There is no big secret when it comes to Investing in commercial real estate, and like any other financial decision, one must do their home work prior to investing. Real estate should be treated with the same focus, care and diligence that any prudent investor would show to the balance of their investment portfolio. When deciding to invest in commercial real estate there are a few things you can do to properly prepare and educate yourself to better understand the market and asset class before proceeding forward.
Prior to investing in commercial real estate and becoming the next Donald Trump, its impetrative that you have a basic working knowledge on how the different commercial real estate property types and how to properly underwrite potential opportunities. Every seasoned commercial real estate investor has their own criteria, and core values that need to be met when underwriting potential investment opportunities. Typically investors of commercial real estate focus on one or two particular asset class of commercial real estate, which range from;
• Shopping Center
• Multi-Family (Apartments)
Once you’ve done your homework, and feel comfortable with one or more commercial property types, it would be prudent to network with experienced commercial real estate investors in the area for that particular property type. The information and experience these individuals can share with you will prove invaluable when finally take the plunge into becoming the next commercial real estate investment mogul. In addition, there are hundreds of networking groups that meet weekly to discuss investing in commercial real estate and a simple search online will go a long way in connecting you with other investors.
The information shared within the many commercial real estate networking groups will be extremely valuable in your matriculation, and help you better understand the finer nuances of commercial real investing. In addition these individuals can assist you in the proper way to underwrite potential commercial investment opportunities.
Now that you’ve researched the different commercial property types, and met with a few networking groups, its imperative that you have a working knowledge on how to properly identify important financial indicators when underwriting a property.
When underwriting commercial real estate to evaluate the given properties value one should look at a number of items including the Sales Comparables within the area of the subject property which will be used as a vital foundation for value determination. Below you’ll find the terms and definitions along with the formulas involved in the underwriting of commercial real estate.
1. Capitalization Rate- A percentage that relates the value of an income-producing property to its future income, expressed as net operating income divided by purchase price. Also referred to as cap rate.
(Net Operating Income/Property Value = Capitalization Rate)
Example #1: A commercial real estate investor wants to purchase an apartment building listed at a price of $1,150,000 at a cap rate of 7.5%. During the course of the initial due diligence the buyer is informed that the property has a net operating income of $75,015 a year. In order for the buyer to achieve a Cap Rate of 7.5% he/she would need to purchase the property at a price point of $1,000,000 using the formula below, you’ll see how the investor came up with that number;
$75,015 / $1,000,000 = 7.5%
NOI Purchase Price Cap Rate
By using this formula a potential investor will be able to complete a quick analysis of the properties current performance based upon the Cap Rate in relationship to value.
Remember, the higher the Cap Rate the larger the return will be on your investment.
Another financial indicator used during the course of underwriting a potential commercial investment opportunity is the Gross Rent Multiplier or GRM
2. Gross Rent Multiplier (GRM)- A method investors may use to determine market value. This method calculates the market value of a property by using the gross rents an investor anticipates the property will produce at end of year 1 multiplied by a given factor
Example # 2: Using the same property described above in determining Cap Rate, the same investor decided that based upon the property generating Annual Gross Rents of $142,857 at the potential purchase price of $1,000,000 the expected going in GRM would be 7.07 x Gross. The buyer derived at this number by dividing the Purchase Price by the Gross Annual Rental Income as seen in the formula below;
$1,000,000 / $142,857 = 7.07
Purchase Price Gross Income GRM
Now that the commercial real estate investor has calculated both the Cap Rate & GRM he/she has determined the major financial indicators at a purchase price of $1,000,000.
Whenever determining Cap Rates & Gross Rent Multipliers, always remember to compare them against the Sales Comparables to determine that they are in line with the market. The sales Comps in the area of the subject property will be your foundation for the underwriting of the potential commercial investment opportunity.
There are several other factors that go into underwriting a potential investment such as;
• The Cost Per Rentable Square Feet = Purchase Price / Total Rentable Square Feet
• The Cost Per Unit = Purchase Price / Number of Units (Only if your underwriting a Multi-Family property)
• Down Payment & Interest Rate
• Annual Operating Expenses
• Market Rents & Expenses
All these factors can be compared against current Sales Comparables to insure the investment opportunity is in line with that of the market.
In addition to researching the many different commercial properties and having a working knowledge of the property type you have chosen to pursue, it’s just as vital to do your research when selecting a Licensed Commercial Real Estate Agent to represent you. An experienced and sophisticated Commercial Real Estate Agent can make the difference between consummating a successful transaction, and losing the deal due to incompetence.
One should research and speak to several licensed commercial real estate agents in your areas of interest that specialize in that property type you have chosen. A licensed Realtor can provide you with current knowledge of the market, and has experience in negotiating sales prices and contract terms and the strategy know-how in pricing your offer. The real estate agent also offers exclusive access to off-market of commercial properties.
Once you’ve done the necessary due diligence on the different commercial property types, met with other investors and located an experienced commercial real estate agent to represent you, your ready to make your first investment and on your way to becoming the next success story in the world of commercial real estate.
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