Identifying CRE Operating Challenges, Managing Risk, and Knowing When to Sell

Reaching peak NOI as a commercial real estate operator or investor is contingent upon spotting operating challenges before they become barriers or derailers. Owners and operators must know where to focus efforts to optimize performance, improve valuations, reduce exposure, and reposition the property. Empowered with data, you can determine in which regions and property types have the most upside.

This article will explore market and operational factors that affect cash flow, measuring and comparing performance, moderating risk, and repositioning or exiting when it’s the prudent decision.

1. Market factors vs. operational issues

Before making improvements, you must build an awareness of the various elements of the market and your operations that affect portfolio growth. Factors that influence the performance of assets into can be classified in two categories: internal and external.

Internal factors are those you can, in most cases, exercise direct control over. These include operational expenses, property condition, management efficiency and proficiency, tenant satisfaction, and more. On the flip side, external factors include prevailing lease rates, asset demand, inflation, the Fed funds rate, labor/employment/income/population growth, tenant/user trends, and many other considerations.

Some factors, such as occupancy and lease rates, ride the line between internal and external. While the market dictates effective rents and the overall demand for space, you play a tremendous role in ensuring your properties are in suitable condition and possess the ideal amenities to create a competitive advantage that secures a favorable share of demand at market rates.

2. Performance measurement and data collection

Recognizing market and operational factors, you can start the process of measuring performance. While there are a few areas of operations where you can measure qualitatively or anecdotally (i.e., via personal observation), accurate quantitative (numerical) data fuels decision-making and makes a solid case to partners, lenders, investors and other stakeholders.

For real estate operators, data represents the facts — the truth of how you’re performing and utilizing your capital. The challenges for most owners and investors are gathering, organizing, centrally storing, and efficiently interpreting the data.

If your firm still uses legacy property management and accounting software or Excel spreadsheets, it can take time and expense to assemble the data. Consider implementing a data management system specific to commercial real estate to unify your data and make it easier to analyze and leverage for decision-making.

What types of data should you collect?

There are myriad internal data points in CRE operations, and some of the most relevant in measuring performance include:

Income

• Net operating income (NOI)
• Gross potential rent
• Gross rents
• Rent adjustments
• Net effective rent
• Loss or gain to lease
• Additional revenue

Tenancy

• Vacancy/occupancy
• Tenant turnover/satisfaction
• Re-leasing costs

Expenses

• Operating expenses
• Management fees
• Leasing expenses
• Taxes and insurance
• Repairs and maintenance
• Utilities

On the external/market side, metrics to collect data on include:

• Occupancy rates
• Lease rates
• Lease default rates
• Space absorption rates
• Rent growth
• Population growth
• Employment growth
• Construction starts  

Various professional/trade organizations and publications collect this data, and where needed, consult your broker for information sources.

3. Leveraging performance benchmarks

Often, having data regarding various performance metrics isn’t sufficient to determine how well you’re doing. Without an objective frame of reference, we may be unable to differentiate superior from sub-par performance.

Fortunately, the CRE industry solved this challenge decades ago. Organizations such as NAA and IREM publish annual property performance benchmarks that gather data directly from thousands of operators and properties across regions and asset classes. An experienced broker is a valuable ally in gathering and interpreting these and other data sources relevant to your market, asset class, and objectives.

Comparing asset-level KPIs to benchmark data allows you to see where your properties fall on the performance spectrum. Without external comparison, you may think you’re doing okay — particularly if NOI is already reasonably positive.

But once you see the potential other owners and operators have reached, weaknesses and opportunities become apparent. You’ll know there’s room to optimize and widen your profit margin to the limit.

4. Risk management, repositioning, and timing your exit

Measuring performance and referencing benchmarks also helps manage risk as you scale by enhancing situational awareness and decision-making capacity — ensuring you run lean, leave ample margin for market corrections, and reserve funds for Capex.

With the insights gathered, you can chart a fact-based, defensible path to repositioning assets (optimizing rents and expenses, physical improvements, enhancing amenities, etc.) that appeals to tenants, lenders, and other stakeholders.

Portfolio and brand growth is reliant upon positioning ventures as ‘data-driven.’ Lenders and investors do value and require positive NOI as a qualifier for underwriting; however, they also need to know you’re on a stable upward trajectory backed by scientific data.

Likewise, business plans, pitch decks, and offering memorandums must demonstrate you’re equipped to weather market volatility with data and analysis that allows you to embrace emerging opportunities and sidestep threats.

Looking at a range of vetted market data also guides toward regions with ideal demand factors and minimal economic risk (e.g., low lease default and vacancy rates; rising populations/incomes). When all signs point to exit, you’ll know where to start the next feasibility study and invest capital for optimal returns and managed exposure.

Fostering Growth

Most operating challenges, particularly those restricting NOI, can be identified and overcome by analyzing your processes and the market with actionable data. Get started by considering all the relevant internal and external factors that influence growth, then collect data accordingly and compare your KPIs to industry benchmarks for similar properties.

Though requiring some time and incurring moderate expense, these strategies foster portfolio growth, improved cash flow, enhanced valuations, credibility among investors, and situational awareness. For support and efficiency in gathering the data, making sense of it, and defining a repositioning or exit strategy that meets your objectives, partner with an expert in your asset class.