JF1215: Lessons from over $2 Billion In Commercial Real Estate with Brian Hennessey
Wow! Today we have a major commercial real estate investor dropping knowledge. Brian literally wrote the book(s) for commercial real estate investing. Not only will he give us actionable advice for commercial investing, but a lot of the advice applies to any form of real estate investing. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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Brian Hennessey Background:
– Senior VP of Avison Young Intelligent Real Estate Solutions
– Portfolio transactions totaling approximately 12 million square feet at values in excess of $2 billion.
– Prior to Avison Young he served as Senior Vice at Colliers International for 5 years
– Been in the commercial real estate industry for over 30 years.
– Author of “The Due Diligence Handbook For Commercial Real Estate”
– His book was written originally as a personal reference tool/checklist, but is a #1 best seller on Amazon
– His latest book is “How to Add Value for Commercial Real Estate”
– Based in Los Angeles, California
– Say hi to him at: www.impactcoachingsystems.com
– Best Ever Book: What Every Real Estate Investor Needs To Know About Cash Flow
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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any fluff. With us today, Brian Hennessey. How are you doing, Brian?
Brian Hennessey: Really good, thanks very much for having me, Joe.
Joe Fairless: My pleasure, nice to have you on the show. I read one of your two books – The Due Diligence Handbook For Commercial Real Estate, and I reached out to my team and I said “Let’s bring Brian on… This is some good stuff.”
A little bit about Brian – he is a senior VP of Avison Young Intelligent Real Estate Solutions… You need an acronym for that, that’s a mouthful. Prior to working there, he served as Senior Vice at Colliers International for five years. He’s been in commercial real estate for over 30, and he’s got a new book that is out – it’s How To Add Value For Commercial Real Estate. Based in Los Angeles – with that being said, Brian, do you wanna give the Best Ever listeners a little bit more about your background and your current focus?
Brian Hennessey: Absolutely. I am an investment broker with Avison Young, based here in Los Angeles, but over my career I’ve done a number of positions in the commercial real estate industry, including being a syndicator and an acquisition person for an investor where I purchased properties all over the US, over nine million square feet, just with him. That’s where I really got to learn the due diligence into the business, when we were buying so much property so quickly that we really had to be on our A-game because we just had a small group that we worked with when we were purchasing these assets… So it really required me to be very scrutinizing.
Actually, let me tell you a brief story of how it happened. I ended up — the first couple transactions that I did, I made so many mistakes, and even though I had been in the business for 18 years, I thought “Oh, this is a natural slide.” Well, I had never been a buyer of large commercial properties before… And that’s when I decided I’d better start creating a reference manual for myself so I don’t have to reinvent the wheel every time, because there were so many things to remember.
So that’s how my reference manual came about, and then when I decided to get back into the brokerage end of the business again, I said, “Well, what am I gonna do to differentiate myself?” I decided to take my reference manual and create an investor handbook that I could use as a marketing piece. I actually put it up on Amazon, just never thinking it would ever sell one copy. I wouldn’t even spend $150 to format it, because I figured “Why do it if it’s never gonna sell?” and I ended up just handing it out to people as I spoke with them… Much to my surprise, the book started selling, so I decided to take it a little more seriously, create a professional design cover and format it and put it out there, and that’s when it took off, and I’m still shocked today that it’s been a number one bestseller on Amazon for real estate books.
This also tells me, as I’m going out speaking to people, that it’s a very critical component that people are missing when they’re investing in real estate. So I go out there and try to tell people “You really wanna have a proven system to do this, because there’s just way too many things to remember, and things would just slip through the cracks.” Having and adhering to a proven system allows you to conduct due diligence faster, easier, more efficiently, and you’re less likely to miss something.
Joe Fairless: Speaking of missing something, what are some due diligence items that tend to be overlooked if you don’t have a system?
Brian Hennessey: Well, in my talks I talk about the mistakes a lot of investors make, and we can talk about those if you like…
Joe Fairless: Yes, please.
Brian Hennessey: The first mistake I see a lot of investors make is really not valuing the property correctly. What I mean by that is they go out and they will negotiate a deal with a seller, and then find out later “Wow, I’m really over-paying”, or maybe they don’t find that out until they go to put a loan on it. I tell people, you really need to do your homework first. Make sure you’re checking all sale comps and other available properties on the market. We have checked a few things out and everything is working out okay, but that’s not always the case.
Segueing from that is not understanding your lender’s underwriting requirements. What happens is a lot of people will say “Okay, I’ve made this deal on this property”, whether it be some units or a commercial piece or whatever it is, and they’ll go in and the lender will say “Well, we can’t lend this kind of money that you’re looking to get…”
What I tell people is before you spend a lot of time, money and energy on conducting due diligence, you wanna have those preliminary discussions with some lenders about the amount of the loan you’re considering to put on there. Otherwise you could be spinning your wheels out there, which you don’t wanna do.
Joe Fairless: Great point.
Brian Hennessey: Another one I tell people to do is check to see if the property complies with all the current municipal building codes. That’s just a quick trip down to the city building department. But you don’t wanna get into the due diligence of it and overlook that part, because if you’re gonna be doing some work, it could trigger some compliance issues which could cost a lot of money. That’s where I see people getting tripped up, like “I didn’t know it was gonna cost me this much money if I was gonna do this…”, and it’s like “Well, if you would have made a trip down to the city, you might have found out.” So I tell people, just make that part of your routine when you’re conducting due diligence, because there may be some issues coming up where you need to comply in the future that could affect the property you’re looking at.
Joe Fairless: What specific department do you go to and then what questions do you specifically ask?
Brian Hennessey: Usually, the planning department will say “Let’s look up the property on the computer here and see what’s going on with it. Okay…” Sometimes they’ll say “Oh, there is an issue outstanding here that it’s not compliant with this code, so you need to make sure… They’ve been sent a notice”, and I say “Can I get a copy of that notice?”, which I will. Then I’ll say “Are there any future code compliance issues coming up that I need to be concerned about regarding this property?” “Oh, there might be a sprinkler retro-fit” or something of that nature… These are the things that I wanna find out.
Joe Fairless: Yes, that’s great. Great stuff.
Brian Hennessey: Another mistake I see is a lot of people assume there’s no issues with any of the tenants’ leases, and these are tripwires that can be avoided if you’re scrutinizing the leases carefully. What I mean by that specifically is if it’s a commercial building, you wanna look to see if there are any termination provisions, contraction provisions? Are there any caps on operating expenses? Do they have unlimited use of the HVAC (heating, ventilation and air conditioning) or electricity that the landlord is responsible for? Issues that are gonna affect the value of the property.
A perfect example of that might be maybe they have an option, but it’s at a fixed rent, and they get another 5-10 years that they can exercise that option. That’s gonna affect the value of the property.
So make sure you’re scrutinizing the leases carefully. Go through the tenant correspondence files if you’re going to a property management company, or if it’s the owner of the property, “Can I see your correspondence file with your tenants?” Why? Because it’s gonna have valuable information in there. If it’s a multi-tenant property, then you’re gonna see correspondence in there that’s gonna tell you a lot about what the issue have been. Hey, the windows are leaking; hey, the roof is leaking; hey, the air conditioning is not working properly… Or whatever the case may be. Hey, we had another break-in… These are all red flags that are popping up and you’re saying, “Well, I’d better find out more about this.”
Joe Fairless: Do you have a team that does it – a third-party team – usually, or… I know you’re not doing it right now in your role, but would you do it personally if you were in that situation?”
Brian Hennessey: Yes, I would, and you can hire outside third-parties to do it; very expensive. Personally, I like to do it, because I’m looking at it much more subjectively, because I’m the one that’s gonna inherit the problems when I own the property.
As a matter of fact, Joe, I do do it as a broker. I’ll ask my clients, and the ones that know me usually say “That’d be great. I’d love to have your help on this.” The ones that don’t – and for your broker listeners out there, that are in the brokerage end of the business, I’d shoot a quick e-mail off to your clients and say “Since we’re in escrow now, I’d love to help you with your due diligence. Please let me know and we can go through the list of things that we wanna accomplish” and if they turn you down, at least you have documentation that you’ve tried to help them.
That brings me to another point I would have your listeners pay special attention to, and that’s to communicate everything through e-mail. That doesn’t mean to say you can’t talk on the phone, but you have a written paper trail on an e-mail. If somebody say, “Oh, I’m gonna get you the backup information on that request you just made.” “Hey, can I get the paid invoices on that tenant improvement job that you did, or the paid leasing commissions?” and they’ll say “Yeah, I’m gonna get that to you. Let me dig that up and send it over.” Well, if they don’t get it over, now you’ve got a running list of the things you asked for.
What I’ve seen people do is they get involved in these transactions and they’re so busy and they’ve got so many things coming at them that they can’t possibly remember everything they asked. Do it in an e-mail, and you can go back and say “Oh yeah, last Tuesday I asked for this, and I never got it.” You can forward that on, “Hey, as per our conversation last Tuesday, you were supposed to get this to me”, and if they don’t, what’s happened to me before is I’ll get towards the end of my due diligence period, and say “Well, if I’m not gonna get it by tomorrow, then I’m gonna assume I’m gonna a credit for that amount at the close of escrow”, and all of a sudden…
Joe Fairless: [laughs] You start getting the stuff, huh?
Brian Hennessey: Right, you start getting that, and “Well, here’s what’s going on – we’ve got a dispute on this one”, and now all of a sudden you’ve uncovered the real problem. But what happens is if you’re not paying attention to it, guess what? It’s gonna slip through the cracks, and then once you’ve closed escrow, it’s much more difficult.
Joe Fairless: Oh, forget about it.
Brian Hennessey: Yeah, it’s much more difficult. So I tell people, just send off the e-mails; it’s easier to keep track of, and worst-case scenario is if you don’t get it and you forget it but you’ve asked for it, you’ve got something to bring to court, which I hope you don’t have to do, but… Sometimes you do.
Joe Fairless: Have you had to do that?
Brian Hennessey: Yes, as a matter of fact.
Joe Fairless: What happened?
Brian Hennessey: Essentially, we were told that a certain tenant was to have paid a [unintelligible [00:13:42].23] when in fact they didn’t, and we let it slip through the cracks, and then we went back… What happened was with one letter to our attorney and the backup e-mails and what have you, we were able to get a settlement from him. But you try to avoid that as much as possible.
Joe Fairless: Absolutely. Everyone loses.
Brian Hennessey: Yeah, exactly. It’s just more brain damage than it’s worth. So if you do your due diligence properly upfront, you’re gonna minimize this. Warren Buffet said “Risk comes from not knowing what you’re doing.” When you have done proper due diligence, what happens is you’re minimizing that risk and you’re able to make those decisions, whether to move forward on an investment or not, based on your investigation.
Joe Fairless: One item that resonated with me because it recently happened to me is number two, not understanding your lender’s underwriting requirements. Well, we understood the underwriting requirements… Let’s see, this was about three days ago – we got our appraisal back and all of the third-party reports for an apartment community we’re buying, and we’re getting a loan with Fannie Mae, and they have a shorter effective useful life on certain cap-ex items, meaning that those items have to be replaced more frequently over the term of the loan, which increased the replacement reserves from $246/unit to $263/unit. We pushed back as much as we could, but that’s the lowest that they would do the reserves…
So it’s just stuff like that, where you’ll want to — I mean, I’m not sure if we would have asked those questions ahead of time if that would have netted out, [unintelligible [00:15:31].00] underwriting process, but that’s a prime example of asking in advance, just to make sure that everything is coming in where you think it should come in.
Brian Hennessey: Sure. Another thing that you triggered a thought of mine was — another mistake I see people make is letting the appraisal process go on autopilot. That’s a dangerous thing; you’re just basically throwing the dice and hoping it all works out, especially in today’s lending climate.
I’ll give you an example – every time that I am involved with a transaction, I always ask the lender, “I’d like to meet the appraiser at the property”, and when I go there I have all of the sale comps, all the lease comps that’s applicable… Anything that’s gonna positively put the property in a positive light.
I went through an interesting transaction recently where we sold a small building to one of my clients, and they brought it to me and said “Here’s a building we’re really interested in.” I said “It’s very pricey”, and they said “But it’s perfect for us. We don’t care. If we don’t get this building, we’re gonna lose some business, because we don’t have a place to take care of it at.”
So I contacted the broker, he said, “Well, it just fell out of escrow. This is the price”, and I was like, “Wow…!” But they submitted it to the lender, and the lender said, “Well, we’ll get the appraiser out there, but I just want you to know something – this is the fourth time we’ve seen a contract on it going into escrow; it hasn’t appraised out.” So I said, “I can understand why. Well, my clients really want the property. I’m gonna go out there, I wanna meet the appraiser.”
So I went out there… I had a book for this appraiser, and I said, “Here’s all the sale comps; we had to go further out. There’s all the lease comps, so here’s why we believe the property is worth this amount of money.” He was shaking his head and said, “Well, I’m gonna have a tough time with this, but look, this is what’s going on in the area. This area is improving. Here’s what’s going on, here’s who’s moved in, here’s what’s happening here in the near future…”, and I stayed with him. I said, “Is it alright if I call you in the next couple days?” “Yeah.”
I called him a couple days later. “Do you have everything you need?” “I think I’m getting there.” “Okay, I’ll give you a call in a day or so.” I called him back, he said, “You know what, I’m there. I’ve got it. We’ll take care of it.” And we got it appraised Had I not done that though, I can tell you right now it would have never appraised out.
What I’ve done with other properties, I’ll go back and say “By the way, did you know that this lease proposal was just accepted? And they’re going to leases on this, and we’re gonna be reducing the expenses, and this is how it’s gonna work.” When you start giving them the information to help them put that into perspective to get to the number you need to get to, you’re making their job much easier, and the chances of you getting the loan amount that you need to get go way up. So I tell people, “Do not let it go on autopilot. Be proactive with your appraisal process and your odds of getting the loan you need to get are much higher.”
Joe Fairless: Great advice, and thank you for that. Based on your experience as a real estate investor – and you’ve got three decades under your belt in real estate – what is your best real estate investing advice ever?
Brian Hennessey: I’m gonna give you my best real estate investing advice, and that would be assume nothing; if you’re gonna assume anything at all, you need to assume there are multiple problems to discover. The seller is not gonna come to you with a list of issues and problems and say “Hey, you’d better think about these things that could cause you an issue when you’re buying this property.” It’s up to you to discover what those problems are… And you also have the potential of coming up with some hidden value enhancers to increase the property value as well. So I would say if you get nothing else out of this, it’s assume nothing.
Everybody that wants to really do a good job in due diligence needs to assume there’s issues there that they need to uncover.
Joe Fairless: Are you ready for the Best Ever Lightning Round?
Brian Hennessey: Sure.
Joe Fairless: Alright, let’s do it. First, a quick word from our Best Ever partners.
Joe Fairless: Best ever book you’ve read?
Brian Hennessey: Best ever book I read as it pertains to real estate, obviously – I think Frank Gallinelli’s book, What Every Real Estate Investor Needs To Know About Cashflow, it’s one of the best ones I’ve ever read.
Joe Fairless: Best ever deal you’ve done?
Brian Hennessey: We did a portfolio sale with Equity Office that was a big one; four big buildings in Dallas. That was about 1.8 million square feet. I thought those were great values and it was exciting to work on because we had to do so much in so little time that I felt like it required so much focus and attention that I really had to be on my A-game for that. Once you get through something like that, it kind of stretches your mind to the point where you think you can pretty much handle anything that’s thrown at you.
Joe Fairless: What’s a mistake you’ve made on a transaction?
Brian Hennessey: Oh, gosh, I’ve made a lot of mistakes on transactions.
Joe Fairless: Ditto.
Brian Hennessey: And that’s how the book Due Diligence Handbook For Commercial Real Estate came about, because I was making so many mistakes, I didn’t wanna reinvent the wheel. It’s like a pirate’s checklist – you wanna go through it and make sure that… You can’t possibly remember everything, so you wanna be able to go through and check them off as you’re going.
I guess, would you say — what’s the worst mistake I ever made? Was that the question?
Joe Fairless: Just any mistake you’ve made on a transaction that you can think of…
Brian Hennessey: A mistake – I assumed people were giving me good information when they weren’t, and I assumed that a seller would not ever do a thing that they said they wouldn’t do, and then they did it. So it really — I don’t wanna say it makes you jaded, it just makes you cautious… So I tell people, it’s okay to make mistakes, by the way; that’s how human beings learn, by trial and error, but you try to minimize it as much as possible.
Joe Fairless: What’s the best ever way you like to give back?
Brian Hennessey: The way I like to give back? I love talking to people about my experience, and investing in real estate, and doing due diligence. What I find is very gratifying is that people, when I give a talk, or I get e-mails or talks or calls from people that say “Thank you so much for sharing your information; you really saved me a lot of money and headaches and time… I really appreciate you sharing the information.” That to me is very gratifying and that’s what keeps me going.
Once in a while I get an e-mail from somebody that says “Oh my gosh, I learned so much. Thank you so much. It really saved me”, and I was like, “Wow, that’s great!” I love getting that. That’s probably why you love doing the podcast too, right?
Joe Fairless: Yeah, absolutely. There’s many reasons why I love doing the podcast, and that’s one of them. How can the Best Ever listeners get in touch with you?
Brian Hennessey: They can go to my website, ImpactCoachingSystems.com, or reach me at Brian@ImpactCoachingSystems.com. Also, I would highly recommend they get the due diligence handbook for commercial real estate on Amazon, because they will not just read it once and put it away; every time you do a transaction, you pull it out. The reason I know that is I do that, and a lot of people tell me they do that, and it’s because, like I mentioned before, it’s a checklist, and you wanna be able to go through the checklist. I still use it every time I do a transaction.
Then in the “How To Add Value For Commercial Real Estate” I talk about all the different ways that you can create value with your commercial real estate investments.
Joe Fairless: I really enjoyed our conversation, especially since I’ve read your book, the Due Diligence Handbook For Commercial Real Estate, and that’s why I wanted you to be on the show, because of so much value that’s in the book, so I highly recommend getting that book, number one.
Number two, thanks for taking us through that list of six mistakes a lot of investors make in the due diligence process. Number one, not valuing the property correctly. Two, not understanding your lender’s underwriting requirements; I gave a specific example of that that I’ve recently experienced. Three, going up to the planning department and not confirming the building codes are in compliance, so you should confirm that the building codes are in compliance and anything that you need to be concerned about in the future – for example, you gave the sprinkler example.
Number four – any issues with the tenant leases, make sure that’s resolved. Five, get things in e-mail (sometimes we don’t) so that we can prove if we need to, in a court of law, that that transpired. And six, some people let the appraisal process go on autopilot – don’t do that. I love the story that you provided as evidence.
Thanks for being on the show. I hope you have a best ever day, and we’ll talk to you soon.
Brian Hennessey: Thanks so much, Joe. I really appreciate you inviting me on. I enjoyed it immensely.Follow Me: