You’ve probably heard that millionaires are often made in difficult economic times and it’s certainly true that commercial real estate can help you build wealth. What you need is some basic information that will provide the necessary analytical approach to purchasing property. Here are some things you’ll need to know.
1. Cash flow is king.
This axiom is seldom, if ever, argued. The importance of cash flow in commercial real estate held for rental income is critical because it determines market value (Capitalization Rate), lending limits (Debt Coverage Ratio) and your return (Cash-on-Cash). When you express an interest in an income producing property, you’ll receive information that itemizes the revenue, expenses and net operating income. When you decide what you’ll offer for the property, you divide the net operating income by the price which provides you with the capitalization rate.
2. Up-front costs associated with a purchase.
A down payment will be required and is usually between 25%-40% depending on risk and stabilized vs. development property. Typical closing costs are around 4% of the purchase price. Based on these estimates, you’ll need about 30% cash on hand to close on a commercial real estate investment. The closing costs will usually include such things as:
• Tax / Flood Zone Searches
• Title Insurance
• Site Inspections
• Property Condition Report
• Environmental Report
• Legal Fees
• Loan Fees
• Processing Fees
3. Risk assessment.
Determining an acceptable or tolerable degree of risk is essential to a successful commercial real estate investment. You accomplish this task by getting the best information available prior to the purchase. The capitalization rate and risk factors follow each other. A high capitalization rate therefore has a high risk factor and a low capitalization rate a low risk factor. As the capitalization rate and risk goes up, the price goes down therefore, the lower the capitalization rate the higher the price.
4. Get expert advice.
You need to educate yourself before purchasing commercial real estate and during this process you’ll determine that engaging a broker to represent you provides a variety of advantages. Your broker will help you find and analyze properties as well as advise you throughout the transaction. You want to find a broker that is less interested in selling you a property and more interested in helping you purchase the right property. Your broker will assist you with research, value, negotiation, due diligence and more.
So, if investing in commercial real estate has been a dream of yours, take a look at what is available. It may be the right time and the right place.
Your comments are always appreciated, so let me know what you think.