How to Analyze a Piece of Commercial Real Estate

Determining commercial real estate values is the first step in buying commercial property. In order to analyze a piece of commercial real estate for possible acquisition, you first need to understand that the two most important factors are the net operating income of the property and the capitalization rate (cap rate) that is currently prevalent in the marketplace for the type of property that you want to purchase.A commercial real estate analysis has three major components: income, expenses and debt. You need to compile and analyze each of these parts in order to understand the deal.You also need to decide what you really want from the deal:- Do you want a passive income stream?
- Do you want to hold the property for the long term to build wealth?
- Or do you want to rehab it and sell it for a quick profit?ANALYZING INCOME
1. Verify the rents the property is receiving and compare them to current market rents by calling commercial real estate brokers in the market area. You should calculate the income on an individual tenant basis and per square foot basis per month or per year2. If there is a tenant on a short term lease, adjust their rent to current market in your analysis if market rents have gone down.3. Review and carefully verify all of the income that is being shown on the spreadsheets.4. Think about ways that you can increase the income.ANALYZING EXPENSES
1. Using actual and true operating expenses in your analysis is the best way to analyze expenses, but if they’re available, you can get your most reliable expense data from your property manager or a property manager that manages similar properties in the area.2. When analyzing expenses, analyze them as a percentage of the income, and expenses per square foot, and compare these numbers to industry and local data.3. When analyzing taxes, make sure that you’re putting in the new property taxes based upon your purhase price.4. Once you have the data, go through it thinking about ways that you may be able to decrease the expenses once you own the property.ANALYZING DEBT
When you find a deal you’re excited about, run it by your lender to understand how much money you will need to put down, and the type of loan and interest rate that this property will qualify for.DETERMINE THE VALUE OF THE PROPERTY
Once you have determined the income, expenses and debt, you’re ready to take the next step in determining the commercial property value. Figure out the capitalization rate, the cash flow, the cash on cash return, the net operating income and a break-even analysis on the property to understand its value to you.Capitalization rate is the net operating income divided by the sales price. Also known as the cap rate, it’s the measure of profitability of an investment. Cap rates tell you how much you’d make on an investment if you paid all cash for it (financing and taxation are not included).Cash on cash return is the cash flow divided by the down payment amount.Net operating income is the income after deducting the operating expenses from the gross income.Gross income is all of your income that is coming in on the property.Break-even point is the point at which occupancy income is equal to the mortgage payments.Knowing how to analyze a piece of commercial real estate should include what you want from the deal.
Starting guidelines that I suggest are to make sure that you have:- positive cash flow
- cash-on-cash return of at least 10 percent
- cap rate of at least 8 percent