The Anatomy of Commercial Real Estate
- an inconclusive list of “what-is-its” for the lay (or wannabe) real estate enthusiastI had the privilege in February of a trip to the Vienna / Fairfax VA area to take the first of 5+ courses of the CCIM designation. Save for the fact it rained almost the whole time… it was a fabulous trip, and I was able to spend time with family. The CCIM designation, considered by most RE pros to be the top designation for commercial agents, stands for Certified Commercial Investment Member. The class was awesome! It incorporated a lot of what I’ve learned over 16 years in my own practice, along with finance principles which were very familiar to me from my MBA. Finally, it tied it all together with real life experiences shared by instructors and class members. (For any of my banker, commercial RE, or investor friends, do yourself a favor and take a look at the program). For the rest of you… keep reading. 🙂 The world of commercial real estate can be quite elusive when it comes to understanding even the most basic of principles. Most people, even many residential agents in the business, often don’t fully understand some of the essential components. Since our company has many followers of both residential and commercial interests, I’m going to give you the George Emami crash course in commercial RE! #1 - Commercial Real Estate is “all about the Benjamins” We’ve all heard the top 3 rules of real estate are: Location, Location, Location. Well… when it comes to commercial.. Cash-Flow is King. Think of it in this way… in commercial real estate, the amount someone is willing to pay for a property has a lot more to do with prospective rents for use of the property than the town it’s in or the value of the property next door; or even the physical features of the structure and improvements. In a way, a commercial RE investor is primarily purchasing the promise or prospect of cash-flows (income) first, then the physical attributes of the land, location, and improvements. This aspect of commercial real estate makes it a lot more like investing in stocks, bonds, or mutual funds than a typical residential home purchase. #2 - Commercial Real Estate will Bust-a “CAP” in Yo Assets - I beg your forgiveness and appreciate your humoring me with the above title 🙂 … But.. you can’t have a conversation about commercial RE without discussing “CAP” rate (Capitalization Rate). Here’s the easiest way I can describe the CAP rate of a real estate investment:
- It's a way to derive a logical sales price (and establish value) of a commercial or investment property. (Remember, Commercial RE is all about the Benjamins.)
- More specifically, it is the rate at which your net operating income (NOI) will pay back your total investment, on an annual basis. So, if a property produces $10k in net operating income, and comparable properties sell at a “10 CAP” (or 10% CAP rate), then the value of the property should = $100,000. In residential real estate, it would be inconceivable to try to determine value based on potential income without even looking at the property. But, in a theoretical way, that can be done in commercial RE.
- Business / Property Combos Are Easier to Finance - If you are purchasing a commercial property with the intent to occupy it as your personal business’s primary location, there are lending programs out there that will lend up to 100% of your purchase price. In many cases, it’s possible to achieve a higher loan-to-value ratio on the property and still acquire financing for your business at the same time: for example, by utilizing a SBA 504 loan program. (If you want more info on this topic, please reach out to us).
- Track Record is Important to Financiers (Or Equity Investors) - One of the biggest things a lender will consider is if you truly know what you are getting yourself into. By starting small (with one investment that you feel comfortable with) and running the “business” of that property (hiring the right people to help you & by keeping good P&L statements), you have a lot more “leverage” (pun intended) when seeking financing for your next transaction.
- Start with a Deal - One of my mentors told me many years ago -- “You don’t make money when you sell real estate, you make it when you buy.” I firmly believe in this. If you’ve never owned investment property, the key to you being successful and enjoying your investment is to buy right from day one. When you walk into equity and upside, there is room to make mistakes and still come out ahead. In the end, your experience on your first transaction sets the pace and the trajectory towards success (or not). So get good help and make sure your first investment is a WINNER!