Analyzing Commercial Real Estate|Crucial to Successful Buying

To do a proper commercial real estate analysis, you must understand its market value. Long term successful investors make money when they buy, not just when they sell. You reduce risk and increase your chance for great returns when you buy properties at or (preferably) below their market values.

3 Techniques to Value Properties

Investors, lenders and appraisers rely on three techniques to value properties.

1. Cost approach:

  • Calculate how much it would cost to build a subject property at today’s prices;
  • Subtract accrued depreciation;
  • Add the depreciated cost figure to the current value of the lot.

2. Comparable sales approach:

  • Compare a subject property with other similar (comp) properties that have recently sold;
  • Adjust the prices for each positive or negative feature and/or differences of the comps relative to the subject property. Note:  It is best to have three or four properties to compare.

3. Income approach:

  • Estimate the rents you expect a property to produce;
  • Convert net rents after expenses (net operating income) into a capital (market) value amount. In other words you divide the net operating income of the property by a market cap rate for that particular type of product in the marketplace.

You evaluate a property from these three perspectives to check the value estimates of each against the others. Multiple estimates and techniques enhance the probability that your estimate reflects reality. If your three value estimates don’t reasonably match up, either your calculations err, the figures you’re working with are inaccurate, or the market is acting “crazy” and property prices are about to head up (or down).

3 Factors of Income Approach

Concerning commercial real estate analysis, the approach I put the most emphasis on is the Income approach. The three factors of the Income approach are Effective Gross Income, Operating Expenses, and Capitalization rates (Cap rates).

When looking at effective gross income and operating expenses, be careful that you’re looking at the actual numbers – not the “pro forma” numbers. Pro forma numbers are projections and you want to be dealing with actuals. Cap rates are derived from the comparable sales of comparable properties in the immediate market area and/or by the rate of return that you want on your money. If you talk about a 6 cap, then you are saying that you want a 6% return on the existing net operating income of the investment.

4 Things to Determine a Good Buy

When I analyze a property, I calculate the following four things to determine if I want to buy the property:

1.  Net operating income (NOI):   Net operating income = effective gross income – operating expenses.

2.  Annual cash flow:   Annual cash flow = net operating income – debt service

3.  Cash-on-cash return:   Cash-on-cash return = annual cash flow divided by down payment

4.  Cap rate:   Cap rate = net operating income divided by sales price

Other Important Factors

Also note that other important factors in your commercial real estate analysis are the use of/or zoning of the property, the location of the property, the credit worthiness of the tenant(s), the leases in place, the condition of the property, the contracts on the property and any possible environmental problems with the property.

1.  Use of/or zoning of the property – Make sure the current use matches the zoning of the property.

2.  Location of the property – Is it in a growth area, are there complimentary users around, is there easy ingress and egress, do the demographics match the use, what are the traffic counts around the site, what is the vacancy factor in the marketplace – These are all questions that verify a good or bad location for the property.

3.  The Lease(s) – Is it or are they NNN, NN, N, Gross, how much term left, if there isn’t much term left, what is the likelihood of renewal, are there any hidden Landlord costs, what is the entity on the lease and is it guaranteed, is it a standard lease for the marketplace or is it unusual for the area, is it assignable, does it have options, review all amendments – These are some of the things that you need to be reviewing in the lease to make sure you understand just what you are buying – Some people believe they are buying a building while others believe they are buying a lease or leases.

4.  Condition of the property – Do a thorough inspection of the property to include the roof, the mechanical systems, the structure, the electrical, the plumbing, the parking lot and all of its fixtures – Estimate the life span of each of these things and make sure that you put this into your financial picture of the property.

5.  Contracts on the property – Make sure that you review all existing contracts and the vendors so that you know your obligations and whether they go with the sale – These contracts are also an indication of whether the property has been consistently maintained – If there are no contracts, then you need to take this into consideration so that you can paint an accurate financial picture.

6.  Environmental – Are there any obvious environmental issues that need looking into and have there been any environmental notifications sent to the current owner or to any of the tenants – You should also check with the local environmental agency to not only learn about your building, but the area in general.

With careful analysis you can take away some of the risk when purchasing the property.

As I have said before, if you have any questions or I may be of assistance with your real estate questions please contact me. My way of giving back is to give away my knowledge. Thank you for reviewing this article.

Buying Commercial Real Estate|Closing the Deal

In order to understand the closing of a deal when buying commercial property, let’s review the steps of the sales transaction:

1.    Buyer submits an offer to buy the property either through a Letter of Intent or a formal Purchase Agreement, any necessary negotiations are completed, and the Seller accepts the offer and executes the Purchase Agreement.

2.    Buyer opens escrow by submitting his earnest money deposit.  Typically, escrow is opened with a Title/Escrow Company or an attorney.

3.    Buyer begins the loan process by submitting documents to his lender.

4.    Buyer commences his Due Diligence process and does his physical inspection of the property.

5.    Buyer reviews title and proceeds to remove any contingencies in the contract.

6.    Buyer and Seller agree on any remaining issues in the contract.

7.    Buyer gets a loan commitment from his lender.

8.    Buyer receives the Closing Statement and gives his final closing instructions to the escrow company.

9.    At closing, Buyer and Seller sign the closing documents and Buyer submits his funds.

10.  The Deed gets recorded, the monies are applied and the Buyer takes possession of the property.

An escrow is an impartial party that serves all parties in a transaction to transfer property.  Duties that an escrow officer performs include:

•    clearing up any outstanding liens
•    ordering a title search
•    examining the title report
•    obtaining title insurance
•    handling and disbursing all monies in the transaction
•    preparing and issuing the final Closing Statements
•    recording the Deed
•    sending all loan documents to the lender

After you complete your due diligence and prior to finalizing the deal, I suggest that you go back and review your original thoughts on purchasing the property to make sure that your original assumptions concerning your plan and profit are still true:

•    Review your exit strategies again and check your goals to make sure your exit time frames still work
•    Make sure that the profit you originally projected still appears attainable after examination of the information you received during due diligence
•    Make sure your loan assumptions still work now that you have actual loan information from your lender
•    Check that your tax advisor still agrees with your tax goals.

You’ll want to review the final Closing Statement at least 48 hours prior to closing so that if there are mistakes, there’s time to correct them.  As a buyer, you should double check everything and take nothing for granted.  Some of the items that need close review include:

•    checking the loan documents to make sure that they are what you agreed to (check interest rate, loan amount, amortization period, loan term, monthly payment amount, prepay penalty, due date, impounds for taxes, insurance and maintenance reserve account)

•    the credits assigned to you

•    completed repairs by Seller

•    review rent prorations and security deposit amounts for accuracy

•    ensure that personal property is being transferred with an appropriate Bill of Sale

•    review the Deed for correct purchase price, names and dates

•    review all fee amounts for accuracy

•    verify that defects in title are cleared

•    have your down payment and closing costs ready to be wire transferred

•    make sure that you agree with the amount at the bottom of the Settlement Statement

•    verify that you are taking title in the entity that you have chosen

The sale officially closes when Buyer has paid all monies due, the escrow officer has received the signed loan documents, Buyer and Seller have signed the final Escrow Closing Instructions and a specific date to record the Deeds is chosen.  After escrow gets a check from Buyer’s lender to pay off the Seller’s loan, escrow sends the lender the closing loan documents, releases Buyer’s payment and gives the approval for the Deed to be recorded.  After the Deed is recorded, title will be transferred to you and the sale is officially closed.

Congratulations, you are now the proud owner of real estate.  Your work has just begun.  If you have bought the property right, you are on your way to financial independence.  If you have bought a rental property, it is now time to get to know your tenants or find tenants for your property.  Make sure that you treat your investment as a business., not a hobby.  You should be friendly with your tenants, but businesslike.  If it is your responsibility always take care of problems promptly and if it is the tenants responsibility let them know that so that you can keep the relationship open and communicative.

As I say throughout my blogs, if I may be of assistance with your real estate questions please contact me.  My way of giving back is to give away my knowledge.  Thank you for reviewing this blog.

Commercial Real Estate Appraisals|Overcoming a Low Appraisal

The commercial real estate appraisal can be a very interesting process. You often feel that you already know what the value of the property is, but now you’re waiting for someone else to see if they validate your opinion.

At the same time, you’re relying on an appraiser who may not be an expert at valuing your exact type of property in your exact geographical location. This is because appraisers often work on valuing a wide range of properties in many different cities. So when they’re valuing one particular property, they need to become as much of an expert as they can on that one property. As a result, they end up relying on the people who really are the experts.

They end up calling the commercial real estate brokers in the area who have closed transactions on what may be comparable properties, asking these brokers details about those transactions. From this information and from their own interpretation of how it applies to the property, the appraiser arrives at his value for the property.

In the process, different appraisers can come up with a wide range of values for a property. This can depend on which comparable transactions they’re utilizing for the appraisal, how they’re interpreting the information, and how well they understand the subtle nuances between the comparable properties that they’re using and the subject property that they’re appraising.

As an example, two comparable properties that the appraiser is using could be ten blocks away from the property being appraised – but with each property being ten blocks in the opposite direction from the subject property. The appraiser, not being a full-time expert in this particular real estate market, might not recognize that one of those two comparable properties is in an area that commands lower prices. The other comparable property may be in an area that is very similar to the property being appraised. If the appraiser is unaware of the differences in these areas, it will impact the value he will give in his written appraisal.

In addition, both the underlying reason for the appraisal and the instructions given by the person paying for it can affect the final value arrived at for the property. If someone is getting a property appraised just because they want to feel good about their own net worth, the appraisal may come in at the highest value that a buyer could expect to pay for the property.

But if a lender hires an appraiser because they’re thinking about lending money on a property, the lender is going to want to get a more conservative valuation of the property, and the final value given by the appraiser will probably lean more towards the lower end of what a buyer would pay for the property.

So when it comes to getting an appraisal, recognize that it’s a very subjective process, and that there are different underlying factors that will impact the final appraised value of the property.

If you disagree with an appraisal, please note that you will need actual and verifiable facts to get it adjusted. One of your best sources to get you the information that you require are real estate brokers that specialize in your particular type of property.

If your appraisal doesn’t come in where you need it to, following are a few of the things you can do to overcome this problem:

1.  Renegotiate the sales price with the seller to get close to the appraisal or ask the seller to take a second mortgage where you may make a lump sum payment at a later date or a short term loan where the buyer makes monthly payments to the seller.

2.  Increase the down payment to come into line with the appraised value. If this presents a major hardship to the buyer, then you may try to do a combination of getting the seller to lower the price and having the buyer put up a larger down payment.

3.  Ask to see and review the appraisal. If you have some actual and verifiable facts that are different from the report, you can send them to the appraiser and ask for a meeting to discuss the differences.

4.  You can ask the lender to get a second appraisal. Usually, you will have to pay for this second appraisal if the lender agrees to do it.

5.  Apply with another lender.

Always remember that real estate always involves negotiation and compromise, so keep negotiating until you have come up with a solution.

As I say throughout my blogs, if you have any real estate questions that I can assist you with, please feel free to contact me, as I truly want to help. My way of giving back is to give away my knowledge. Thank you for reviewing this blog.

How To Get Started Investing In Commercial Real Estate

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If you want to invest in commercial real estate and build significant wealth, it’s going to require that you take the time to think things through. It requires planning, patience and persistence – or, in other words, it requires you to develop a strategy or business plan. Think of this as your road map.

Mission Statement

Your first step in buying commercial real estate should include a mission statement. This is where you clearly define your purpose and should include some benefits that will be derived. Don’t spend a lot of time here at first, just put together some general concepts.

Goals

Secondly, you should set some goals. This step is the why am I doing this. Do you want to quit your current job or do you want to retire early or set up a way to pay for your kids college education or do you just want some extra spending money for that new car, dream vacation, etc. Set these out and refer to them often. I like to set short and long term goals. Short goals so that I can achieve them and have some immediate gratification and long term goals so that I always have something to look forward to. Your goals should also include how many properties you are going to buy or that you want to make $5,000 per month if that is your goal. The key thing in goals is to write them down and adjust or update them as you achieve them.

Time Frames

The next thing to do is to set out time frames within which you want to achieve your goals. Be realistic in this aspect, but also stretch yourself. State when you are going to buy those properties or when you are going to be making the money that you want or when you will take that vacation.

Strategy

The next item to tackle would be to think about your strategy. There are many, many ways to make money in commercial real estate. If you want to buy a property a year, write that down. If you want to flip a property every 3 months, write that down. Your strategy is how you will be using real estate to accomplish your goals. Note that this can be an evolution over time, but you need to start somewhere. The key thing is to write down a strategy, then adjust if you need to as you go along. In the beginning you may think that you want to buy and hold apartment buildings, but you may find out that your preference is to buy apartments, fix them up, then flip them. The key thing is to work within a specific niche such as apartments or nnn properties or office buildings or shopping centers, etc. It’s best to start out in a particular niche, because you will have a learning curve to go through. It’s easier to learn about one particular type of real estate than to try to tackle all of them in the beginning.

Market Area

Your next step is to define your market area. Most beginning investors start in their own backyard, because you already have some knowledge about that area and you can easily drive it to find properties or locate brokers to call, etc. Once you have completed a couple of deals you will find that you can expand your area and look into other cities around you and then other areas of the state and so on.

Establish Criteria

To me this is the most important thing that you can do for your investing business. Sometimes the best deals are the ones that you walk away from. In this step you are establishing the return on your time and money. Setting your financial parameters as well as establishing the type of property you want to buy are the keys to setting up your success in this business. The financial items that you will want to consider are maximum purchase price, cash flow requirement, return on investment, loan to value ratio, maximum cash outlay, max rehab costs and time frames. Deviating from your criteria can be disastrous for you. By having clearly defined criteria you will be able to recognize your deal faster and let others know exactly what you are looking to buy. If you are not finding deals you can look at other markets or adjust your strategy. Always ask yourself “What is this property worth to me?”, not “What is this property worth?”. Also, remember that you want make your money when you buy the property. If you’ve bought outside of your criteria you didn’t make money when you bought the property, you have already put yourself behind.

Financing

Here is the point where you need to consider how you are going to finance your deal. You are not looking for specifics here, you are looking for concepts such as will you be using conventional financing, private money financing, seller carryback financing, hard money financing, using a lease option, using partners or some other type of creative financing. In my opinion, if you want to purchase several properties you will need to seek out private money financing so that you will have a never ending supply of cash available, however you typically need to establish yourself with a couple of deals first.

Marketing Yourself

This is where you need to state how you plan on attracting deals. How are you going to find the best sellers which are motivated sellers? Will you be using brokers or newspapers ads or direct mail or doing online searching through companies like LoopNet or just driving around or all of the above. Once you have established how you are going to find the deals, then you will want to clearly define your purchasing process. This should include submittal of the offer, acceptance of the proposal, putting up the earnest money deposit, submitting loan documents, commencing due diligence, review title, agreement to all terms and conditions and closing the deal. During this thought process you will want to define your team. Will you need an attorney, a construction or maintenance person, an accountant, an insurance agent, etc. You don’t need to know or state any particular people, but you do need to know your own strengths and weaknesses and how people on your team can help make your deals go smoothly.

Exit Strategy/Strategies

Another very important step is to define your exit strategy. Beginning investors should have more than one exit strategy. If you want to buy and hold, define the number of years that you want to hold and the return that you are seeking. While your preferred choice is to buy and hold, you may want to consider flipping the deal or wholesaling deal if you get into trouble with it. There are many ways to exit a deal other than just selling it. Some of them include 1031 exchanges, sell it on a note, sell the entity holding title or doing a lease option. Having back up plans is a must in the real estate game.

Personal Financials

Prepare a current personal financial statement and then project it into the future for five or ten years based upon the goals and strategies that you have plotted out above. You are going to want to update this as often as needed, but at least once per year. This is the fun part, projecting your wealth as you grow your portfolio.

Always remember that this business plan is a guide, not a hard and fast rule. You have set this up to guide and motivate you. If you fail to plan, you plan to fail.

As I have said before, if I may be of assistance with your real estate questions please contact me. I truly want to help.  My way of giving back is to give away my knowledge. Thank you for reviewing this blog.

Why Now is a Good Time To Buy Commercial Properties

In the current market, all commercial properties are on sale, because either cap rates have increased and/or vacancies have increased.

Increasing cap rates example:
Assume Net Operating Income is $120,000 per year and cap rates have increased from 6% to 8%

At 6% your purchase price would have been $2,000,000.
At 8% your purchase price would be $1,500,000.
You would receive a $500,000 discount, just due to the change in cap rates.
If you are a long term holder, you know that cap rates will go down again, so even if NOI does not increase, the value of the property will increase.

Vacancy increase example:
Assume a property at 100% occupancy has a Net Operating Income of $120,000 and it was previously leased at 95% occupancy which would produce a NOI of $114,000, but now it is leased at 85% occupancy, which would place the NOI at $102,000. This $12,000 decrease in NOI at a 6% cap rate means a $200,000 discount.

If you have any questions, feel free to leave a comment and I’ll respond.

5 Common Mistakes of a Commercial Real Estate Investor

We’ve all done it; we all make mistakes in real estate investing. The 5 mistakes that I see commonly made in commercial real estate investing are poor due diligence, insufficient market knowledge, not running your property like a business, not having an exit strategy and having too much debt.

  1. Performing poor due diligence. Not paying close attention to the property condition or cutting corners while inspecting the property is a license for disaster. Look closely at the physical items such as building systems, environmental matters and structural components as well as the intangible items such as title, survey, zoning and land use regulations. If you don’t know an answer, find an expert who does have an answer. Get accurate estimates from professionals. Analyzing these inspections can save you thousands of dollars.
  2. Having insufficient market knowledge. To avoid costly mistakes, do thorough research. Analyzing the demographic trends of population growth, income and employment in the local market, will give you a feel for where opportunity lies. With commercial real estate, it’s mostly about being in the path of progress or going into a marketplace that’s ready for major growth. Know that a great property in a poor market can be a loser and a poor property in a great market can be a big winner. Review the market information, then listen to what it tells you about how, when and where to invest.
  3. Forgetting to run your properties like a business. You need to make sure that you maintain a nice property appearance, that tenants are satisfied, that the budget is being adhered to, that you know what your competition is doing and manage your cash flow. Being passive with your investments can be dangerous. Don’t think that you can buy an investment and kick back and watch the checks roll in. You should be receiving your payments within the time frames that are called for in your leases. Keep a friendly, but business like rapport with your tenants. Let them know that this is your business. Some people find it easier to tell the tenant that they are the manager and that they are only carrying out the owners wishes.
  4. Failing to have an exit strategy. Don’t focus on one exit strategy, have multiple exit strategies. An investment plan incorporates all of the due diligence findings and lays out all of the possible outcomes that includes best case and worst case scenarios. Failing to plan is a plan to fail. Your plan should include how to get out if things go wrong, the amount of money you expect to make and how long it will take, the improvements that are needed for the property and their costs and how you will manage the property. The plan will reveal the strengths and weaknesses of the property and should show you how to maximize value in the least amount of time. Make sure that your business plan is updated at least once per year to make sure that you are adjusting your exit strategy as things change in the property, your life and in the overall economy.
  5. You have too much debt. Over leveraging by putting too much debt can be lethal. Highly leveraged deals do happen, however it needs to be backed up by a solid plan with sufficient capital or cash reserves. Every property should be evaluated to understand the break-even ratio. The break-even ratio is the operating expenses plus the debt service divided by the gross potential income. Typically, anything greater than 80% is an accident waiting to happen. Debt can be a good thing. Let it work for you, not against you. Properties with a high upside where you can substantially increase rents in a short period of time are the properties that can handle a high debt ratio.

In some of these areas you may need help. A local commercial broker can assist you with market knowledge, a contractor or general maintenance person can assist you with due diligence, a mentor may be able to help you get into a business mindset and help you with a business plan and a mortgage broker can probably help you with debt and financing concepts. Having people that you can trust is always a good thing. You probably don’t need them on a daily basis, but having them available when an issue arises can help you immensely and boost your confidence when needed. I believe in being pro active so that you can try to stay in front of problems.

As always, if I can help or be of assistance with your real estate questions please contact me. My way of giving back is to give away my knowledge. Thank you for reading this article.

Investing in Commercial Real Estate

Investing in commercial real estate can be extremely lucrative and rewarding. And in the current economic conditions, it can provide more security than investing in the stock market.

The stock market is currently on shaky ground, surviving in large part due to government bailouts. Continuing market corrections are inevitable. At the same time, most companies aren’t paying much in dividends.

On the other hand, commercial properties, purchased correctly and with the right tenants in place, can provide security through income, tax benefits, equity, appreciation and leverage.

But investing in commercial real estate, like any other kind of investment, requires preparation, diligence and perseverance.

1. The first step is to understand the types of product available to invest in and the major differences between them. Each property category has its own unique characteristics and requires specific knowledge to own. The types of commercial properties are:

• Apartments ranging from 5 units to hundreds of units, from a single level to a high rise building.

• Hotels ranging from a small bed and breakfast to a motel to a large multi-story hotel.

• Office properties can range from a single building to a campus of buildings to a high rise building.

• Industrial properties can go from a small building with one tenant to a large building with one tenant to a large building with multiple tenants.

• Retail properties consist of single buildings, neighborhood shopping centers, power centers, regional malls and lifestyle centers.

Of course, you can also have multi-use properties where you have any combination of apartments, hotels, offices and/or retail stores. You don’t need specific knowledge in order to invest in any one category; get the help of an expert in that product type to guide you until you gain this knowledge.

2. Next, determine the amount of money you are able to invest and what return you need to generate from the investment to make the investment worthwhile. This number is purely subjective and can vary from instance to instance.

Typically, you have two types of investments, value driven investments and value added investments.

Value driven investments are secure investments backed by stable leases with periodic rent increases which will generate a return in the 6% to 14% range depending on the marketplace, demographics, tenants’ credit, age of property, etc. These properties will typically become more competitive the larger they are as institutions will compete for the larger ones (over 100,000 square feet). Since institutional investors require a lesser return, they will drive the price up to a point where it’s no longer worthwhile for a smaller investor. I would suggest looking for properties which can generate over a 10% return so that both you and the investors can make money.

Value added investments will offer larger returns, especially in the long run, since the risk is typically higher. Typical value added properties generate a 12% to 25% return on investment depending on how long it will take to maximize the value.

3. Now that you have a number of how much you have to invest and the return you require, you are ready to start looking for a property. There are several places to look for properties such as online services like LoopNet, CoStar, and Catalyst, but I suggest that you utilize a commercial real estate broker who specializes in the type of property you want to purchase. You can find these brokers on the internet or by driving around your area and getting names from the signs at different properties. Speak with 3 or 4 brokers to get a feel for which one can best assist you with your particular needs.

4. If you find a property that meets your requirements and you need a loan, submit it to a bank or a mortgage broker who will shop it around and get you some quotes. This is important as they will issue you a letter of intent stating the terms upon which they will be able to lend to you.

At this stage you can determine how much you need to invest, how much your monthly mortgage payments will be, and what your cash on cash return will be. This will help you make an educated decision on whether or not you want to buy the property.

Understanding real estate leverage is important whenever investing in commercial real estate. I suggest that on value driven investments you utilize no more than 70% leverage, but in value added investments, I feel that you can go as high as 100% leverage depending on how quickly you can do the things which will add the value.

As I say throughout my blogs, if I may be of assistance with your real estate questions please contact me, I truly want to help.  My way of giving back is to give away my knowledge.  Thank you for reviewing this blog.