SoldCORE - Commercial

SOLD COLORADO REAL ESTATE

SoldCORE - Commercial 

 

Commercial property is a different beast than residential.   The end use and location, location, location, are much more critical.

There are a lot more things to worry about and investigate for a commercial property than you encounter with a residential property.

You definitely want to get a thorough commercial inspection and a Phase 1 Environmental study to ensure there are no contaminants in the soil that you cannot easily see.  They will investigate the history of the property and nearby hazardous sites and if warranted they may require a Phase 2 Environmental study with possible sampling or borings.  

Getting the study and identifying the existing problem, protects you from inheriting the liability of the environmental contamination. 

Commercial Property is also different from residential property or land - because (other than dirt and complete rehabs or tear downs) its Value is largely determined by "actual" cash flow.   How much Rental income does the property bring in and How much Net Income is left over after all the expenses have been paid.

The Value of Commercial Buildings or Property that have Rental Income is based on the Net Income.

Net Income = Gross Income - Expenses

Value = Net Income / Cap Rate (ROI)

For Example:

Annual Gross Income $120,000

Annual Expenses $20,000

Net Income = $100,000

ROI = Return on Investment - what would you get in net income or return on investment, your money, if you paid cash and had a turn key business (without a job - way too many people try to sell jobs and overvalue their business, by not paying themselves a fair wage).

Cap Rate = Capitalization Rate

Cap Rate = ROI = CAP

Value = Net Income/Cap Rate

 

SO THE VALUE OF THIS PROPERTY IS

At 7% ROI or CAP

$1,428,571 = $100,000 / .07

 

At 8% ROI or CAP

$1,250,000 = $100,000 / .08

 

At 9% ROI or CAP

$1,111,111 = $100,000 / .09

 

At 10% ROI or CAP

$1,000,000 = $100,000 / .10

 

At 11% ROI or CAP

$909,091 = $100,000 / .11

 

So the difference in "Value" or "Fair Price" based on a subjective opinion of risk or required rate of return on your investment (not to mention cash flow)... varies by $519,480 between a 7% ROI and a 11% ROI for a property making $100,000 Net Income.

 

Therefore it is possible to justify low offers based on several methods.

First - Closely examine and project actual expenses to run the property or business and property.  Determine the "REAL" Net Income.   Dont forget that for every $1,000 in expenses, hidden, unexpected, or otherwise at 7% cap rate that affects the value of the property by $14,285 and by $9,090 at 11%.  Similarly if you think rents are sub market and you can "safely" increase them and the income, the value will go up.  Pay for what is there NOW!  Only what is there NOW!

Second - Look at the market and tenant risks and determine a fair Cap Rate or ROI.  Develop your justification and or minimum standard for what Cap Rate or ROI you expect from your commercial investments.  All the gurus I have ever listened to say don't touch anything for under a 10% Cap.  Yet most of what you will see out there on the open Realtor Market will be listed at closer to a 7% CAP or ROI. 

Third - Consider Terms - Commercial Real Estate is much more flexible than Residential in terms of how contracts can be negotiated and debt carried back, even with cash back after closing in some cases...  Compare and negotiate terms that work best for you.  Shop your commercial loan for the best rate, because unles you can afford to pay cash for a property, then the loan rates make a huge difference in feasibility.

Fourth - Consider Cash Flow - as stated above unless you are paying cash, the real rate of return and feasibility is determined by what the money you borrow to purchase the property and a good cash flow analysis to ensure you are not buying your way into an money pit and cash drain.

Other Considerations:

• Don't forget the deposits in the transfer, check the numbers closely.  If there is doubt check with at least some of the tenants to make sure they agree.
• Check for Prorations of both expenses and income... Look for prepaid expense and prepaid rents, that need to be prorated and factored into the final price at closing.
• Location, Location, Location - Don't forget this ever.  Of course your business or the type of commercial property can be wherever it works, but don't kid yourself pretending you will get top rents (or tenants) with a mid or lower quality address.
• Numbers, Numbers, Numbers - check them twice and chrunch them thrice.  Project them, question them, put on your pessimist's hat and really crunch them.... If it still looks good BUY IT!

 

If the management or market is bad and rents are down, then the Value of the Property is DOWN.  

If you buy one of these struggling Commercial Properties, then you have the opportunity to step in with better management, maintenance, reduced expenses and necessary capital improvements in order to increase the income or decrease the expenses to grow the Net Income and therefore the Value of the Property.