Category: General

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.

Time for a New York-Style Housing Fix

Street signs for W 125 st.

 

Previously, I’ve written about a man who works in our office who lived in New York City back in the late ‘80s and early ‘90s – let me assure you that while that does seem like a very long time ago, it’s not nearly as far back as when the wheel was invented and humankind learned to harness the power of fire. If you’ve been to New York City recently and blissfully walked around Harlem to get chicken and waffles at Sylvia’s on Malcolm X Boulevard between 126th and 127th Streets or stopped in at Keybar on 13th Street between First Avenue and Avenue A to wedge yourself into a cozy corner next to their notable fireplace, you wouldn’t get a sense that these areas were once . . . not as welcoming and glitzy as you now see them. Our office mate has told some fairly interesting stories of living in those and other areas of New York City that give a much different sense.

In the late ‘80s/early ‘90s, no matter how many great things you heard about Sylvia’s food, 127th Street and Malcolm X Boulevard (back then, it was Lenox Avenue) wasn’t a place you popped up to for Sunday brunch – it was an area you didn’t visit unless you had . . . official business. At that same time, between 14th Street to the north and Houston (pronounced HOW-STUN) to the south and east of First Avenue – known as Alphabet City (still is) – that was an area full of very hard-living folks who would sell their right arm (or yours, it didn’t matter to them) to get their next fix, and I’m not talking about an appliance repair. The Lower East Side (of which Alphabet City is a part) was full of tenements and government projects that tucked itself into the shadows of the bright and shiny skyscrapers that surrounded it – A LOT of bad stuff happened in the darkness of those shadows.

Anytime he tells one of his New York stories, they all seem to end with him saying, “Back when I lived there, I NEVER would have thought many of those areas would be safe to go back to and show my family.” And whenever he says that, he gets a bit of a far-off gaze fixed on his face: one that could mean he’s momentarily transported himself back to an earlier time (or he needs to get back on his medications).

Between the late ‘80s and today, New York City has continued to grow, population wise. Sure, the city has improved and become safer, but there were many years before those improvements and that safety came about, and the city’s population STILL grew. There was something that kept them there and attracted more people.

Recently, I read an article that said an end to the housing shortage is in sight. Granted, the article went on to say that it’s still probably about eighteen months out, but it does cite a number of reasons for being optimistic. There are many of you who have been saddened or depressed because you feel you’ve been priced out of the market as a result of this housing shortage. Well, now is not the time to give up. In fact, NOW is the time to formulate, implement, and execute a plan that will enable you to seize the moment when the right house at the right price becomes available. There are many things that you’ll want to look at like your current spending habits versus your current saving habits (or lack thereof) and how much debt you currently hold (credit card balances, car payments, student loans, etc.), just to name two. If you wait until the housing shortage abates before you work on a game plan, you’ll be even further behind the eight ball.

If you’re a real estate agent, may I suggest seeking out and marketing to folks who need to do a little work in anticipation of the housing shortage letting up? You’ll fill a great pipeline that will be a constant source of leads as conditions continue to improve inventory availability. If you’re someone who feels like you’ve been forced on the sidelines, get with a lender TODAY and have them help you formulate that plan because when you’ve found the right house at the right price, you’re going to want to have enough for a down payment – relying on the option of selling your right arm isn’t wise.

Size Can Be Deceiving

On a recent episode of a podcast I follow (I won’t tell you which one in case it would lower your opinion of me – if that’s even possible), the host was chatting away with the show’s supporting cast, and he made a comment about cars that struck me: the Ferrari that Tom Selleck’s character (and mustache) drove in the television series Magnum, P.I. takes longer to go from 0-60 than the latest model of the Mini Cooper S. They thought he was pulling their legs, so one of his staff Googled the info while the host nattered on about some other things and quickly came back with confirmation that the 1983 Ferrari 308 GT goes from 0-60 mph in 6.9 seconds while the 2017 Mini Cooper S can do it in 5.3 seconds. Get out of town!

The host of this podcast is a huge car aficionado (although that’s not the theme of his podcast), so he obviously knows his stuff. However, I’d be willing to bet if you walked up to random people on the street and asked them to place a small wager on which of the two cars would win in a drag race (1,000 feet), more than the majority would place their money on the sleek and sexy Ferrari 308 GT. It looks like it eats Mini Coopers for breakfast, right?

With that little lesson planted firmly in your minds, I’m sure you can see where I’m going with this, but since I love to state the obvious, I’ll go ahead and say it. Isn’t that EXACTLY what so many people do when it comes time to purchase a house: they let their preconceived notions guide them in their decision-making process, and quite often, that costs them money (and/or a great deal of time). I can hear some of you now, though, protesting, “Not me! I do a lot of research myself and make sure I know all my options before I make a big decision like a mortgage.” I’m not looking to pick a fight, but I’m going to call bull on that for most people.

The reality is that the “research” most people conduct covers one subject, and one subject only: can I afford to buy a house? Now, that’s the most fundamental subject you SHOULD research, and one that you should have down cold before you borrow a large chunk of money over a long period of time. And once that research is complete, you toddle off to find a company that will loan you that money. All done, right?

A mortgage lender worth a hoot (yes, I said “hoot”) isn’t going to let you walk into her office and start applying for a mortgage. What do you mean? Isn’t it sort of hard for a lender to make any money if he’s keeping borrowers from applying for a mortgage? Calm down, I’m getting to that. The hoot-worthy (you’re going to start using that term, I know it) loan originator SHOULD ask a few questions like what are your short-term and long-term goals with this property, and how do those goals play into your other goals with your family, career, etc. The answers to those questions should prompt new questions that start off with “Have you considered . . . ?” As an example, a little over a year ago, we had a young single guy come to us, and one of our LOs (all of our LOs are hoot-worthy, of course) asked those questions. Because of those questions, the young man went from his preconceived notion of a single-family residence to purchasing a duplex. He lived in the duplex for a year, rented out the other side, had the tenants basically paying his mortgage the whole time, and has now moved out (while keeping the duplex as a rental – both sides of it) and purchased a single-family residence for himself. All of this happened because we asked some questions and listened.

A duplex, of course, isn’t nearly as glamorous as a house, just as a Mini Cooper S isn’t going to turn as many heads as a Ferrari 308 GT. However, when you’ve TRULY done your research (assisted by someone worth a hoot), you’re going to reach your real estate goal a lot faster by picking the right vehicle (and you can still sport the ‘80s mustache regardless of what you choose).

From the Jersey Shore: an Olympic Lesson

statue of Olympic symbol 

There’s an old saying: “A bird in the hand is worth two in the bush.” Personally, if I’m being honest, I believe the bird in the hand is worth a lot more than the two in the bush because, let’s be honest, we have no idea what those birds are doing in the bush and whether they’ve been taking care of themselves (working out and eating a healthy diet v. binge watching “Jersey Shore” and eating gluten). I’ll just add this to the old saying: “But one that’s been plucked, roasted, and served up on a silver platter is worth the most.”

There’s an old saying: “A bird in the hand is worth two in the bush.” Personally, if I’m being honest, I believe the bird in the hand is worth a lot more than the two in the bush because, let’s be honest, we have no idea what those birds are doing in the bush and whether they’ve been taking care of themselves (working out and eating a healthy diet v. binge watching “Jersey Shore” and eating gluten). I’ll just add this to the old saying: “But one that’s been plucked, roasted, and served up on a silver platter is worth the most.”

When submitting an offer on a house, there are generally three types of offers:
1. Based on a pre-qualification (two in the bush)
2. Cash (bird in the hand)
3. Based on a qualified approval (plucked, roasted, and served)
Let me describe how the seller sees each type of offer (using “Jersey Shore” as my backdrop):
1. Based on a pre-qualification: the buyer is basically saying, “C’mon. You can trust me. I’m good for it.”
2. Cash: the buyer is saying, “Tree hunnerd is too high, you know. I got two-fiddy right heah, right now. Let’s doooo this!”
3. Based on a qualified approval: “Here’s a cashier’s check for your asking price.”

Allow me explain and define a Qualified Approval. Underwriting a home loan is made up of two major parts: the home and the borrower(s). Most people overestimate the amount of information needed regarding the “home” portion. In reality, all that’s required is Title Work, an Appraisal, an Inspection, and a Contract – very minimal but very important. However, those are all things that have to be done with limited involvement from the borrower.

The “borrower” portion can be complicated, taking Underwriters down a road full of twists and turns, which translates into time. We are required to verify current income, job history, credit scores, any negative credit history, rent history, large deposits, and the list goes on. By doing all of this up front to obtain a Qualified Approval, we can issue you an “all clear” to show the potential Seller that you, the Borrower, are fully underwritten and ready to purchase their home – this gets your home loan 85% complete before you even start looking for and finding the house of your dreams.

Going the Qualified Approval route is like Usain Bolt’s journey to his first gold medal. The actual race that won him that medal sped by in mere seconds, but he spent THOUSANDS OF HOURS preparing for the moment he would have his chance to run THAT ONE RACE. It paid off, right? THAT is the essence of a Qualified Approval. Getting a pre-qualification is like starting the race with your eye on the prize and being held up in the middle while the officials decide if you’re qualified – and you’re forced to watch someone else claim what you’ve wanted for so long. At that point, the only bird you’re eating is crow. Ouch!

We Salute You

In 1921, an unknown World War I American soldier was buried in Arlington National Cemetery on a hillside overlooking the Potomac River, and this became the focal point of reverence for America’s veterans. Similar ceremonies occurred earlier in England and France, where an unknown soldier was buried in each nation’s highest place of honor: in England, Westminster Abbey; in France, the Arc de Triomphe. These memorial gestures all took place on November 11 in universal recognition of the celebrated ending of World War I fighting at 11 a.m., November 11, 1918 (the 11th hour of the 11th day of the 11th month). The day became known as Armistice Day. In 1954, to honor ALL veterans, President Eisenhower signed a bill proclaiming November 11 as Veterans Day. While many people don’t know the origins of Veterans Day, there are as many people – if not more – who have a lot of misconceptions about a VA Loan. Allow me to highlight and correct some of these myths:

Myth #1: VA Loans are not a great option for a buyer.
Ha! Not only can you borrow over $400K with no down payment and no private mortgage insurance, VA Loans have a higher allowable debt-to-income ratio than many other products!

Myth #2: It’s a “one and done” product
Double ha! While there are some restrictions, you can use your VA Loan eligibility as often as you wish – it’s even possible to have more than one active VA Loan at the same time. Also, if you’ve lost a VA Loan to foreclosure in the past, that doesn’t mean you’re no longer eligible.

Myth #3: VA Loans have slow turn times, too much red tape
You’re KILLING me here! VA Loans can close just as quickly as other products. Now, in the past, every VA Loan had to be reviewed and approved by the Veterans Administration, and they had a lot on their plate – but that was YEARS ago. Get with the times!

Myth #4: There’s no such thing as a Jumbo VA Loan
Wrong AGAIN! In cases when the loan amount is more than $417K, all the borrower needs to do is come up with 25% of the difference as a down payment. For example, if the loan amount were $517K, the borrower would only have to come up with 25% of the $100K difference. Quick math: $25,000 (the down payment needed) is only 4.84% of $517K. On a conventional purchase of $517K requiring a 20% down payment, that would require the buyer to come up with $103,400. Wow!

Let me throw out just a handful of things to consider – things that many agents and homebuyers alike either don’t know or have forgotten: even a low credit score can qualify a borrower for excellent rates and terms; bankruptcies and foreclosures are treated much more leniently with this product; and since private mortgage insurance isn’t required, the buyer can afford more in her/his monthly payment.

While we can ALWAYS do more to thank the women and men who selflessly serve in the armed forces, the least we can do is make sure they know what they’ve earned and deserve! THANK YOU, Veterans!