Looking at an off market office property, owner has owned for 10 years, and has not done a PCR since they originally purchased it. 70's vintage, definitely B/B- quality, walked the property last week and it definitely needs capex, both elective and required.
That being said, without having the benefit of a current PCR with a 10-year replacement cost analysis, I am unable to accurately bake in the capital upfront. My response to the owner was that I would underwrite as is, and whatever comes back needs to be addressed via owner credit (most likely) or owner doing the work themselves (less likely).
Where it gets tricky is determining just how much of the capital recommendations would the buyer be justified in asking for back as a credit? The PCR runs a 10 year schedule, based on recommended year. Strategically, should I address the entire 10 years? Do I use some form of NPV argument and run it against the full 10 years so that items in years 7-10 are being captured but maybe not at 100%? Just curious how others approach this. The play here is a 4-5 years value add, but I still need to be looking at capital after year 5 as we would likely need to address this to the next buyer.
Thanks
I'll play devil's advocate here to help you think through it.
Generally, as an owner, I don't provide engineering or needs reports to buyers. You, as the buyer, should have your own PCA done as a part of your DD. You should walk the property with your construction guy or whoever you trust with this sort of thing and budget for that as a part of your offer; if you find something material during your DD we can discuss a price credit or me fixing it, but I'm not going to give you any of that without some bids or some way of bracketing that costs, i.e. you can't tell me the asset needs ~$200k worth of work without some sort of evidence to substantiate that claim. I generally don't give a shit if you think the thing will need a new roof in year 3, that is your problem to account for.
You just need to budget for all of these things in your reserve tables and your upfront underwriting before you make an offer. If you find something material then retrade, but you better have evidence to back that up and that is just the starting point of the negotiation. ADA/ fire/ life safety issues are all cut and dry and the seller should fix or give a credit, everything else is shades of grey. Owner may still tell you to get fucked, but that would be how I would approach it.
Hope that helps and good luck.
I have found typically on listed deals, if there is capital required then the broker advises the seller to have third party reports done and they are provided during the later rounds of bidding. They want to know that the buyer is accounting for that capital.
Absent a PCA, I can't say whether capital is $200,000 or $2M. And as a buyer, I won't spend money on a PCA until I'm under contract.
Fair enough, I just know we wouldn't give them to you. We'll tell you what work we've done over the last 2-3 years, but there is no way I'm giving you a third party report that outlines everything wrong with the property. I'd generally expect a buyer to have that done during their DD. In my mind you should have some number from your construction team (or whoever) before making an offer. I would expect buyers to U/W whatever capital they think the property needs as a part of their offer; I'm just not going to tell you what that number is as a seller. That's my groups take / philosophy, and your view may vary and I totally get that, just wanted you to know where I was coming from.
On the buy-side, we always try and bracket the capex and/or deferred needs at the asset before submitting an offer, and then have a PCA performed as part of our DD (otherwise how else do you know what to budget for before going hard). That being said (and I am literally having to do this today on a live deal) if we find material issues that we did not account for, we have to negotiate either a price cut or the seller needs to do the work; it isn't fun to do and obviously the seller hates it but you have an obligation to your investors.
We don't provide reports either FWIW. It's assumed that you would have a pretty good idea from touring what generally needs to be done if you're experienced.
A good tip is to have a PM/AM walk through it with you if possible to get a second pair of eyes real-time prior to offering/going UC. If that's not doable, send the OM to your team internally or any 3rd parties you work with prior to going under contract (telling them that it's confidential of course), and ask them to give you a ball-park based on the OM and your notes from the walk. That way you can say you did some thinking up front. Then if something comes back egregiously wrong/funky in the reports, at least you can say you thought you accounted for it but this is beyond normal scope, etc.
Yep, that's how we do it.
If we're serious about a deal and taking a hard run at it, I'll send some one from property management, Asset Management, construction, and I'll even try to push key investment committee folks to go through it or at least vet it thoroughly with them. Never want to get into DD and have some person on your team tank the deal because they "didn't realize how bad a shape it was in". That's just good internal deal management. Helps on a buyer interview call to be able to outline that and get the seller comfortable with your grasp of the capital needs and your ability to close.
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