Let’s catch up on some general tips to help you quickly assess your next commercial real estate deal.
Investing in commercial property can be exciting. The additional cash flow, the relatively open playing field, an influx of affordable property managers, and usually a larger payoff in the end—all make for compelling reasons to get involved with commercial deals. However, if you don’t have any experience weighing the value of a commercial real estate deals, exciting won’t be the word you use to describe investing. Maybe try: dangerous, instead? Let’s help you with some basic guidelines to assess the value of commercial real estate deals.
Learn the differences compared to residential deals
Commercial real estate is value differently than residential property. The income a commercial property generates is related to its usable square footage—obviously that’s not the case with a home. Also commercial property leases last longer than on residential homes, which can lead to a greater cash flow. The last big difference is the cash you’ll need to bring to the table, as most commercial lenders like to see at least 30 percent down.
Gather all the information
Create a spreadsheet to track and compare the following information for the properties you’re looking into:
- The type of property
- Financing needed to purchase the property
- Terms and condition of the sale
- Market condition in the local area
- Location components of the property
- Physical characteristics of the property
- Economic characteristics
As with so many real estate tips—the relationships you build are nearly as vital as your own knowledge and experience. Establishing and cultivating relationships with property owners, local businesses, and even residents in your target area can make an immediate impact to your evaluation process. You may identify a motivated seller in the area or hear about a property that has had a few deals fall through in the past.
A couple of good terms to know. . .
Net Operating Income (NOI): The NOI of a commercial property is calculated by taking the property’s first year gross operating income and then subtract any operating expenses for that first year.
Cap Rate: A property’s “cap” (or capitalization) rate, is used to determine the value of income producing properties. The cap rate is the Net Operating Income (NOI) to property value. For example, if a property was listed for $1,250,000 and generated an NOI of $150,000, then the cap rate would be: 8.33%
Cash on Cash: A formula which compares the first-year performance of competing properties. To determine, investors must uncover the amount required to invest to purchase the property, or their initial investment.