CRE Market Analysis: A guide for Investors & Developers

When it comes to commercial real estate development, one of the most important questions to answer is “What to develop?”. What does the market need? The idea will just be that until the market analysis is complete and ready to pitch.

Of all the important tasks on a CRE punch list, the market analysis is the one that makes the project a reality. It has three different audiences:

• The financial sources
• The leasing brokers
• Future tenants.

If a market analysis is missing any part of the picture, it could mistakenly turn a “yes” into a “no” resulting in a lost opportunity, or vice versa resulting in a project with hidden risks.

“Market analysis can be and can encapsulate a variety of different things,” said Benjamin Jacobson, partner at Forman Capital, a commercial lender and investor. “It could be as simple as the average rental rate and occupancy in the submarket.”

Sector-specific considerations

Every market analysis needs an overview that sets the stage for the project’s viability. A commercial lender wants to see whether a project has a chance of success and enough cash flow to make debt payments or ensure a return on investment. Here are a couple examples on how consideration is applied.

Retail centers

“Commercial lenders are not banks. We’re investing dollars,” said Jacobson. “We want to make sure that when we invest dollars to create whatever it is, or acquire whatever it is, that there’s a need for whatever it is we’re doing because if there’s not, how are we going to protect our dollars; and secondarily, get a return?”

Jacobson says that one street boasts four 400,000-square-foot retail centers, and there’s land to accommodate a fifth one. What’s the plan to lease it and generate adequate cash flow? As a lender, he said that he’d be looking closely at whether the market can absorb another 400,000-square-foot retail center at that location.

Religious institutions

Renato Matos, managing partner of Capell Barnett Matalon & Schoenfeld, specializes in the development of religious institutions. His process is readily transferable to all CRE project market analyses. 

“We’re providing for the needs of the site owner and what they plan,” he said. “There’s always…a full understanding of who the team is from the developer. We want listings of projects and contacts at those projects so that we have an opportunity to make sure that those have gone well.”

A team to bring the project to fruition is essential to the market analysis.

According to Matos, the market analysis needs to show that the team has the financial ability to complete the project within timelines and budgets. This is the heart of the analysis for lenders.

“In your due diligence, (the main topic) you’re putting out there is pretty much location,” Matos said. You may say to yourself, ‘Yeah, I could build it, but is the market going to absorb (it)?’”

He said the analysis for lenders and brokers trying to lease it needs to know if the answer to that question is ‘yes’ or ‘no.’ 

If it’s ‘no,’ Matos says, “You probably shouldn’t build it. If the answer is ‘yes.’ There’s a reason. You’re always filling a need.”

Site status and analysis

Some lenders and investors are looking for more than just the numbers pulled from the Internet. Sure, lenders want to see population, income, traffic volume, and a competitive analysis.

Ryan Gibson, CEO and president of Spartan Investment Group, wants to know the tale of cities.

“I would want to know the story of the city,” he said. “Is it growing? Is it dying? What are your major employers in that market? What is the projected population growth? The more people that move to a market, it’s just a numbers game. More people equals more occupancy.”

Looking beyond the city’s story, Gibson wants to know significant market and micro-market trends five miles around the development location. There is still a need for market analysis inclusion in the project.

“I want to understand what the trailing expenses are and how much property taxes and insurance are,” Gibson said. “I would want to look at what they’re spending on technology to run the facility: Internet, utility expenses, etc.”

Lastly, he wants more competitive analysis. Not only does he expect a market analysis to include the current competitive setting, but he also expects to learn if there are other similar project permits in the pipeline and more competitors within a five- to ten-mile radius.

“I also want to know the visibility from the main road so you can know if you can see my property when you drive by,” said Gibson. “And the traffic counts. How much quality is the traffic count? Is it on a two-lane highway that you can access from both directions? Easy access, easy on–easy off. Then, does it have a lot of traffic count?”

Considerations for location analysis

CRE brokers often cite that “location, location, location” is everything on CRE. It’s essential, but it means different things to different projects. The market analysis has to identify how “location, location, location” connects to a proposed project. Lenders need that information.

Early-stage developers tend to view the market analysis as focused on the property. Jacobson says it’s much more than that.

Surrounding project support

“Let’s say Cushman-Wakefield is going to develop a major office complex with 2,000 workers at full occupancy,” he hypothesized. “(In most cities), that creates a need for somebody to have restaurants, office supplies, things like that.”

He says those needs are catalyzed by CRE development or a large residential subdivision. It doesn’t matter much in the largest markets–New York, Chicago, Los Angeles, Houston–but growth patterns well outside the bounds of a proposed development need to be considered in the mix in the next tier of large cities.

“On a map, you’ll see (what is) very, very dense,” said Jacobson. “Then, as you go out, you will see how the needs have grown. A person living in the city wants a little bit more space, so he moves to the suburbs. Now, there are a bunch of people out there in the suburbs (who) want services. They’ve created the need.”

Confirm the need and demand

Lenders and investors will want answers to the question, “Why is this project needed?”

Gibson said it’s all about what’s in the package. He cites, as his eyes are scanning the analysis for trends in the micro market.

• Basic operating costs and expenses
• Class of tenants
• Lease rates
• Competition

Investment strategy & cycle

Steve Betts, managing director of development for the Holualoa Companies, says that the analysis must cover the beginning, the operations and the exit strategy.

Lenders and developers want to know what’s in it for them by an exit strategy.

“Once somebody gets into a project,” he said. “How do they get out?”

A developer may not want to get out but hold the property as part of building a real estate portfolio. However, lenders and investors want to know when they will get paid. Betts added that holding property allows the equity to leverage additional CRE development or real estate acquisitions. In other cases, lenders do, but sometimes investors want their money when the project is completed.

What risks need to be managed for CRE development?

Macroeconomic conditions beyond a developer’s control can affect the plan.

• Tariffs on construction material imports
• Strikes
• Inflation
• Rising interest rates

These are all factors that can dramatically affect the budget and timeline. There are, however, other perils that can be strategically addressed. 

Project risk profiles

Lenders and investors are telling clients to develop risk profiles for CRE projects. In the “old days,” coverage for structural damage, liability and workers’ compensation was all considered necessary. Today, there is a lot more.

Project type

“(Perils) can come from a lot of different areas,” said Taylor Lister, principal at Marsh McLennan Agency. “There are inherent location hazards. There are construction risk hazards. There are risks from different product types.” She explained that risks differ from a concrete tilt-up, flex industrial building versus an office space.

Tenants

“There are tenant risks once the project is complete,” said Lister. “So you have to think about what type of risk the different tenants are going to bring to the table. There’s contractual risk depending on who you’re partnering with.”

Communicating risk

The risk management strategies need to be communicated in the market analysis. Hence, lenders and investors see how their risk is protected from “known unknowns”—knowledge that perils exist, but if, what, when and how much impact are unknown.

“You have to be prepared to communicate those with your insurance underwriters and also your stakeholders,” she said. “For example, in Los Angeles, if you’re developing a property, you should probably check to see if it’s in a wildfire zone. If it is, I would advise proactively putting together a written wildfire mitigation plan. That’s just one example.” 

Lister recommends that after identifying the risk hazards and communicating the risk management strategies, CRE developers must assess their project risk tolerance, which will vary depending on their financial and exit strategies. 

“We’re in a bit of a paradigm shift,” she said. “Because, one, when insurance is unavailable, or two, cost prohibitive, are you confident that the deal still makes sense? Are your stakeholders prepared to take on more risk or adjust their insurance requirements? 

If insurance is too expensive or unavailable, it could devalue the project upon completion.

All these decisions and information must go into the complete market analysis.