Due Diligence Needed in Real Estate Secondaries Market

CREModels managing directors advise LPs to scrutinize the investor waterfall, reexamine asset value and performance, and study the fine print on all loan covenants  

ST. PETERSBURG, Fla., April 26, 2023 /PRNewswire/ — Real estate limited partners (LPs) need to sharpen their focus on due diligence in today’s accelerating secondaries market, advise the managing directors of CREModels in a column for SecondariesInvestor.com.

“Even before the capital markets further tightened due to the fallout from Silicon Valley Bank, researchers were predicting a higher number of recaps in 2023,” write Mike Jaworski and Mike Harris. “In such a faster-paced, higher-risk real estate environment, due diligence will be critically important.”

Harris and Jaworski frequently advise secondary investors seeking an objective and data-driven perspective on real estate transactions. They boast decades of combined experience in due diligence, document abstraction, financial modeling, acquisition underwriting and other real estate services.

In the April 19 piece for PEI’s Secondaries Investor (“Real estate LPs Need to Step Up Due Diligence“), the coauthors encourage LPs to fully understand waterfall pro forma models.

“Typically, both GPs and LPs will maintain their own accounting processes and spreadsheets, and as a result their distribution calculations are rarely in alignment,” explain Harris and Jaworski. “Often, timing is the issue—one party books entries earlier than the other, with the differences in interest accrual leading to significant daylight between the two calculated distributions.”

CREModels routinely reviews partners’ waterfall trackers and analyzes the underlying financial data and files to help the partners come to a timely consensus.

Real estate LPs should closely scrutinize partnership cash records and general ledgers, and make sure all payments have been made correctly, per stipulations in the waterfall agreement. Another best practice is to game-plan scenarios for what will happen, per the waterfall, if asset values fall, or if occupancy at the property decreases.

The co-authors warn of GP “shadow risks” beyond the target asset itself. “While the LP might be interested in buying into just one high-performing property, what if the GP’s other assets are in deep trouble, or perhaps cross-collateralized with the subject asset?”

Harris and Jaworski encourage secondaries investors to review at least three years of performance reports created by the GP for the LPs, as well as an updated report on the business plan, rent rolls, partnership agreement and contributions/distributions. Updated due diligence of this type can catalyze transactions at a time when jitters are running high.

“In one recent recap involving a large shopping centre in North Carolina, having such information in hand reassured the secondaries investor that the departing LP was exiting the deal simply to pursue another opportunity—not because there were ‘hidden surprises’ with the property,” the executives recount.

In other situations, however, the departing LP could be fleeing a looming, unannounced anchor tenant vacancy or an upcoming refinancing that will put the partners in a bind.

In any prospective office, industrial or retail deal, advise Harris and Jaworski, “a thorough review of retail leases, for example, could uncover impending termination dates for critically important retailers, or problematic co-tenancy provisions that, if triggered, could open the door for other operators to vacate the center.”

Today’s real estate sector is more challenging, but tighter capital markets are also creating strong opportunities for LPs, they conclude: “With the right due diligence, they can make smart, low-risk investments that will yield strong return on investment when the real estate market rebounds.”

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Media Contacts: At CREModels, Mike Harris, (201) 252-7487,