Commercial real estate owners and operators in all parts of the country are dealing with a market recalibration as property values decline. With ongoing uncertainties about expenses and revenues, many property owners are being forced to rethink the actual values of their assets.
But without accurate data and credible information to determine the catalysts of rising expenses and diminishing revenues, it can be increasingly difficult for a borrower to discover the value of a property. It is equally likely that the cause of decreasing cash flow is either internal or external — or a perfect storm of both.
Commercial mortgage originators can help borrowers find their way to better data analysis by introducing them to and helping them understand the value of commercial property performance benchmarks. In any trade, a gauge is vital to consistently produce the highest-quality observations and results. In the commercial real estate space, benchmarks are among the most useful tools to measure the performance of real assets.
Originators can work with their clients to pull data and interpret results. With the answers in hand, operators can develop an optimization strategy and all parties can confidently move forward with financing efforts.
Real estate benchmarks consist of external property data associated with various measurements, including market rents, occupancy rates, operating expenses and net operating income. This data is collected from management teams for assets across a range of sizes, features, locations and classes.
The data is then organized and analyzed to identify trends and typical benchmark ranges. Owners can compare the benchmarks against their internal property data, with the results helping them to identify areas of operational improvements or strategic changes to maximize market trends. The subsequent decisionmaking tree will differ depending on the answers and the principals’ objectives.
Benchmarks, however, are beneficial for more than asset optimization. They are indispensable in assessing the value of a single property or portfolio in the acquisition, refinance or disposition processes. They can also help to narrow the bid-ask spread and identify value-add opportunities. During times when valuations are in flux, benchmarks can help borrowers get a better idea of a property’s true value.
Property performance benchmarks have been around for years, but the size and quality of these datasets have grown substantially due to recent technological innovations. Organizations such as the Institute of Real Estate Management, the National Apartment Association, and the Building Owners and Managers Association, regularly collect and report data tied to commercial real estate, including multifamily, office, industrial and other types of assets.
Collection and analysis
Benchmarks do not offer much utility unless operators possess quantitative data to understand the performance of any properties to be acquired and can then compare this information to marketwide data points. Gathering this external data, however, can take significant time and labor. It requires coordination between management teams, especially when the owners are benchmarking a portfolio of assets.
Once the information is assembled, it can be analyzed to prepare the necessary data points for comparison. For assets or portfolios on a midsize or large scale, this analytical work requires specialized expertise. Therefore, whether hiring internally or contracting with third parties, the retention of data analysts (or data scientists for more complex portfolios) is a prudent move to draw the needed points and conclusions from the raw datasets.
This is an area where innovation can create greater efficiency, clarity and results. Industry-specific data and asset management platforms connect all systems or silos where data is housed. They automatically aggregate, organize and analyze the data, then report the key performance indicators (KPIs) and insights. While it’s not a substitute for seasoned analysts and decisionmakers, technology can significantly streamline the benchmarking and optimization process.
With internal data for their own properties in hand, the next step for operators is to identify the groups of external assets for comparison, aka “competitive sets.” Comparing owned asset data to that of a properly assembled competitive set allows a borrower to objectively view the value of their properties and how they’re performing relative to the rest of the market.
For instance, if internal revenues are down year over year but are on par with the rest of the market, this provides a clue that the property is being well run and any change in value may be tied to external factors. Conversely, when these metrics fall short of market averages, it can signify that attention is needed internally.
Determining which properties comprise the competitive set is an important component of the benchmarking process. While the perceived sets are typically those with similar superficial characteristics (i.e., asset type, location or size), the actual set may include properties with similar operational parameters that can be statistically identified. Mortgage originators should seek out team members or advisors with experience in collecting and analyzing benchmark data and grouping it for effective comparisons.
Once the competitive set is defined and the data is prepared, the owner or asset manager can then determine how the property compares with similar assets from a revenue or expense standpoint. If the property is in the top quartile across the board, it is doing pretty well. But if it is in the bottom quartile, it is clear that work needs to be done.
Owners and operators should concentrate their attention and efforts in areas where they can influence results. Some data points or KPIs to look at on the income side include net effective rents, gross rents, rent adjustments, and losses or gains to lease rates. In regard to outflows, it pays to compare management costs along with the expenses of leasing, utilities, insurance, taxes and maintenance.
Revenue as a percentage of operations is a crucial measurement and a high-level point of comparison. It is valuable to know by what percentage revenues exceed or fall short of expenses. Expense ratios are another critical group of metrics to evaluate in the controllable expense line.
Another important benchmark is to look at the level of cumulative or specific expenses that are being consumed as a percentage of the gross operating income. The analysis will let a borrower know whether the property is being managed efficiently, and if the geographic market is favorable in terms of typical operating costs that are influenced by location-specific variables such as taxes, materials and labor.
In addition to providing the basis for assessing the performance of a particular asset, market lease rates and occupancy metrics help owners understand the strength of the subject market and other geographic areas. The data points uncover how much upward potential there may be for rent increases, and they are instrumental in the due-diligence process for acquisitions.
Strategy and decisionmaking
Commercial mortgage originators need to keep in mind that the purpose of this entire process is strategic planning and decisionmaking. Whether for optimization, acquisition, disposition, refinance or other initiatives, benchmarking equips the broker and borrower with knowledge of where an asset or portfolio stands in respect to the broader market.
For each of these objectives, a strategy powered by technological innovation and management is best served by the insights gained through benchmarking. Knowing the KPIs through internal benchmarking and comparing them to the market as a whole creates a starting point for finding both problems and solutions. But from there, a framework is required to efficiently plan optimization efforts and align team members across an organization with a clear vision and unified approach.
An ideal framework for using this new information is objectives and key results (OKRs). These are tools used by companies to set goals and create the steps to reach them. OKRs encompass key performance indicators, which can be used to measure the results of how the company did in achieving its set goals. This process is complex, but there are many resources available to plan and implement an OKR-driven strategy.
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The U.S. economy is testing the resolve of all stakeholders in the commercial real estate industry, with property owners and potential buyers positioning themselves to take advantage of this time of fluctuating values. Benchmarks are both a ruler and a compass that equip commercial mortgage originators and their clients with tools to navigate murky market conditions. They’ll be more likely to gain a true sense of direction in their pursuit of stability and growth, despite the upswells in mortgage rates and expenses. ●