Author: loantucson

Analyzing commercial real estate

growing prices of commercial real estate properties

Investing in real estate is a pretty safe way to grow your investment. The initial capital can be high, and real estate prices tend to increase. Even though you can see good returns soon, it relies on how well you maintain your investment. More and more millennials are looking to invest in commercial real estate. Only 50% prefer to invest in stocks.

Commercial real estate refers to apartment buildings, industrial, retail, warehouse, office, and other mixed-use buildings. Generally, commercial properties tend to be more complex than residential properties. And as such, calculating the potential returns can also be challenging.

One way to calculate the returns is by analyzing commercial real estate. Experts suggest looking at certain factors at both the micro and macro levels. This article takes you through the different defining factors. Every factor influences a different sector. And it also determines whether to invest in a commercial real estate deal.

What is Commercial Real Estate Analysis?

Real estate analysis analyzes the current market value of properties compared to the property you are looking to invest in. It is a pivotal part of real estate transactions.

Commercial real estate analysis is a form of due diligence. It reveals the trends and helps industry experts predict the future. The analysis looks at various economic, socioeconomic, and demographic factors. This helps to arrive at a decision. Moreover, it also includes employment rates, housing vacancy, and cost of housing.

The result of the analysis helps reveal critical information such as

  • Supply and demand
  • Income-generating potential
  • Rent

What are the 4 Main Categories of Commercial Real Estate?

Commercial real estate is reserved for properties used for commercial and industrial purposes. It also serves as a residence for tenants (multifamily real estate) under a landlord.

The four main categories of commercial real estate include:

  • Multi-family rental
  • Office space
  • Industry
  • Retail

These categories can further be classified for zoning and licensing needs.

For example, office spaces can further be categorized as Class A, Class B, and Class C.

  • Class A is the best of the lot with regards to space, location, age, aesthetics, and infrastructure.
  • Class B is older and not priced as much as class A buildings. Therefore, developers target these for restoration purposes.
  • Class C are old buildings over 20 years of age and in not-so preferred areas. They are in dire need of maintenance.

How to Analyze Commercial Real Estate Deals

More and more investors are looking to invest in commercial real estate deals. However, it can be challenging for even an expert, much less a novice. Hence, real estate professionals prefer to analyze a commercial real estate deal from micro and macro levels. For example, general market trends are one factor in the macro levels.

Some property-specific details have to be studied too. Each of these factors determines whether to buy or sell commercial real estate. And also on whether they invest in a primary market, secondary market, or tertiary market.

Assess Market Trends

commercial buildings

Investors looking to invest in commercial real estate can learn about a deal in a few different ways. One way is to hunt for deals which a beginner can find challenging. Another common way is to look for partners who can bring the deals to your attention. In either case, the first step is to monitor the industry trends.

First, a commercial real estate investor will want to understand the market cycle. And where we are right now. Market cycles generally last around a decade. In any case, it is pretty risky to invest when the market is at its peak.

Where we are in the market cycle can affect your industrial real estate investments regardless of the location. Hence it pays to follow a local market when analyzing commercial real estate trends. The following questions can help you understand more about the local market trends:

  • Is the population shrinking or increasing? If it’s the latter, why are people moving here?
  • Who is the major employer in the area? What is the rate of unemployment? How diverse is the local economy?
  • What is the average household income?

Conduct Commercial Property Analysis

Commercial property analysis is a comprehensive evaluation of various quantitative and qualitative variables. For example, you are ready to invest in a certain submarket based on positive market analysis. These factors help you identify the feasibility of the transaction.

The most important of these factors are the numbers from the property. It includes income, operating expenses, property taxes, insurance, and general maintenance. They help a prospective investor determine the return on investment.

Other quantitative factors investors may be interested in are:

  • Age of the building
  • Square footage
  • Number of units
  • Lot size
  • Length of the current ownership

Remodeling is a significant factor investor may consider. That is assuming that buyers are ready to undertake any remodeling after the sale. Remodeling requires quite a significant capital but is a value add.

Property history

Investors also consider the property history of any asset. Investors will want to know:

  • When was the property built?
  • When were the major systems like HVAC and roof installed?
  • How long has the current landlord owned the property?

Property patterns are pretty obvious. For example, consider that a business turns around more often. It is likely an indicator that it has often underperformed.

Performances can be gauged by factors like vacancy rates and current rate rentals. Property owners should realize that the ownership structure is a key part of history. And that it reflects the property’s performance and vacant rates.

Building and Lot Analysis

A buyer should conduct the building and zoning analysis before investing. This means identifying the current land and its size and configuration. Besides, you also need to know the local zoning ordinance to verify how the parcel will be zoned. It also tells you how many houses can be built on the estate.

Properties zoned for one particular use can be redeveloped for other uses. There will likely be what’s called the “entitlement process.” A prospective buyer seeks permission from the town to build a new structure. This could include obtaining specific variances or zoning reforms. It is often the case when the owners are constructing a structure other than the permitted one.

Net Operating Income

NOI is derived when the gross profit is subtracted from the operating expenses. The operating expenses include all expenses necessary for maintaining a piece of property. It includes expenses such as taxes, insurance, utilities, and management. Besides, repairs and maintenance are also considered operating expenses. On the other hand, improvement and renovations are not. Therefore, calculating the NOI is an essential part of valuing the fair market value.

Monthly Cash Flow

NOI and cash flow are close enough that many use these terms for the other. Cash flow is the sum of all profits and losses generated by the asset. The net cash flow can be measured using the formula:

NIO – debt service payments, tenant improvements, lease commission, and capital expenditures.

Cash on Cash Return

Cash on Cash Return is the indicator of the property value. It is a measure that calculates the return on investment. Cash on cash return is measured using the below formula:

Annual Cash Flow(Pre-Tax)/ Total Investment x 100%

Most commercial real estate investors will look at properties that have a cash-on-cash return of 8%-12%.

Cap rate

In commercial real estate, “cap rates” refers to capitalization rates. It is a formula used for estimating the potential return for investing in a property. The cap is represented in percentages that range between 3% and 10%.

Caps generally have an inverse relationship with the property value. The more valuable the property is, the lower the cap rate. For example, buildings that generate more than $500,000 of NOI and cost tens of millions to buy can have a cap rate of 5%.

How do I Run Comps on Commercial Real Estate Deals?

Commercial real estate is evaluated on different terms than residential real estate. However, both of them consider the price and sales of comparable properties in the same area. In the case of commercial real estate, it is not everything.

Real estate professionals use a set of comparisons or comps to evaluate the property. The most common method is to compare the cap rate of similar properties. To calculate the cap rate, divide the sale price of the property by the net operating income.

The less common valuation methods include:

  • Net Operating Income – Income the asset brings, including any loss, vacancy but before mortgage payments.
  • Cash Flows – Profit after all the expenses are paid, including the mortgage.
  • Cash on Cash Return – A measure of ROI calculated by dividing the capital with the annual cash flow.
  • Gross Income – Cash flow before the expenses

The largest commercial listing website is Loopnet.com. It is owned by the commercial property database CoStar.com. This is also where you can locate commercial property leasing comps and listings. Commercial properties are not listed under marketplaces such as Zillow, Realtor, or Trulia.

How Do You Determine if a Commercial Real Estate Property is a Good Investment?

Investing in commercial real estate has several advantages and disadvantages. Many investors understand the benefits of such an investment. However, investors should do due diligence to verify if it is a good investment. Furthermore, it should also fit your financial goals and limitations.

Cash Flow

Ask yourselves these questions:

  • What is the monthly cash flow?
  • If the cash flow is low, does that mean the property is not a good investment?
  • The property has a good cash flow but with risks. Is it worth investing in?

Keep in mind that the answer will vary for each property, and so should your expectations. It is up to you to decide if the property meets your expectations and helps you reach financial goals. But, commercial real estate properties with a good cash flow are a good passive investment strategy.

Value Add

value of commercial real estate investment

A property is a value-add if it requires more work before being rented out or charged higher rent. A value-add asset should:

  • Requires renovation
  • Prolonged maintenance
  • Need better curb appeal

Keep in mind that this is an active investment strategy. And until you do the value add, the cash flow will be lower. Once the renovations are complete, you can see a better cash flow or sale price. However, you will need to be on top of the team or rely on someone to complete it on time.

Holding Time

How long are you planning on holding on to the property? Here are some timelines expected for the investment strategies:

  • Value add properties have a holding time of 1-3 years.
  • Flipping strategy involves buying and selling within a year.
  • Cash flow properties stay on hand until they generate the income required to invest in another property.
  • Commercial properties in prime real estate areas are generally not sold or flipped. Therefore, there are chances that the market value will keep on increasing.

Appreciation

Here are some questions you may want to ask before deciding on the possible appreciation:

  • What is the demand for land or space for new constructions in the locality?
  • Is there a floating population of people moving in the area?
  • Are the rental prices increasing?

What is the 2% Rule in Real Estate?

The 2% rule of real estate helps to identify profitable investment opportunities. In the real estate sector, investors use it to locate better investments. The 2% rule is generally a guideline and not always feasible. It is considered extreme by experts since it is not possible to adhere to.

The 2% rule is a good commercial property generates a monthly rent of 2% of the purchase price.

What is a Good Return on Investment for Commercial Property?

The ROI of a commercial property can range anywhere between 5% and 10%, much more than that of a residential property. The latter has an ROI of just 1%-3%. This is because the commercial real estates follow a lease agreement, not a rental. The lease agreement can run for years altogether, even as long as ten years.

Conclusion

apply for loan

Commercial real estate is those that are used for business or income-generating purposes. Investing in commercial property requires more finesse and significant capital from investors. The analysis and investment process is quite complex for commercial real estate. This discourages investors from analyzing commercial real estate deals.

The first few deals are the most challenging. However, it gets easy with time. Experienced investors will look into many deals before investing in one. Most deals require a commercial real estate broker and a real estate attorney on the table. Though the seller will have a team, having your team is in your best interests. You may also want to consult with a financial advisor to check if the investment is aligned with your financial goals.

Once you score the property, hire a property manager as the first order of things. The right property manager can make or break an investment.

Real Estate Industry Sectors

Different Types of Real Estate

The real estate industry is one of the most critical industries in the current market. It is considered to be one of the pillars of the US economy. It covers many aspects such as developing, appraisal, managing, and leasing real estate.

In 2018, commercial real estate contributed 2.7 trillion dollars to the US economy. This amounted to 13% of the US GDP. Moreover, it employs 2 million people compared to 800,00 people in farming. Thus, the industry plays a massive role in the US economy. In addition, it relates to other sectors and industries by providing a factory or office space to operate.

Hence, it is essential to know what types of real estate exist in today’s market and their difference.

This article discusses the real estate industry sectors – the umbrella term for commercial and industrial real estate. We’ll also discuss US real estate and its growth.

Real Estate Industry

The real estate industry refers to the buying and selling of property or investment or for use by the real property owner. There are 5 main categories of real estate:

  • Residential
  • Commercial
  • Industrial
  • Raw Land
  • Special Use

The term real estate includes vacant land along with natural and artificial structures.

Types of Real Estate Industry

As of today, there exist only two major types: Residential real property and non-residential real property.

Residential Real Estate

2-Story Home for Sale

Residential real estate refers to the property used for living purposes. It includes single-family homes, condominiums, apartment buildings, as well as the land.

Residential real estate has experienced rapid growth in recent years. This is due to several factors, such as population increase and a notable drop in interest rates.

The US has experienced a boom in residential housing construction since World War II. In fact, from 1960 to 2000, there were close to 75 million new homes built across the country.

This amounts to an average of one house built every 17 seconds!

During this period, real estate was an avenue for people to build wealth rather than being a house. As such, people began buying up properties left and right. It was unsurprising considering how low-interest rates had been during this period. The trend only recently ended by the 2008 financial crisis. The commercial real estate market peaked and then plunged, coinciding with the recession.

Non-Residential Real Estate

Non-residential real estate refers to realty that goes beyond residential use – properties. They are not meant for living, but rather for business or productive activities instead. For example, office buildings, shopping malls, warehouses, and other properties.

This sector has been growing at an even faster rate than its counterpart since 2010. This is because it offers investors better yields per dollar spent compared with other investments.

Are There Any Industries Under the US Real Estate Industry?

There are several different sectors involved, including:

  • Construction companies who build them
  • Retail outlets that occupy commercial spaces within malls or office spaces
  • Grocery stores occupying land used for producing food products and more

Governments also play an essential role in this sector. They manage land other crucial resources like water supply (e.g., California’s drought).

The economic impact of the industry is notable – reaching over $700 billion every year. Some groups estimate that it has created close to 20 million jobs worldwide. It can be broken into three main categories; investing, development and management.

Each category presents opportunities to innovate new ideas while pushing forward the industry. For example, the US real estate market alone is worth over $35 trillion – some estimate it to be even higher.

What Comes Under the Real Estate Sector?

There are two real estate sectors: commercial and industrial.

  • Commercial Sector: Income-producing purposes
  • Industrial Real Estate Sector: Produces goods rather than services

The commercial sector includes multi-story structures like shopping centers, business parks, entertainment venues. On the other hand, the industrial sector includes warehouses, factories, and similar places.

Both the sectors are multiplying as of 2017 since investment continues to flow into real property assets. Moreover, those in the commercial sector offer investors higher yields per dollar spent.

Is Real Estate a Services Sector?

Though often recognized as a part of the construction industry, it is pretty far from the truth. Instead, it’s a service sector that works along with other sectors in this area (e.g., engineering). But, it also exists on its own within many industries like manufacturing or retailing.

According to NAIOP, it is a business model that offers its clients access to commercial properties and facilities. Above all, you can use it as such or modified to suit the customer’s needs.

What Is an Industrial Property?

Industrial Real Estate Industry - Factory

Industrial property refers to those built for industrial purposes. They include properties used to develop and manufacture products. In addition to that, assets used for storage and those that support the production also come under the industrial property. For example, warehouses, factories, and other places like multi-story structures with a roof.

Industrial real estate produces goods rather than services like manufacturing or wholesaling. These properties aren’t as glamourous as malls, skyscrapers, and well-manicured apartment buildings. However, they play an essential part in the economy, enabling it to run without a hitch.

What Are Market Segments in Real Estate?

Market segments in real estate refer to the earning capacity of a property and its resale value. In terms of finance, it applies to different real estate investment sectors. For example, the retail sector refers to malls, shops, grocery stores, and more.

Investors and developers tend to focus on the sector that best serves their industry. For example:

  • Retail Property (Shopping Malls)
  • Industrial Property (Factories or Warehouses)
  • Office Spaces (Companies in Need of Headquarters)
  • Data Centers

What Does Commercial Real Estate Include?

Commercial real estate includes multi-story structures used for income-producing purposes like office complexes and malls. These types of properties are generally multi-storeyed with a roof. Its uses depend on what they will be rented out for. For example, an apartment complex might contain residential units and some commercial space to generate more revenue. Commercial property can also encompass things like business parks, entertainment venues, corporate campuses, and more.

Is Commercial Real Estate an Industry?

Commercial Real Estate - Office Complexes in China

Commercial real estate is not an industry but rather a service. It intersects with other industries and sectors – such as real estate, construction, engineering, finance. But it can also exist on its own within several business types like manufacturing or retailing.

Commercial real estate consists of companies that develop commercial, industrial, or residential properties. In addition to that, it also includes companies that provide services such as buying, selling, renting, leasing, and managing real estate.

What Are the 4 Main Categories of Commercial Real Estate?

Commercial real estate comes in a few different forms, including:

  • Office Buildings
  • Retail (Shopping Malls)
  • Multi-Family Housing – This is a property intended for people to live in. Apartments and other such complexes are also good examples.
  • Industrial – As mentioned earlier, industrial realty includes warehouses, factories, and the like. They are generally multi-story structures with a roof. For example, storage facilities or manufacturing plants that produce goods instead of services.

What Is the Difference Between Commercial and Industrial Real Estate?

Commercial real estate refers to properties used for income purposes like office buildings and malls. They are usually multi-story with a roof, but the purpose depends on the business they host.

Industrial real estate refers to those built for industrial needs like warehouses and factories. These types of properties are used in productive activities like manufacturing or wholesaling. Some examples might also exist within the transportation sector. For example, you can see it at airports. They have warehouses (on several stories) that handle goods from international flights.

Unlike commercial properties, it doesn’t have to be multi-story or have a roof. It can come in both non-residential and residential forms depending on the business.

Can You Invest in Real Estate without Owning Physical Property?

No, owning physical real estate is necessary when investing in this economic sector. Buying these properties allows investors to access their unique economic benefits. That said, there are other ways one might make indirect investments. For example, it can be through funds that focus on real estate assets like stocks, bonds, and more.

In What Economic Sector Are Real Estate Agents?

A real estate agent is someone who deals with all types of properties, including homes and commercial buildings. In the past, they were professionals who showed homes to potential buyers or tenants.

Today real estate professionals are often contracted by companies instead (e.g., RE/MAX). But their responsibilities remain similar. Find new clients for property owners and helping them buy or rent it out again if necessary.

As cities expanded, the demand for real estate transactions doubled. Real estate agents were at the forefront, helping to buy, sell and lease these properties.

Conclusion

Commercial Real Estate - Skyscrapers in Cityscape

The real estate industry is massive. But to make sense of it all, you must first understand the difference between commercial and industrial real estate. There are four main categories of properties included in this sector:

  • Office Buildings
  • Retail
  • Multi-Family Housing
  • Industrial

There are other ways for those who want to invest without owning physical property. One of them is funds that focus on assets like stocks or bonds like Real Estate Investment Trusts.

Now you know what makes up this industry’s sectors and the types of properties used in them. You can now dive into investing with a solid business strategy!

A related article you may also enjoy:

Everything You Need to Know About Commercial Real Estate

Commercial Real Estate in ChinaCommercial Real Estate (CRE)

According to the wall street journal, commercial real estate sales have bounced back to the pre-pandemic level, thanks to low interest rates. It looks like the future of investing lies in real estate, at least for now. Due to its growth potential, passive income, and consistent returns, it is appealing to the masses.

But what exactly is commercial real estate (CRE) and what are some of the benefits and drawbacks of purchasing or owning CRE? The following topics will help answer those questions and more:

What Is Commercial Real Estate?

Commercial real estate (CRE) is property that is exclusively used to conduct business and provide income at a profit to the property owner. It can either be a building or land as long as they are used for business purposes. Moreover, large residential rental structures also come under commercial properties. These holdings can also bring in rental income as well as investments. They are also financed and taxed in a different manner than that of a residential property.

In short, it is a broad category of assets from stores to shopping malls and office buildings.

What Is the Best State for Commercial Real Estate?

Apart from the mainstays like San Francisco and New York, the best commercial real estate market is St. Louis, Missouri. It set records in the year 2016 by absorbing 6 million sq ft new commercial property. In the next three years, it set record highs for rental rates. The rates peaked in the third quarter of 2019 and remain steady since then.

Their Cortex Innovation District has attracted many a tech giant. Microsoft opened its branch in September 2018.

What Are the Different Types of Commercial Real Estate?

A wide variety of assets fall under commercial real estate. It includes but is not limited to storefronts, land, apartments, and theme parks. Self-storage facilities, industrial properties, government real estate, and marinas also come under CRE.

As such commercial real estate is of 8 types:

Multi-Family

They serve as a residency but are built for investment purposes. The property owners make a profit by renting out the residences.

  • Duplex, Triplex, and Quadruplex are two, three, and four-unit rental units.
  • Garden Apartment is a collection of low-rise apartment buildings, 3-4 stories high. They have a shared yard, no elevators, or access to parking.
  • Mid-Rise Apartment is found in urban infill neighborhoods. It is 5-12 stories high with 30-110 units.
  • High-Rise Apartment is a residential building more than 12 stories high. They are often managed by professionals.

Retail

Commercial Real Estate - Shopping MallRetail real estate is one that houses a store that sells services or products to customers. They exist to provide the maximum convenience possible to consumers.

  • Shopping Center is a smaller storefront that sometimes contains anchor tenants like Walmart. It may also be a cluster of small stores in one locality.
  • Community Retail Center measures 150,000-350,000 square feet. They contain multiple anchors such as grocery stores, pharmacies, restaurants, etc.
  • Regional Mall is a 400,000-2,000,000 square foot large property. It has a handful of department stores, high-end shoppers, and such. They can be indoor and outdoor and are anchored by a major retailer with a handful of smaller stores.
  • Out Parcel is a standalone single-tenant asset closer to shopping centers. For example, Starbucks and Panera.

Industrial

Industrial real estates are one of the best investments due to their flexibility. Moreover, the tenants tend to stay for longer periods due to the difficulty in relocating.

  • Heavy Manufacturing is a customized industry space specific to an industry.
  • Light Assembly – Product assembly, storage, and workspace
  • Flex Warehouse – A combination of workspace and heavy manufacturing
  • Bulk Warehouse is a large holding measuring 50,000-1,000,000 square feet. It is used for both storage and distribution.

Office

Much like residential structures, these buildings can also be categorized as low, mid-rise, and high-rise. However, the classification depends on the size, location, and neighborhood.

  • A-Class Building – A structure that is best in terms of placement and construction
  • B-Class Building – A high-quality construction in a less than desirable area
  • C-Class Building – A dilapidated building in a bad neighborhood
  • Central Business District – A office building located in the heart of the city
  • Suburban Office Buildings – A 80,000 – 400,000 square-feet space located in the suburbs

Hospitality

Hospitality real estate serves people who travel both for pleasure and professional reasons. For example, hotels and temporary-stay residences.

  • Full-Service Hotels – Big-name hotels located in central business districts or tourist spots
  • Limited Service Hotels – Smaller boutique property with limited amenities
  • Extended Stay Hotels are designed for people staying for a longer time period. They have large rooms and a kitchenette.

Mixed-Use

Mixed-use is a combination of the above-mentioned properties. For example, restaurants or offices with residences on top.

Land

  • Agricultural – Undeveloped property used for agriculture, farming, ranch, orchard, and the like
  • Infill – A plot within the city, already developed but remains vacant.
  • Brownfield – Property previously used for industrial purposes but now available for re-use.

Special Purpose

They are other real estates that lie outside the classification but are commercial. For example, Stadium, theatre, zoo, parking lot, bowling alley, and many more.

Advantages and Disadvantages of Commercial Real Estate

Investing in commercial real estate can be attractive to many, especially with the current low interest rates. The stock market behavior has also made this a more viable option. However, as with everything, it has its benefits and drawbacks. Investors need to be aware of both the pros and cons to help make the right choice.

Benefits

  • Steady Passive Income: Commercial property can yield anywhere between 6 to 12% in rent, indicating a steady cash flow.
  • Prolonged Tenancy: Tenants with a commercial lease will stay for 3-10 years. It brings about a steady income as long as the tenant occupies the building.
  • Capital Appreciation: As long as you maintain the property in a regular manner, it will continue to yield a steady income. Furthermore, the chances are that it will increase in appreciation depending on the market.

Pros & Cons to Commercial Real EstateDrawbacks

  • Rules and Regulations: Commercial assets have legalities a mile long. The paperwork, tax, maintenance responsibilities, and legalese often deter buyers from purchasing them. Furthermore, the law and statutes differ according to the state, country, and trade.
  • Risk of Tenant Turnover: The uncertainty of the current times has brought a new risk. There has been a slew of unexpected tenant closures without much prior notice.
  • Different Needs: With a commercial property, every tenant has a set of specific needs depending on their trade. The cost of renovations can cause you to lose money, especially if you have a high turnover.

Commercial Lease

A commercial real estate can either be owned outright by the company operating out of it. Or you can also lease it. In the latter case, it is a commercial lease. These leases can run anywhere from 1yr to 10 years. However, the standard time frame is five years and ten years in contrast to the yearly basis of residential buildings. The pricing is run on a yearly basis and is calculated in a price per square foot format.

Data from a 2017 study by the CBRE Group, Inc., a market analyst firm revealed interesting results. They state that the length of the lease is proportionate to the size of the property. This is to lock in reasonable rates in a rising market environment. And also due to the limited availability of properties that match their needs.

Four Types of Commercial Leases

  • Single-Net – Tenant is responsible for the property taxes
  • Double-Net (NN) – Tenant is responsible for property taxes and insurance
  • Triple-Net (NNN) – Tenant is responsible for property taxes, insurance, and maintenance
  • Gross – Tenant pays the rent, and the property owner is responsible for the rest.

Managing Commercial Properties

Owning commercial real estate is not an easy task. It requires regular maintenance and ongoing management by the owner. Owners are better off employing a real estate management firm to manage the property and the tenants. They also do general upkeep and oversee the leases. The rules governing these assets vary depending on the state and country. Hence, you need someone knowledgeable to manage your investment.

Is Commercial Real Estate a Good Investment Right Now?

Property, be it residential or corporate, real estate is always worth the investment. Even though few property sectors are in a slump, commercial real estate has been flexible. In fact, the prices have grown at a 1.4% annual rate in 2019-2020. With the US opening up after the COVID-19 lockdown, it should be easier to find CRE right now. The best investments are those ending the financial terms or in troubled waters. You can get those with a discount on the sale as long as you are patient.

What Are Commercial Real Estate Transactions?

The concept of buying a commercial property is referred to as a CRE transaction. The process is similar to that of a residential property but with some slight yet significant changes. A CRE comes with scrutiny from both the buyer, seller, and lender. Unless you are familiar with the intricacies of the law, it’s easy to misstep and get yourself in legal trouble.

What Is Due Diligence in Commercial Real Estate Transactions?

Investing in real estate comes with its risks, both from the buyers’ and sellers’ sides. Due diligence helps to mitigate these risks. It allows you to investigate prospective buyers before buying the property. It encompasses various aspects, including physical and financial conditions. The time between signing the contract and closing is called the due diligence period. It helps you ensure that the cash flow is as mentioned and you are not cheated out of your money.

Office BuildingsConclusion

Any non-residential property used exclusively for business-related purposes is commercial real estate (CRE). These tend to yield a better return than your average residential assets. Instead of renting, they operate within a lease lasting five to ten years, generally on a triple-net.

While real estate in all forms is helpful, CRE has the potential to bring in a significant amount of income. However, it is crucial that you do thorough due diligence before buying the property. Get to know the risks and benefits before investing in CRE.

Is Now a Good Time to Refinance Your Mortgage?

Refinance Your Mortgage ApplicationRefinance Your Mortgage

To refinance or not to refinance is not the question here. Thanks to the ongoing pandemic, the Federal Reserve has kept the interest rates fairly low. But is now a good time to refinance? Unfortunately, the answer is not that simple.

Refinancing your mortgage refers to the process of taking out a new loan to replace the present mortgage. The mortgage is one of the substantial financial burdens. So, it makes sense to seize any opportunity to reduce the burden a little. That means you could refinance your mortgage and save.

With many homeowners seeking to make better use of the interest rates and refinance, it may soon be late. For example, the average interest rate on a 30-year fixed-rate mortgage was below 3% in April 2021. But by May, it has increased to 3.28% and will continue to increase. However, this increase was predicted by many groups, including Fannie Mae and The Mortgage Bankers Association.

Here is everything you need to know about refinancing:

When Is a Good Time to Refinance Your Mortgage?

Generally speaking, mortgage refinance is a good idea to lower the interest rate by at least .5% – 1%. This will substantially lower your monthly payment.

Moreover, the new loan will be based on the balance of the original mortgage. So, if you had paid some of your principal, refinancing could lower your monthly payments and save money.

In addition to that, how long do you want to stay in your home? What are your financial goals? What is your home equity and your current credit score? These factors also play an essential part in refinancing. So, if everything works out, now is a good time as any to refinance your mortgage.

Is Refinancing Worth It?

Refinancing is worth it if you use it for the right reasons. If not, it can quickly increase your financial burden. While lower interest rates may be attractive for one person, others may prefer to refinance for higher monthly payments.

While .5% – 1% makes sense, even a modest 25% makes sense if the costs are low. So instead of looking at the new interest rate, look at the broad picture. Consider how much you will save per month, how much you will save over the loan term and the closing costs.

How Does Refinancing Your Mortgage Loan Work?

The refinancing process is similar to the mortgage loan. You can replace the current loan with a new loan, often with a lower interest rate. After you refinance your existing mortgage, you will have a much favorable interest rate. Monthly payments will be lowered, and possibly a different lender than your original loan.

However, with the new mortgage, you would be resetting the clock depending on the terms. For example, consider you are five years deep in your 30-year mortgage with 25 years on the clock. If you refinance for 30 years, you would be extending the loan terms. However, if the term is 20 years, you would be able to pay off the loan sooner by five years.

Keep in mind that you’d have to pay closing costs which can be a few hundred dollars. Alternatively, they can be anywhere between 2% to 5% of the loan amount. In addition, it may include an origination fee, appraisal fee, and discount points.

According to Ellie Mae’s Origination Insight Report, the average time to refinance a conventional mortgage is about 38 to 48 days in 2019-2020. However, it can take more than a week longer than a conventional loan for FHA and VA loans.

Why Should You Refinance Your Mortgage?

Refinancing doesn’t come free. So, if you are looking to refinance your most significant debt, you better have a good reason. As such, you need to have a clear head about your refinancing goals.

Here are some of the reasons why someone would refinance a mortgage.

Save Money on Lower Monthly Payments

Refinance Your Mortgage - Save Money on Lower Monthly PaymentsEven the slight difference in the interest rate can create a noticeable impact on your monthly mortgage payments. For example, consider a 30-year $300,000 loan with a fixed interest rate of 4% and a payment of $1,567. Refinancing the loan to the same period with a 3.25% interest rate, your monthly payment drops by $134. This amounts up to $48,420 over the life of the loan.

With a lower interest rate, your new monthly payment will most likely shrink. In addition, it allows you to save money. You can put up the monthly savings against your principle. Or use it for other expenses like an auto loan or maybe your retirement fund.

However, it makes sense to pay off the home loan instead of refinancing for lower payments. At the same time, you may have to sacrifice your savings, including your retirement savings, to finish your loan first. But the advantage is that you will have a home with no mortgage payments. Now you can get back to savings and investments.

Save on Interest Costs

A low-interest rate decreases the mortgage interest you pay throughout the loan.

Both the interest rate and loan term decide how much you save in interest costs over the life of the loan. Reducing one or both factors can result in increased savings both in mortgage interest rates and monthly payments. However, you can prepay the interest in paying for mortgage points.

Ensure that you shop around with multiple lenders for better mortgage rates and terms. Before seeking a new lender, ensure that you check with the current one. They may even offer a better rate if you stick with them.

Get Shorter Loan Term

In 2019, Freddie Mac reported that 78% of borrowers refinanced from a 30-year fixed-rate mortgage to a similar loan. In addition, 14% went from a 30-year fixed to 15-year. And a last 7% refinanced from a 30-year fixed to a 20-year fixed.

Freddie Mac also reports that people refinancing their 30-year mortgages to 15-years pay less interest over a long period of time. They also shave years off your loan. On the downside, your monthly mortgage payment will increase. However, this can help save the interest payments if the property doesn’t qualify for an interest deduction.

Tap into Home Equity

With refinancing your mortgage, you can convert the equity into money and borrow it on your current loan. In such a case, the lender gives you the difference as check or cash which is called a cash-out refinance. However, the condition is that, to qualify for the loan, you need to have enough equity, at least 20% or more.

A survey by Black Knight indicates that 45 million homeowners have tappable equity lying unused. With a cash-out refinance, you can convert the equity to usable money, which you can use for investments or home improvements.

Consolidate Debt

Refinancing offers a low interest rate compared to other mortgages. Hence, it is attractive for homeowners looking to pay off debts. Since the loan allows you to tap into the equity, you can take advantage of the cash-out refinance option. You can use to consolidate debts like personal loan, credit card debt, student loans, or home loan into one single loan. Your loan balance depends on the equity you decide to cash in.

Keep in mind that if your home equity falls below 20%, you may have to pay mortgage insurance on an FHA loan.

Remove Private Mortgage Insurance (PMI)

PMI comes into the picture when you do not have enough down payment for a mortgage. It can cost you a considerable sum every month until the home equity builds to 22%. At this juncture, your lender is required to cancel it if the monthly payments are current.

However, you can get rid of mortgage insurance early by refinancing your loan. But they are an expensive option with closing costs as high as 2%-5% of the loan amount. But if you have other benefits such as a low-interest rate and short break-even point, you can opt for refinancing.

If you are stuck with an FHA loan, and you may be paying PMI for 11 months or even the life of the loan. This depends on how big your down payment was. In such a case, refinancing may be the only option.

Ability to Switch Mortgage Types

Some borrowers refinance their mortgage to convert their adjustable-rate mortgage (ARM) and lock in on a fixed-rate loan. This is true if the current mortgage rates are low and not planning to sell shortly.

In the same line, it makes sense to move from an ARM to a fixed-rate loan in certain situations. For example, this works if you plan to sell in a few years and are not afraid to take on a higher interest rate. It eliminates the fear of future interest rate hikes.

Is Refinancing a Bad Idea?

No rule says refinancing your mortgage is a bad idea. On the contrary, if done right, refinancing your loan can help save a few hundred dollars at least. However, certain factors can drive up the expenses and cost you more in the long run, so caution is advised.

Longer Loan Term – To calculate the profitability of the refinancing loan, take the mortgage rates as well as loan term for a complete picture. Do not take refinance if you aren’t saving enough.

Higher Closing Costs – The closing costs come with unnecessary fees such as loan processing and application fees. Moreover, if you cannot pay the upfront costs and instead add them to your mortgage, you’ll end up paying more.

Moving Soon – If you see yourself moving soon, it is a bad idea to refinance your current mortgage. This is because you are not likely to save enough to outweigh the loan’s closing costs.

Is it Worth Refinancing a 30-Year Mortgage into a 15-Year Mortgage?

At the beginning of a 30-year loan, most of the monthly payments go towards the interest costs. Unless you pay into the principal, you would not be able to build home equity for many years to come. Or you can refinance it into a 15-year loan. While this helps to build the equity, you’ll be taking on a higher monthly payment. If you are someone looking for a lower monthly payment, it may not be ideal for you.

With a 15-year mortgage, you are looking at:

Refinance Your Mortgage Pros and ConsPros

  • Low-interest rate
  • Low-interest costs
  • Pay off the mortgage quicker

Cons

  • Higher monthly payment
  • No flexibility
  • No leeway in case your financial situation worsens
  • Less investment and savings

However, you can refinance the current loan to a longer term and tide it over if the situation warrants it. When personal finances change for the better, you can save up and pay the principal faster.

Am I Eligible for a Mortgage Refinance?

To refinance your mortgage, you’d have to go through a refinancing process, starting with the application. FHA and VA loans qualify easier than conventional loans.

The qualifying criteria for a mortgage refinance are similar to a new mortgage. The most important of them are:

Credit Score: Most mortgage lenders require a credit score of 620 to be eligible for mortgage refinance. However, for a competitive interest rate, you need at least 740.

Debt-to-Income (DTI) Ratio: The lower the DTI ratio, the better your interest rate. However, it depends on the lender as well. Few go as high as 43% for conventional loans, while 50% for FHA loans.

DTI Ratio = Total Monthly Debts ÷ Total Monthly Income

Apart from these, mortgage lenders create their eligibility criteria. As such, there are a few other factors that lenders consider:

  • Credit history
  • Employment history
  • Payment history on the current loan
  • Home equity
  • Home’s current value

Once you meet the lender’s criteria, you’ll receive an offer with the interest rate depending on the risk you pose. However, you may not get approved or receive favorable terms if your credit history has taken a wrong turn since the first mortgage.

What to Consider Before Refinancing

Before you refinance the loan, consider why you want to refinance your mortgage. To start with, how long do you intend to stay in your home? If you are planning to move in the next few years, stop right there. Refinancing is not the right option for you.

Current Interest Rates: The success of refinancing lies in the interest rate. Even the slightest change in the rate can create a huge impact. Hence, experts recommend you interview several lenders, including your current lender, to find one suited for your current financial situation.

Mortgage Term: Refinancing to a lower interest rate can help you save money but not increase the mortgage terms. That can be counterintuitive since you end up paying more interest over the life of the loan.

Cost of Refinancing: Ensure that you stay in your home at least until you recoup the cost of the refinancing. Refinancing comes with closing costs, including the exact fees and services as when you purchased your home. So, if there is a chance that you may move before you recoup the costs, refinancing is not one of the best financial decisions.

Find the Best Refinance Rates

Just like your initial mortgage, you need to take some time and shop around for better interest rates for the new loan. Look for independent vendors, credit unions, banks, and online comparison sites. If not, you can approach a mortgage broker who can open venues that were previously hidden. They can do the legwork and get you access to vendors and better loan terms.

Make a list of preferred vendors and submit 3-5 requesting loan estimates. It has the estimated interest rate, closing costs, annual percentage rate, and monthly payment. When it comes to mortgages, you’d be better off with a loan that has a high APR, high monthly payment but no fees. Experts suggest you do not pay closing costs with cash; instead, lock it in with the loan amount. And invest the money or stash it for an emergency fund.

Conclusion

Refinancing is a shaky subject, to say the least. While it has its benefits, it is not without drawbacks as well. Refinance loans work well only if you focus on the long-term goals and not on the short term. Having said that, you should go for it, as refinancing could get you through a financial rough patch. A higher credit score, lower debt-to-income ratio, or increased equity could all help you qualify for a better interest rate.

Priority Lending in Tucson LogoSo, is now a good time to refinance? As a rule, the best time to refinance depends on your financial situation. With the interest rates at record lows refinancing can lower your monthly mortgage payments and increase your monthly savings.

Priority Lending, LLC has been providing mortgage loans and helping people like you fulfill their dreams since 1997. Contact one of our loan officers today to get started on refinancing your mortgage.

Commercial Real Estate Lending Explained

Commercial Real Estate Lending - Luxurious Offices in China

As a business owner, your top priority is to grow your business. Purchasing new property or renovating it is a great start in establishing yourself in the commercial world. However, you will need financing, and your regular home loans or mortgage will not work out.

With commercial real estate lending, investors and businesses can purchase or renovate business-related properties. Much like residential loans, they are secured loans where the property being purchased acts as the collateral.

If you consider a commercial real estate loan for your business, here’s everything you need to know before you step foot in the action.

This article takes you through commercial real estate lending: Commercial loans, types of commercial real estate loans, qualifications, important loan ratios, repayment schedules, interest rates, and much more.

We will be considering the following main topics:

What Is Commercial Real Estate Lending?

Commercial real estate lending is similar to mortgage loans. However, they are given to companies to purchase properties for business purposes.

Commercial real estate is a property used exclusively for business prospects or as a workplace rather than a living space. It includes housing, retail sales, manufacturing facilities, medical facilities, restaurants, recreational parks, retail sales buildings (such as shopping centers and malls), warehouses, etc.

Sources for Commercial Real Estate Lending

Apart from a commercial bank, the following also act as sources for commercial real estate lending and provide capital:

What Is a Commercial Loan?

Just like with home loans, banks and financial institutions also provide loans on commercial real estate.

Commercial loans are typically secured loans where the property being purchased is used as collateral. They are designed to help companies purchase or renovate commercial real estate properties and refinance real estate debt on already-owned commercial property.

Commercial real estate loans are made to corporations or businesses that own and operate commercial estate. The large size of the loan poses a potential risk to the lender. Hence, they require a more significant down payment when compared to residential mortgage loans.

How Does a Commercial Loan Work?

Much like your residential loan, every lender has different terms and accepts various risk levels. However, the repayment terms of commercial loans are much smaller. The term can range anywhere from 5 to 20 years. In this case, the amortization period is longer than the loan term.

For example: Consider a CRE loan with a term of 7 years and an amortization period of 30 years. Here, the borrower makes regular payments for the first seven years. Then finally, they make a balloon payment comprising of the remaining balance.

These loans are generally more expensive, with the down payments ranging between 20% to 30% of the purchase price. In addition, the interest rates are again high at 10% to 20% for most borrowers in the same line. However, loans backed by SBA tend to be cheaper at 7.75% to 10.25% depending on the size and length of the loan.

Importance of Commercial Real Estate Loans

Commercial real estate loans are a critical part of the economy. They are generally much bigger than the residential loans making for a bulk part of the income for commercial banks and other lenders. Furthermore, nearly all businesses seek financing to be able to operate firsthand.

Commercial real estate loans are actively sought for various reasons:

  • Companies seeking to purchase a warehouse, workspace, or manufacturing space
  • Businesses seeking for financing to acquire rental property
  • Housing development companies looking to fund a new development project

Qualifications for Commercial Real Estate Loans

Commercial real estate loans are not as easy to get as residential loans. Every lender has his own qualifying criteria. Here’s how you qualify for a commercial loan:

  • Good Credit History: To start with, you will need a credit score of 680 or higher. For credit approval, your history should be devoid of foreclosures, recent tax liens, recent bankruptcies, etc.
  • Low Loan-to-Value (LTV) Ratio: LTV ratio determines the amount of equity or collateral a borrower has in a given property. Those seeking a commercial real estate loan require a minimum of 65 – 80%.
  • Down Payment: A bank may expect a down payment of at least 30% for these loans. However, in the case of SBA loans, it is 10%. Keep in mind that a lower down payment relates to higher monthly payments.
  • Organized Paperwork: An organized application and the required documents may make the difference between your loan approval and rejection.
  • Business Entity: Commercial loans are available for entities and not individuals. So ensure that your business entity is set up before applying.
  • Joint Venture Loan: In case you are not able to secure one as a single entity, you can join forces with someone else and seek a joint venture loan. This would effectively make you both partners.

Make it a point to write down the qualifications of different lenders, both your bank and other online lenders, as you shop around. This helps you compare and choose the one with less stringent requirements.

Loan Repayment Schedules

Commercial Real Estate Lending Repayment SchedulesIn short, you pay monthly payments for the repayment term and then a final balloon payment at the end. Again, not all lenders allow you to pay the amount early. Here are some potential charges you may encounter:

  • Prepayment Penalty
  • Interest Guarantee
  • Lockout
  • Defeasance

Interest Rates and Fees

Commercial real estate loans have higher interest rates than mortgage loans averaging at 5 – 7%. SBA 504 loans provide a lower interest rate, below 3%. Depending on your loan type and structure, lenders may go lower than the average range.

Coming to fees, you may have to pay closing costs (appraisal, origination, legal, and application fees) and more. It can amount to 1 – 2% of the commercial loan amount. In addition to that, you may also have to pay a guaranty fee that can cover a portion of the loan. It can be as high as 3.75%.

Prepayment penalties and prepayment fees can also be costly, depending on the lender’s size and the financials of your business.

Read the fine print to understand how much you might be charged if you choose to pay off your debt early in a commercial real estate loan. Commercial real estate loans do not require private mortgage insurance, so that’s one less thing to worry about.

Important Loan Ratios

Not just commercial real estate loans, every loan is based on the loan-to-value ratio and the debt-service coverage ratio. These ratios help determine the loan size and the interest rate.

Loan-to-Value (LTV) Ratio

The LTV ratio measures the value of the loan against that of the property. Lenders use it to determine how much money they can lend.

Commercial real estate lenders prefer an LTV of around 75 – 80%. However, according to the National Association of Realtors® (NAR), only 60% use it as a criterion for determining how much a business can borrow.

Borrowers with less LTV have a good chance at qualifying for better interest rates than those with higher LTVs. Another point to note is that there are neither VA nor FHA programs nor private mortgage insurance in commercial lending. In the absence of insurance, the lenders depend on the property in case the borrower defaults.

Debt-Service Coverage Ratio (DSCR)

A DSCR compares a property’s annual net operating income (NOI) with the annual mortgage debt service (including principal and interest). NOI is a company’s revenue minus certain operating expenses (COE), not including taxes and interest payments. The ratio helps the lenders determine the loan size based on the cash flow generated by the property.

A lower DSCR is adequate for loans with a stable income or a shorter amortization period. However, for businesses with volatile income, lenders may require a higher ratio.

Types of Commercial Real Estate Loans

Commercial real estate lending is a broad topic; there are many financial structures offering loans. This structure attracts buyers with favorable terms and deals. There is practically a loan for every situation you find yourself in.

Nonetheless, these are the most popular types of commercial real estate loans:

Permanent Loans

A permanent loan is similar to a traditional mortgage. It is also the first loan acquired on a commercial property.

While you can obtain a loan from any commercial lender, they are not open for short-term needs. They come with a repayment term of 5 years or more and an amortization schedule.

SBA Loans

SBA 7(a) Loan

  • SBA 7(a) Loans: SBA 7(a) loans are provided by a single private commercial lender and have a lot of flexibility. Up to 85% of the loan is guaranteed by the SBA, which you can use to provide working capital and purchase inventory.
  • SBA 504 Loans: SBA 504 loans are offered through two lenders: a private commercial lender (50% of the project costs) and a certified development company (40% of the project costs). You may need to provide 10% as the down payment.

A Key Point to Remember: Real estate investors are not eligible for an SBA loan.

Bridge Loans

Bridge loans are short-term loans with terms ranging from 6 months to 3 years. Small business owners waiting for long-term financing use this in the interim period. They can also be used by real estate investors looking to buy and flip investment property for short-term gains.

Hard Money Loans

Hard money loans are strictly short-term financing offered only by private companies and individuals but not your bank. The value of the property guarantees them. The term lasts between 3 months and three years because investors do not hold on to the property for long.

Owner Financing

Owner financing allows home buyers or real estate investors to purchase a home and pay the seller directly without availing of a mortgage. They are helpful if your credit score is low or you have a hard time verifying your income. They are also a welcome alternative when traditional lenders would not work with you.

How Much Will My Bank Lend for Commercial Property?

The amount that a bank lends depends on your contribution. For example, most financial institutions require a 30% down payment for a commercial real estate loan. In other words, your lender will consider lending you 70% of the property’s value.

Conclusion

Investing in real estate is one of the efficient ways to financial independence. It offers incredible returns and better tax breaks. In addition, real estate investors often look at commercial lending quite favorably since they give more control over the value of the assets.

Commercial real estate loans provide an excellent platform for small business owners to establish their own businesses. However, with so many loans available, you may want to shop around for suitable financial options and lenders for your needs.

Compare each loan, the terms, and the repayment period firsthand. Also, look at the fine print for the prepayment penalty (if any). Taking time to look around can help you find the right loan for your business.