More often than not, real estate investment decisions are made based on two simple considerations – an investment property's current ability to generate a healthy return and the asset's future potential to produce a stable yield. However, when 'value investing' in real estate, the logic does not apply. Value investing considers the underlying intrinsic value of an asset, requires vision, and also commands a higher appetite for risk (which correlates to higher returns). In short, the opportunity to make a profitable investment occurs when the purchase price of the asset is less than the replacement cost of the asset. Consequently, the role of an effective acquisition strategy in value investing is vital. Every dollar saved, from negotiating the purchase price to minimizing the cost of performing due diligence, impacts total return and shareholder value.
Five basic steps during the acquisition phase
- Market Analysis. To make an informed investment decision, it is critical to intimately understand the local rental market. This means researching economic trends, understanding what generates rental demand, being aware of new supply (both proposed and under construction), and knowing new developments in the community that impact all of the above.
- Operational Assessment of the Asset. Although current operating performance may be less meaningful in value investing than yield investing (as properties are often mismanaged or dilapidated), it is still an important step in the acquisition phase to understand where efficiencies and cost-savings can be created. Also, anything red flagged during this initial assessment should be reviewed in detail during formal due diligence.
- Tie Up the Deal. Once confident in all market research conducted and comfortable with the asset itself, the purchase price, the terms of the deal, and the initial operational assessment, it is time to conditionally tie up the deal.
- Formal Due Diligence. Once the deal is conditionally tied up, formal due diligence should be performed. This includes a comprehensive review and inspection of the physical asset, of any financial obligations that will be assumed, of the environmental condition of the building and site, and of any legal implications (zoning, illegal suites, restrictive covenants, etc.). During this stage, negotiating price reductions based on report findings and effectively minimizing costs create additional value by reducing the total cost of acquisition.
- Closing. Once fully satisfied with report findings during due diligence and corresponding price reductions and/or associated risks, it is time to close. Again, by ensuring diligent and thorough execution of steps one through four, the closing process can be expedited, which minimizes legal fees and further impacts the total cost of acquisition.
By deploying a systematic and efficient acquisition strategy, the value created in a real estate investment can be enhanced. Ensuring that a potential investment is in the right market/neighbourhood, is the right asset, and has the right deal terms in advance greatly reduces the time it takes to make an acquisition. In turn, this increases the chances of making a profitable investment. Conversely, a less methodical approach is often associated with higher (or unnecessary) due diligence costs, excessive legal fees, increased holding costs, thereby decreasing the likelihood of making a profitable investment.
Mainstreet Equity Corp. is a publicly-traded (TSX: MEQ) residential real estate company in Canada. Mainstreet currently owns and operates properties in Surrey, BC; New Westminster, BC; Abbotsford, BC; Calgary, AB; Cochrane, AB; Edmonton, AB; Fort Saskatchewan, AB; and Saskatoon, SK.
Mainstreet provides affordable, renovated apartment suites to Canadians, and is committed to creating real value without diluting shareholder interests.