Basic Commercial Property Tips from Todd
Purpose of This Blog: To give you some absolutely “free” information that can help you understand some of the commercial real estate investment fundamentals.
Jill and I have completed several of the commercial courses and have made 5 purchases over the last several years following the "playbook" that is typically used to first underwrite properties to come up with a reasonable purchase price and then executing on value add strategies to increase the asset value.
I will be sharing the common principles that we have learned and applied to our commercial properties. These strategies do work if one pays attention to the details and is willing to put in the time to make your investments successful.
You are also free to ask me any question and I can try to help find you an answer or refer you to someone that can help.
We are also in the market to buy new residential or commercial properties so reach out if you have one to sell.
For those of you who would like to invest, we also have investment opportunities in our current deals for the passive investors. Please send me an email to ToddHenry.Boston@gmail.com if you would like more information or to be added to our investor's list.
Blog #1 – What exactly is Cap Rate and how is it used in commercial property investing? Why should I care?
You should care.... as it is a good first pass to determine if you are getting a good deal or you are paying too much for a property?
I will start the discussion with 2 pictures and a question.
New Apartment Old Apartment Building
Which building seems more risky to you? Would you want a higher return to compensate you for the risk?
Obviously, the old apartment building presents more risk as more building components could fail which would cost big dollars to replace. The old building may also present a higher revenue stream risk due to rent collection issues. This means that the building valuations will be somewhat different when the risk factors are considered. We will relate these differences to cap rate later on in this blog.
Cap rates are used to help set market valuations as they reflect the return expected from a given commercial property. If you have an older building, you would want to get a higher return which would be reflected in a higher cap rate. A new apartment building may command a 5-6% cap rate while an older building may be 8 to 11% depending on the risk factors associated with the building. The higher expected return sounds great but there is a lot of risk with higher building costs or rent non-payment that comes with the building.
Let me also say that cap rates can vary by state, city, town. One of the keys to success is to understand the prevailing cap rates for different properties in an area. One can use recent property sales information or one of the commercial building sales platforms to get an idea of cap rates for an area.
Cap-Rate is the common term that the industry uses for commercial property valuation. Capitalization rate is commonly used in real estate and refers to the rate of return on a property based on the net operating income (NOI) that the property generates.
Easy math example: Let’s say you buy a property that has a $100,000 net operating income for $1,000,000 sales price. The rate of return for the year would be $100,000/$1,000,000 or 10%.
This 10% number is known as the cap rate which has the formal definition of Cap Rate = Net Operating Income/Price.
The Net operating income (NOI) is the annual income generated by the property after deducting all expenses that are incurred from operations including managing the property and paying taxes. (Please note that the expenses do not include mortgage interest expense.)
Current market value of the asset is the value of an asset on the marketplace.
That is all for this blog. For the next blog, I will go into greater detail for one of our commercial properties that we purchased in 2020 to show an actual cap rate computation. I will also describe some value add strategies to increase the property valuation while you own the building.