine revenue, prior to expense or reimbursement considerations.
Separating Scheduled Rental Revenue and Cash Flow from the NOI is why you must do a lease-by-lease cash flow analysis.
Third Rule-of-Thumb: Lease-by-Lease Cash Flow Analysis
The real driving force is the lease itself, as well as the cash flow derived from it. Since each lease and every space is a separate profit center, the sum of these profit centers is the economic value of an asset. Hence, the reason a cash flow analysis must be done on a lease by lease basis. Furthermore why sophisticated software, such as ARGUS, is needed to do these models.
In addition to arriving at a good and fair price, a cash flow analysis also reveals the marketing and leasing patterns that gives rise to these cash flows.
These patterns inform them whether there's room for immediate revenue improvements or more cost effective ways of managing the asset, for example. If not immediate, they can help develop the long range marketing and leasing strategy needed to enhance the future value of the asset.
All of this makes for a strategic approach to Acquisition Due Diligence.
This strategic approach was used to value a historic, 1901 office building in the heart of downtown Denver. Rather than wait for the current owners to finish improving and reletting key space in the building, we were able to establish its value upon completion, accounting for the capital improvements and leasing costs of getting there. The net result was a "net equivalent" price. To the untrained eye, it may appear "expensive" today, but it will actually prove to be an astute investment tomorrow.
Everyone got what they wanted, the current owners were offered the highest fair market value (without having to do the work), while the buyers were assured of not paying too high a price. A classic example of Acquisition Due Diligence.
As for the Rest . . .
After a lease by lease cash flow analysis is performed on each profit center, and after a thorough analysis of reserves for rollover, then it's time to focus on operating expenses, reimbursements and the NOI. The rest will take care of itself.
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