Commercial Real Estate Investment Evaluation
If you have ever studied in a new city, lived abroad or started your own business, chances are you’ve had to rent out some space for a while. Office space in particular is much more likely to be rented rather than owned.
So, if your company moved to a new location or a new office suite opened up near to where you work, it is highly probable that at some point you had this thought:
All that money is going to the landlord and he doesn’t really have to do much to earn it.
And then this thought would naturally be followed by a few questions, such as:
- is renting real estate really worth the headache?
- Or, is investing in commercial real estate a solid investment?
Well, this article cannot give you a yes/no answer, simply because the answer depends on many factors and will be different for different properties. However, it will show you how to find the answer for yourself for any property you might be interested in.
The focus here is on investing in commercial real estate, but most of the concepts can be applied to residential real estate investments as well, with certain limitations that will be mentioned as well.
When it comes to investing in real estate, be it commercial or residential, it all comes down to a solid cost-benefit analysis.
- How much will the property cost you per year?
- How much do you expect to earn from it per year?
When you are determining these values, it is important that you anticipate costs and benefits correctly and include all relevant factors.
- Are you going to be doing the property management and maintenance yourself?
- Are you going to need to hire a broker to facilitate leases?
These two factors present two of the main operating expenses that must be taken in consideration especially when investing in commercial real estate.
Some other questions you might want to ask when determining if the investment is worth it or not are:
- Can you expect positive cash flow on Day 1?
- How long can you sustain the property if it becomes vacant?
All of this has to do with the demand for that property type and location as well as with how much you will need to invest just to get the property going. These questions will really make it apparent whether or not you have the financial strength to take up investing in commercial real estate.
If demand is uncertain or having the property empty for a year will seriously jeopardize your financial stability then investing in that particular property is probably not the best idea.
Commercial real estate values are largely dependent on the property’s net operating income (NOI). You can calculate the NOI for a property by starting with the potential rental income and then subtracting vacancy and credit losses to obtain your effective rental income.
Vacancy and credit losses include costs to the investors from vacant units or tenants defaulting on their leases. For projected values, you could use market figures as reasonable approximations. Then, take the effective rental income, add to it any other income from the property (such as from parking, vending, etc.) and subtract operating expenses.
This gives you the net operating income of the property. As such, it is the most useful indicator for comparing different properties when investing in commercial real estate.
Furthermore, you should certainly try to determine the expected return on your investment. Nowadays, keeping your money in the bank will not make you any money – it might actually cost you some.
Whether investing in commercial real estate is worth it or not will certainly depend on the expected return on the investment.
When you calculate it, you should include the cost of financing in your calculations in addition to including the costs and benefits discussed above. If you are using debt to finance your investment, then the expected return on the investment must be higher than the combined cost of investment, interest, maintenance and property management.
In general, many investors find that the biggest returns from commercial real estate are made when the investments are handled in a system and procedure approach.
That is where Retail Solutions Advisors (RSA) becomes such an asset. They have all the processes you need in order to run your investments including:
- Property Management
To sum up:
When evaluating the possible gains from investing in commercial real estate, you should focus on a solid cost-benefit analysis for the potential properties and see how they could affect your financial situation in various scenarios (total vacancy, partial vacancy, or full to capacity).
You should make sure to include all relevant and foreseeable expenses in your calculations. Finally, if you want to maximize your financial gain, you should weigh the expected rate of return on your investment against the return on other types of investments.
All of these steps for evaluating a commercial real estate investment are also necessary for evaluating investments in residential real estate. However, there are also some significant differences between investing in commercial real estate and investing in residential real estate. One of the biggest differences is in determining the value of the property.
The value of commercial real estate is based on its net operating income, the number you get once you finish the cost-benefit analysis discussed above.
Conversely, the value of residential properties is much more dependent on market trends, since a large component of a property’s value today is determined by the potential resale value in the future.
Secondly, the cost and availability of debt financing is vastly different. While commercial real estate transactions are worth millions of dollars, most residential real estate transactions entail only thousands of dollars.
This change in the size of the investment will certainly affect the rate of return and the amount of financing requirements by creditors, and therefore might make it more worthwhile to use debt financing for your real estate investments.
When you are in the beginning phases of evaluating a property, experience can not be gained. Look to the over 100 years of experience that Retail Solutions Advisors brings to your team.
For more info visit our website .