How to Evaluate Commercial Real Estate
Commercial real estate can offer exciting opportunities for large-scale investments that may offer you a big return on your money. But there’s a lot to know before you jump in. Learn how to evaluate commercial real estate, and what you should know about everything from financing to selling and more, here.
Evaluating Commercial Real Estate
What is commercial real estate? It refers to structures used for multi family rentals, office spaces, retail, industrial buildings or warehouses. Commercial real estate works differently in the market than other divisions of real estate.
Figuring out how to evaluate commercial property and take advantage of the right investment opportunities means you might have the potential to make more money, more quickly than other ventures.
Through commercial real estate investments you earn income from rent, and you also might see the property appreciate in value over time. Learn how to evaluate commercial real estate by assessing things like operating costs, local economic climate and prospective renters - you might just uncover a great source of high returns on your investment.
Set Parameters for Investments
It’s important to do your due diligence and understand the basics about any commercial real estate investment you’re considering.
Determine what kind of down payment you can afford to make and what kind of mortgages you can get for the remaining amount. This basic first step in commercial real estate analysis provides the actual sales price of your investment that you’ll measure against its rate of return (gain or loss on the investment over time).
Research how similar commercial properties or commercial real estate comps have performed, which can give you a ballpark estimate of profit.
Assess how much legwork may have to go into the project, like whether there are existing tenants or plenty of units to fill, and how many units must be rented for you to make money.
Know the Lingo
Get familiar with important terms about commercial real estate analysis and investment.
- Capitalization Rate - Capitalization rate, or cap rate for short, is represented by sales price divided by annual net operating income. It describes your yearly rate of return on a property’s original selling price without factoring in mortgage costs.
- Net Operating Income (NOI) - You’ll do quite a bit of calculating net operating income (NOI), which starts with gross operating income like rent and any other incoming money and subtracts operating expenses, vacancies and other costs, leaving actual earnings of the property.
- Cash flow - Cash flow is an important term in the study of how to analyze commercial real estate. It refers to the money you’re left with after you pay operating expenses and mortgage payments.
- Cash on cash return - The phrase cash on cash return aptly denotes your cash payment or down payment on the property’s sales price, divided by annual cash flow it brings in.
- Gross Income - Your gross income, or the initial amount that comes in before you pay operating and other expenses, generally provides the dollar value that starts calculations for how to evaluate commercial real estate.
Using what you’ve learned about commercial real estate analysis, you should be ready to apply for financing with your eyes open and the knowledge that it works differently than financing residential real estate.
Your bank will not only analyze a building’s worth, but also your ability as a guarantor in case monthly monies from the building don’t come in as expected. (But keep in mind, you can take advantage of tax write-offs specific to commercial properties.)
Finding the Right Sellers
When it’s time to sell, it’s important to remember what you learned when buying: commercial real estate transactions work differently than residential. Existing tenants may carry over from seller to buyer, and there will likely be special terms that need to be negotiated.
Brokers who deal with commercial properties know the laws and nuances specific to this area of real estate. Working with a commercial broker with experience selling commercial real estate helps to ensure you’ll be in safe hands.
Evaluating Multi Family Opportunities
Condominiums, apartments and other multifamily structures may be first to come to mind when you consider what is commercial real estate. One central rule for evaluating commercial real estate investments is you want to think about whether you can commit the time, money and effort of your venture.
Plan on thoroughly reviewing the building’s past financial records so you’ll be prepared for the operating costs. Your decision should factor in the significant benefit of capitalization opportunities on multifamily real estate; you’ll be paying less per unit, so bringing in revenue quickly can potentially be easier.
Evaluating Retail & Office Opportunities
The requirements and income of retail and office tenants vary. Investments are dependent on things such as:
- types of businesses that will go in
- current economic climate
- local consumer habits
- cultural trends
Successful commercial real estate analysis and investment in these structures involves learning to be flexible so you can keep the space filled by happy tenants and maintain a healthy cap rate. Research the ins and outs of commercial leases, which may be highly detailed and should be structured to best-fit you and your tenant’s situation.
Evaluating Industrial Opportunities
When thinking about how to evaluate commercial real estate opportunities that are industrial, there are several benefits to consider. Operating costs are often lower, and tenants sometimes take on more of those costs than in a typical relationship.
Additionally, because of the uptick in e-commerce, industrial spaces are in higher demand as storage for items to be shipped is needed. Finally, vacancy rates tend to be lower due to demand.
Thoroughly evaluating commercial real estate opportunities is essential before you make an investment in any property.
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