Ask any real estate professional about the benefits of
investing in commercial property and you'll likely trigger a monologue on how
such properties are a better deal than residential real estate. Commercial
property owners love the additional cash flow, the
beneficial economies of scale, the relatively open playing field, the abundant
market for good, affordable property managers and the bigger payoff from
commercial real estate.
But how do you evaluate the best properties. And what separates the great deals from the duds?
Like most real estate properties, success starts with a good blueprint. Here's one that can help investors evaluate a good commercial property deal.
But how do you evaluate the best properties. And what separates the great deals from the duds?
Like most real estate properties, success starts with a good blueprint. Here's one that can help investors evaluate a good commercial property deal.
1.
Learn
What the Insiders Know
To be a player in commercial real estate, learn to think like a professional. For example, know that commercial property is valued differently than residential property. Income on commercial real estate is directly related to its usable square footage. That's not the case with individual homes. You'll also see a bigger cash flow with commercial property. The math is simple: you'll earn more income on multifamily dwellings, for instance, than on a single-family home. Know also that commercial property leases are longer than on single-family residences. That paves the way for greater cash flow. Lastly, since we’re in a tighter credit environment, make sure to come knocking with cash in hand. Commercial property lenders like to see at least 30% down before they'll give a loan the green light.
To be a player in commercial real estate, learn to think like a professional. For example, know that commercial property is valued differently than residential property. Income on commercial real estate is directly related to its usable square footage. That's not the case with individual homes. You'll also see a bigger cash flow with commercial property. The math is simple: you'll earn more income on multifamily dwellings, for instance, than on a single-family home. Know also that commercial property leases are longer than on single-family residences. That paves the way for greater cash flow. Lastly, since we’re in a tighter credit environment, make sure to come knocking with cash in hand. Commercial property lenders like to see at least 30% down before they'll give a loan the green light.
2.
Map
Out a Plan of Action
Setting parameters is a top priority in a commercial real estate deal. How much can you afford to pay? How much do you expect to make on the deal? Who are the key players? How many tenants are already on board and paying rent? How much rental space do you need to fill?
Setting parameters is a top priority in a commercial real estate deal. How much can you afford to pay? How much do you expect to make on the deal? Who are the key players? How many tenants are already on board and paying rent? How much rental space do you need to fill?
3.
Learn
to Recognize a Good Deal
The top real estate pros know a good deal when they see one. What's their secret? First, they have an exit strategy – the best deals are the ones where you know you can walk away from. It helps to have a sharp, landowner's eye – always be looking for damage that requires repairs, know how to assess risk and make sure to break out the calculator to ensure that the property meets your financial goals.
The top real estate pros know a good deal when they see one. What's their secret? First, they have an exit strategy – the best deals are the ones where you know you can walk away from. It helps to have a sharp, landowner's eye – always be looking for damage that requires repairs, know how to assess risk and make sure to break out the calculator to ensure that the property meets your financial goals.
4.
Get
Familiar With Key Commercial Real Estate Metrics
The common key metrics to use for when assessing real estate include:
The common key metrics to use for when assessing real estate include:
§ Net Operating Income (NOI)
The NOI of a commercial real estate property is calculated by valuating the property's first year gross operating income and then subtracting the operating expenses for the first year. You want to have positive NOI.
The NOI of a commercial real estate property is calculated by valuating the property's first year gross operating income and then subtracting the operating expenses for the first year. You want to have positive NOI.
§ Cap Rate
A real estate property's "cap" – or capitalization – rate, is used to calculate the value of income producing properties. For example, an apartment complex of five units or more, commercial office buildings, and smaller strip malls are all good candidates for a cap rate determination. Cap rates are used to estimate the net present value of future profits or cash flow; the process is also called capitalization of earnings.
A real estate property's "cap" – or capitalization – rate, is used to calculate the value of income producing properties. For example, an apartment complex of five units or more, commercial office buildings, and smaller strip malls are all good candidates for a cap rate determination. Cap rates are used to estimate the net present value of future profits or cash flow; the process is also called capitalization of earnings.
§ Cash on Cash
Commercial real estate investors who rely on financing to purchase their properties often adhere to the cash-on-cash formula to compare first-year performance of competing properties. Cash-on-cash takes the fact that the investor in question doesn't require 100% cash to buy the property into account, but also accounts for the fact that the investor will not keep all of the NOI because he or she must use some of it to make mortgage payments. To uncover cash on cash, real estate investors must determine the amount required to invest to purchase the property, or their initial investment.
Commercial real estate investors who rely on financing to purchase their properties often adhere to the cash-on-cash formula to compare first-year performance of competing properties. Cash-on-cash takes the fact that the investor in question doesn't require 100% cash to buy the property into account, but also accounts for the fact that the investor will not keep all of the NOI because he or she must use some of it to make mortgage payments. To uncover cash on cash, real estate investors must determine the amount required to invest to purchase the property, or their initial investment.
5.
Look
for Motivated Sellers
Like any business, customers drive real estate. Seek the help of a real estate profession to find them - specifically those who are motivated sellers. The fact is that nothing happens - or even matters - in real estate until you find a deal, which is usually accompanied by a motivated seller. This is someone with a pressing reason to sell below market value. If your seller isn't motivated, he or she won't be as willing to negotiate.
Like any business, customers drive real estate. Seek the help of a real estate profession to find them - specifically those who are motivated sellers. The fact is that nothing happens - or even matters - in real estate until you find a deal, which is usually accompanied by a motivated seller. This is someone with a pressing reason to sell below market value. If your seller isn't motivated, he or she won't be as willing to negotiate.
6.
Discover
the Fine Art of Neighborhood "Farming"
A great way to evaluate a commercial property is to study the neighborhood it's located in by going to open houses, talking to other neighborhood owners, and looking for vacancies.
A great way to evaluate a commercial property is to study the neighborhood it's located in by going to open houses, talking to other neighborhood owners, and looking for vacancies.
7.
Use
a "Three-Pronged" Approach to Evaluate Properties
Be adaptable when searching for great deals. Use the internet, read the classified ads and hire bird dogs* to find you the best properties. Real estate professionals can help you find valuable investment leads in exchange for a referral fee.
Be adaptable when searching for great deals. Use the internet, read the classified ads and hire bird dogs* to find you the best properties. Real estate professionals can help you find valuable investment leads in exchange for a referral fee.
The
Bottom Line
By and large, finding and evaluating commercial properties is not just about farming neighborhoods, getting a great price, or sending out smoke signals to bring sellers to you. At the heart of taking action is basic human communication. It's about building relationships and rapport with property owners so they feel comfortable talking about the good deals - and doing business with you.
By and large, finding and evaluating commercial properties is not just about farming neighborhoods, getting a great price, or sending out smoke signals to bring sellers to you. At the heart of taking action is basic human communication. It's about building relationships and rapport with property owners so they feel comfortable talking about the good deals - and doing business with you.
*The professionals are Coldwell Banker
Commercial Benchmark in Jacksonville and Ormond Beach, Florida are available to
you help investors in the North Florida area to find the right commercial real
estate deal. Please contact us at 904-281-1990 or see us on the web at
www.cbcbenchmark.com.
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