A few questions about commercial property… I am a new investor with good credit and cash reserves. I am starting out in residential however it seems (read a couple places) like there is more money to be made with commercial investing/property??? and Also, loans are easier to acquire on a good deal?
Can you recommend any good books or any good ways to get started in commercial? I started looking at Loopnet and dont understand really how to evaluate how much these properties are cash flowing just by looking at the cap rate. What formula’s or cash flow requirements are you guys using to buy commercial? For instance, in residential, you have 65-70% of ARV or the 50% rule…
Also, what aspects of commercial to you find to be the most rewarding as far as less time, money, and risk invested? WOuld it be hotels? multfamily? strip malls? rentals? storage places?
As a new investor would I be able to just jump into commercial investing and get approved for loans (provided I looked at good deals that cash flowed)?
ballgum - this is an interesting topic. Last week I attended a subgroup meeting of my local REIA and the speaker was talking about the concept of “highest and best use” in real estate. The basic idea is to find the “highest and best use” for a given piece of property. For example, she showed us some SFH zoned for multi-family. Basically you could buy the SFH and make the investments to build the multi-family. If done right, it seems that there is a lot of money that can be made.
If you are interested you can google “highest and best use”. You will find a ton of information.
Highest and best use is mostly an appraisal term. It is determined by what is legally permissible (zoning and such), physically possible, financially feasible, and maximally productive for a given property whether improved or vacant. I wouldn’t get hung up on it, though it should be considered with every property.
I don’t know how much cash you have but I would start small. Maybe find a shopping center with 4-10 units, an office warehouse building, or a multi-tenant office building. Hotels are usually sold business and all, so unless you want to operate a hotel I would look for something else. I would start with a solid investment and learn the ropes before developing apartment buildings. Commercial loans are difficult to obtain right now. I have seen some very prominent local investors turned down by lenders.
As far as reading - The Dealmaker’s Guide to Commercial Real Estate by Ray Alcorn. I have the book and it is worth the $500, especially for a newbie. Be careful, commercial real estate is no joke, don’t trust anyone and carrying out your due diligence every time. I’ve always said it’s easier to lose money in real estate than to make money in real estate.
Thanks for the replies! So how much cash would I need on hand if I wanted to get into shopping center rentals? I guess my question when you say “start small”, what price range are you talking about for a shopping center?
You say that it is hard to get commercial loans right now… So if I can’t pay all cash for a property, how would someone like myself go about getting a loan???
How do I go about evaluating cash flow for commercial? I know it is calculated differently using cap rate, but at what percentages and monthly cash flow would you consider a property a “good deal”?
In my area, a decent shopping center can be had for $1M-$2M. The newer and nicer a building is the lower the cap rate (7-8%) though. Obviously there are alot of variables so I hate to just throw out a number like that. You could start smaller in the $500K to $1M range if you have the capital. Find a shopping center that is leased but needs a little bit of work and try and create some value through renovations and rent increases.
I don’t consider a commercial property a good deal until at least a 10% cap. I prefer closer to 12%. You need to start talking to local banks about what they can offer you. Ray’s course talks in great length about using local lenders. I would recommend buying his course. It is very much worth the price.
The formula for cash flow is pretty simple -
Potential Gross Income
(Vacany and Collection Loss)
Effective Gross Income
(Operating Expenses)
Net Operating Income
Based on the asking price, if the cap rate is too low you’re paying too much and vice versa. Ultimately, it comes down to what the property is worth to you (investment value). If you’re okay with buying a property with a cap rate of 7% when everyone else is buying at 8% then more power to you. Your ROI will be specific to your financial situation as it factors in your debt service and initial capital investment. After the purchase of a property I look at the ROE as opposed to the ROI.
How do I go about evaluating cash flow for commercial?
It would take a book,or at least a chapter to answer that question. I don’t have Ray Alcorn’s book yet - just ordered it, it’s on the way. I have heard it is excellent and comes highly recommended.
Artymans’ formula will give you basic cash flow. it’s called an APOD - Annual Property Operating Data sheet. Once you get to NOI, that number is used to calculate “cap rate” Cap Rate is the return on investment if you paid all cash.
Most of us get some type of financing so that has to be calculated into your cash on cash return. (Mortgage payments are not considered “operating expenses” for these purposes) Are you confused yet? That’s why you need Ray’s course.
You say that it is hard to get commercial loans right now
Since the credit market has tightened, lenders are making fewer loans and being more selective in the loans they do make. For example they will typically do lower loan to values now. They also have higher debt coverage ratios. You can get loans now but the deals have to be better or you have to come up with more cash.
As a commercial mortgage broker I can tell you that it is true the credit crunch is very real. Multi-family is the easiest to do and rates and terms are still very good. I would get a loan since the lender will not allow the loan unless the deal makes sense and because of the liquidity rule. The main issue you would have is lack of experience the lender might require a management company. Net operating income is the most important figure for you and Dept service coverage ratio for the lender. When looking at a property you want to look at potential ways that may increase your NOI.
Thanks for the comments / suggestions…I’ll have to look up Ray’s book.
How do you guys go about finding commercial deals? Same as residential? Looking out for distressed places? Loopnet? Marketing such as direct mail to commercial establishments?
It depends where you invest. I have detailed information on privatization processes in Belgrade (Serbia). For example it is possible to purchase complete hotel (fantastic downtown commercial area) for between 1 000 000 and 5 500 000 dollars (one such was bought couple of days ago). You can also buy lots or very old and lousy houses and turn it in commercial building. For such business you would need somewhere between 50 000 to 500 000 dollars (to get land in downtown area), and then to pay building costs (I really don’t know how much is it there). Anyway, for great commercial investment you will certainly need more than 500 000 or 1 000 000 dollars in any European city (Belgrade is one of the most expensive regarding to real-estate, so other European cities might have lower costs). You can also buy couple of offices and put them on sale (that would cost of 100 000 dollars or more per office and will bring minimal return rate of about 6%, or more depending on how much offices are available.
“The Fundamentals of Listing and Selling Comm RE” - Loren K. Keim
“How to Succeed in Comm RE” - John L. Bowan
“The Millionaire Real Estate Investor” - Gary Keller
#1 and #2 are geared toward the newbie commercial agent- as I am, although at least youll know terminology, processes, etc. I work full time in residential and the books have been very helpful and given me basic knowledge. #3 is just a great book + game plan.
Generally speaking, I’ve seen two types of people that succeed in commercial real estate -
Those who start with significant money (whether inherited or proceeds from selling a business) and can afford to make mistakes until they learn the ropes
Those with less wealth who gained the knowledge/experience to succeed beforehand, then started by buying small and gradually becoming a big player
I was a commercial appraiser for several years and had taken numerous advanced classes on valuation and commercial construction before I felt comfortable buying commercial real estate. When you have less money to start with you can’t afford to make mistakes, b/c mistakes in commercial real estate can ruin you. Read the newbie books and they’ll give you a thirst for more knowledge and get you pumped up, but at the end of the day it won’t be enough to give you the confidence to go out and buy properties. Dealing with established brokers, agents, and investors when I first began my CRE career was intimidating. They threw around terminology, names, and numbers so fast that I could barely keep up. If you don’t know what you’re doing it will be easy for a professional to screw you over.
I highly recommend you get a job in the commercial real estate field if you want to invest. Investing in real estate can be a full time job (anyone that tells you otherwise doesn’t own real estate) so you might as well work full time in real estate until you invest. You need to get a feel for your local market, learn who the players are, know values, and be able to recognize when a building hasn’t been constructed properly. The commitment you make to learning will pay off and give you the confidence you need. It takes time though, so be patient while you work toward your goals.
