5 Steps to Analyzing a Commercial Property Investment-Part 3
Building the stone arch at Greystone Cellars (c.1889)
Property of Napa County Historical Society
In my previous articles we discussed the characteristics of investors in commercial real estate and the use of the CAP rate. In my final article of the series we are going to discuss the five steps in analyzing a commercial property investment.
1. Know yourself - as we discussed, only you know your temperament style. Are you a risk taker or do you like a steady and conservative sure thing? Are you okay with a hands-on investment that you would find in an apartment complex or do you only want to collect rent checks like you would in what we call an absolute triple-net leased investment? You need to know what you want your personal financial portfolio to look like, your goals for equity growth, cash flow requirements
and financial independence. Does the investment give you an instant return with the likelihood of equity growth or is it something you will be holding for 10 years or longer?
2. Know your market - who are your potential tenants and is your space in demand? Is the property well located for its type? Is the property in good condition? Is there any functional obsolescence meaning are there new standards tenants expect now? Don't forget about the zoning. With a restrictive zoning you may find you cannot use the property as you had hoped. Lastly, are there any environmental or code upgrade conditions to consider? For example, in Napa we have a few buildings that still need to be retrofitted for new earthquake standards.
3. Know your income - without tenants with good leases paying rent you do not have an investment. Are the leases well written with substantial time remaining in the lease to not give you or your lender concern over the potential loss of rent? Is the total rental income with consideration for realistic vacancies, enough to pay your annual expenses, debt service, reserves for future capital improvement projects and provide you a return on your money invested?
4. Know your expenses - are the expenses reasonable and consistent with expenses of similar properties? Are there any opportunities available to reduce expenses to increase your return and increase the property value by creating instant equity?
5. Know your seller - take the time to qualify the owner. If an investment is such a great deal than why is he or she selling? Find the trigger as to why the owner is selling: is he exchanging into another property, is he tired of being a landlord, going through a divorce, wanting to retire, moving out of the area? In knowing the owners intentions it may give you insight that could help both parties come to a fair and equitable transaction where everyone is happy.
By following these five steps you will be better prepared as you step into a commercial real estate investment.
Have you ever regretted not purchasing an investment opportunity or possibly regretted have done so? Let me know your stories or suggestions for future articles in the comment section below