Spotting a hot market is one thing. Choosing the right property within it is another challenge entirely.
For example, a top-down analysis might point you to Phoenix, America’s fastest-growing city, expanding at a rate of 11.2% between 2010 and 2020 census surveys. Multifamily investors flocked to Phoenix, and Fannie Mae’s Q1 2024 outlook noted a 7.6% increase in new supply development as of Q1 2024.
But this doesn’t mean all Phoenix properties are great opportunities. Look at crime statistic maps, and you’ll see most violent crimes happen in very specific areas. Buying property there could spell trouble.
Or consider the area’s 28 employment centers. The best-performing saw growth of over 100% in the past 14 years, while the worst suffered double-digit declines. These stark differences show why investors can’t rely on broad market trends alone.
While top-down analysis identifies promising markets, bottom-up analysis helps you navigate within them. It gives you a way to dig into these details for specific properties, revealing opportunities and risks that broad market trends might miss. It’s your next step after you’ve identified a “hot market.”
What Is Bottom-Up Analysis?
Investors use top-down analysis to narrow down where to begin investing, such as in a region or city. Market trends, economic situations, and demographics all feed into this data. You don’t want to buy a property in an area where employers are leaving and there’s little new development coming in.
But once you narrow down where, you now need to get into which properties. That’s where bottom-up analysis comes in. This focuses on the details of the property, like how it compares to the competition and what the actual opportunities are with that specific property.
Bottom-up analysis helps you focus on individual properties after you’ve chosen your target area. It’s a way to evaluate the specific characteristics and potential of each investment opportunity.
Key Elements of Bottom-Up Analysis in Real Estate
There are four core areas to a bottom-up analysis:
1. Market studies
Investors take a deeper look at what is happening in the specific market for a potential property. This means evaluating:
- Market fundamentals: Areas to evaluate include what’s happening with supply and demand, economic indicators, and other market dynamics. For example, if several new developments are in process, with delivery in the next one to two years, is there enough population growth or demand to absorb this supply?
- Competitive analysis: Knowing about existing and potential competitors in the market helps you evaluate a property’s viability and potential for success. If competing apartment complexes all have a pool, fitness facilities, and co-working spaces, your property also needs these amenities to compete.
- Regulatory environment: Zoning laws, building codes, and other regulations impact a property’s development potential and compliance costs. Self-storage is an example. Many cities across the country restrict new development of these property types. If your project is a new build, you may face hurdles, but if you are buying an existing property, this creates opportunities, given the limited new supply entering the market.
- Financial metrics: Market studies include looking at capitalization rates, net operating income, and cash flow projections both across the broader market and specific to the project you are evaluating.
2. Rent comparables (comps)
Rent comparables help investors understand market rental rates, similar to how sales comparisons guide home prices. You can compare properties’ rental rates using:
- Property quality and location
- Age
- Occupancy rates
- Number of units
- Total square feet
- Price per unit
- Price per unit type (studios, one-bedroom, two-bedroom, etc.)
- Price per square foot (*decreases as square footage increases, so it’s not a 1:1 ratio for rent comparables.)
Floor plans and design elements also factor into the evaluation. When assessing rent comparables, the units must be similar. Differences like ceiling height or building style, such as single-story units versus three-story stacked apartments, require adjustments. Higher ceilings and a lack of upstairs or downstairs neighbors can justify rent differences even though the properties have similar unit types and square footage.
These comparisons allow investors to quickly see how the subject property performs in terms of gross potential rent (GPR). GPR represents the annual rent the property would receive if you leased every unit at market rates. Using this data, investors can find undervalued properties or opportunities for rent increases.
During due diligence, investors get access to the property’s rent roll, which shows current rates and lease expiration dates. This level of detail may uncover opportunities to increase income as leases renew, bringing the property’s rates in line with current market rates and competitors.
Let’s say nearby comparable properties rent for $1,200 per month, but the subject property’s units only cost $1,000. That’s a clear sign there’s room to bump up the rent.
3. Property-specific factors
You’ve heard that location is everything in real estate. This is especially true for property details investors can’t really change. Picking the right property means looking at these factors to see if it’s worth investing in. What works for one type of commercial property might not work for others.
Here’s what to think about:
- Visibility: Some investments need more visibility than others. Retail centers always need to be eye-catching to attract shoppers and help their tenants succeed. Any commercial property that relies on drive-by traffic must be easy to spot. On the flip side, industrial spaces don’t need to be so visible.
- Access and traffic flow: If you’re buying a place that needs walk-in traffic, it must be easy for people to reach. Think of a gas station on a busy road that’s a pain to get in and out of because there’s no traffic light. For other types of properties that deal with businesses, like warehouse space, being close to transportation and having easy parking for delivery trucks can make a big difference in how smoothly things run.
- Parking: Most properties you’re looking at need plenty of parking. This goes for retail, office, and apartment buildings. Tenants don’t want to hike several blocks to get to your space—they’ll pick other spots with easier parking. One exception might be properties in dense urban areas with great public transit. In these places, limited parking might not be a deal-breaker if there are other ways for people to get around easily.
- Neighborhood quality: For residential properties, good schools, low crime, and neighborhood appeal boost value and attract renters. In commercial real estate, the surrounding business ecosystem matters. An office building near trendy restaurants may appeal to tech companies seeking young talent. The mix of nearby businesses impacts the desirability of your property to these potential tenants.
4. Demographics
Investors analyze demographics to understand how well a property matches current and future market needs. This process involves feasibility studies and market research, helping sponsors determine if their project fits in with demand across different types of commercial real estate.
Demographics provide insights into the local population, which can impact a commercial property’s performance. For example, a retail center’s mix of stores might perform differently in an area with many families, compared to a neighborhood with retirees.
While demographic research is valuable, it’s only part of the picture. A complete bottom-up analysis combines demographic data with information on comparables, rent growth, and vacancy rates to provide a comprehensive view of a property’s potential.
Demographic factors that investors should consider include:
- Population: Overall population size, growth rate, and density influence demand for various property types, such as residential, retail, and office.
- Age distribution: The age breakdown of the population helps identify target markets for specific property types, such as senior housing or family-oriented retail.
- Income: Average and median household incomes determine consumer spending power and potential rental rates.
- Education: Higher education levels often link to higher incomes.
- Occupation: The main occupations in the area influence demand for office space and retail establishments.
- Household size: Average household size impacts demand for residential and retail space.
Investors use this data to:
- Predict demand: Knowing the population and its characteristics helps forecast demand for different property types.
- Identify tenant profiles: Demographics help identify a property’s ideal tenant profile, supporting marketing and leasing efforts.
- Set rental rates: Income levels and household size influence potential rental rates and occupancy rates.
- Evaluate risk: Analyzing demographics helps measure the overall economic health of an area and potential investment risks.
Different property types rely on specific demographic indicators. For instance:
| Commercial Property Type | Example Demographics |
| Retail | Population density, income levels, age distribution, and consumer spending habits. |
| Office | Employers, population with higher education, commuting patterns, and start-up growth. |
| Industrial | Employment in manufacturing, logistics, and trades. |
| Multifamily | Age distribution, income levels, household size, and employment rates. |
| Self-storage | Population growth, age distribution, and residential mobility. |
Importance of Rental Rates
Rent growth drives property value in commercial real estate more than any other factor. Miscalculating future rental rates can severely impact investment outcomes. Passive investors looking at investment opportunities should be wary of sponsors who skip market or feasibility studies.
No matter how strong the demographics are for a property type or how great the location is, if rental rates don’t support the right income levels for the property, it’s not a good deal. These rates create the cash flow that impacts:
- Financing and debt-to-income ratios.
- Funding to support ongoing maintenance needs.
- Profits and distributions to investors.
These rates affect day-to-day operations and a property’s overall value, impacting potential resale price and refinancing options. Investors look for properties where there’s room to grow these rates over time and increase long-term returns.
However, rental rates must be balanced with occupancy. High rents aren’t beneficial if they result in vacant units. Strong asset management means finding the right balance between competitive rates and maintaining high occupancy.
If an investor is eyeing a property and the numbers don’t add up, even with potential rent growth factored in, it’s time to walk away.
Other Considerations in Bottom-Up Analysis
Other factors investors should evaluate as part of their analysis include:
Renovation potential
Is the investor planning to renovate units as part of a strategy to add value and increase income? If so, the comparison needs to be made to both similarly renovated units and unrenovated units to get a sense of fair-market rent. This gives you an idea if you can increase rent even without renovations. Since renovations usually add between $75 to $250 in rent, any projected increases above this might be due to previously below-market rents.
Class cut analysis
Looking at rent rates and occupancy across property classes A, B, and C shows how they compare in different economic conditions. This helps investors spot opportunities to upgrade B or C properties to close rental rate gaps with higher classes, and see which classes are doing better in the current market.
Why Bottom-Up Analysis Matters for Syndication Investors
Property income is everything in real estate syndications. A detailed bottom-up analysis indicates whether a property is a worthwhile investment.
Here are some other benefits:
- Risk mitigation: This analysis reveals property-specific risks that syndication investors need to understand. While top-down analysis might highlight a “hot” market, looking at details of individual properties uncovers potential issues not visible in broader market trends.
- Better decision-making: Bottom-up analysis provides investors with detailed information so they can select deals that align with their risk tolerance and investment objectives. This property-level insight helps investors choose investments that fit their personal criteria.
- Value-add opportunities: Knowing a property’s specifics allows investors to better evaluate its potential for value-add strategies. This analysis helps determine if the sponsor’s proposed improvements are feasible and likely to generate the projected returns.
Final Thoughts
Bottom-up analysis gives real estate syndication investors a deeper look at individual properties. It moves past broad market trends to show what’s really possible with a specific investment. This approach helps investors find risks, spot ways to add value, and choose deals that fit their goals.
Top-down analysis might point to hot markets, but bottom-up analysis shows if a property is actually worth buying. It looks at factors like rent rates, property details, and local demographics to give a full picture of an investment’s potential.
This level of detail allows passive investors to evaluate sponsors’ projections, compare the property to its competitors, and estimate potential returns more accurately. With bottom-up analysis, investors gain better property insights, improving their chances of success in real estate syndications.