Investors have long valued commercial real estate, and the reasons are obvious.
Unlike other forms of investment, commercial real estate investing yields steady cash flow in the form of lease payments, regardless of how well the market is performing. You can hold a commercial property indefinitely, waiting for capital appreciation, or you can leverage your initial down payment to expand and diversify your portfolio by using a tax-deferred 1031 exchange.
Real estate is a relatively safe investment, trading with a lower price-to-earning ratio than most stock equities. And unlike the house you own, commercial real estate appreciates in two ways, both through increases in the value of the property over time and increases in the amount of rent you can charge. Thus, commercial real estate automatically adjusts for inflation.
Of course, not all commercial properties make good investments. So how do you separate the gold from the straw?
Do Your Homework
You want to hire the best broker you can find. But until you know more about the market, you won’t be able to narrow down a choice of potential agents. Begin by familiarizing yourself with the real estate section of the paper and scouting internet sites.
You should also think about what sort of property you’ll feel most comfortable owning. Do you want to lease a restaurant, a shopping center, an apartment complex, or an office building? Each comes with its own risks and rewards.
For some people, a real estate investment trust (REIT), which pays dividends to investors from the proceeds of the properties it holds in trust, gives an acceptable return with little hands-on involvement. Other people want a more concrete connection with their assets.
Learn Key Commercial Real Estate Investing Metrics
In addition to knowing what you want, you also want to know how to evaluate a property’s earning potential. Knowing some key industry metrics can be helpful.
• Usable square footage, rather than location, is the chief determiner of value in the commercial real estate market.
• Net operating income (NOI) is the difference between the property’s first year gross operating income and the operating expenses for that year. Positive NOI in the first year is a good predictor of a successful investment.
• The cap rate helps to assess the value of commercial properties by estimating the net present value of cash flow. There is a complicated equation to determine net present value, but basically it is the difference between what you earn by leasing the property and what you spend on ownership each month.
• Cash-on-cash is the initial amount required to purchase a commercial property, assuming that you will carry a mortgage.
Knowing these metrics can help you determine what you can afford and what your cash flow going forward will be.
“Bird Dog” Potential Properties Yourself
If you haven’t heard the term “bird dogging” in reference to real estate before, it means scouting out properties, sometimes even before they hit the market, that have greater than average investment potential. You can hire someone to do this for you and pay them a commission, but if you want to become more knowledgeable about the market, why not give it a try yourself? Take advantage of commercial real estate’s large variety of property types:
Ultimately, commercial real estate investing is a hands-on business regardless of how removed you are from managing the properties yourself. It pays to know the market and to communicate actively with people in the industry. The more you know, the smarter you will buy.
About Peak Commercial
Peak Commercial is a full-service, professionally dedicated commercial real estate brokerage company located in Woodland Hills, California. Its management and agent team have over 100 years’ experience in local, national, and international commercial markets.