As you begin looking at commercial real estate, understanding the things that make it valuable can take some time. We’ll walk through the basics with you so that you can speak the language, learn what brokers will try to tell you, and learn how you can search on LoopNet more effectively.
In this article, we’ll discuss the following:
- What is commercial real estate?
- How does it differ from residential real estate?
- What is the difference in risk between commercial and residential real estate investing?
- What are the key things to do when evaluating commercial real estate?
- What part of the evaluation can I do when I first see a commercial real estate listing?
- How does CREBake help with the commercial real estate evaluation process on LoopNet?
What is commercial real estate?
Commercial real estate is any property used for business purposes, such as office buildings, retail spaces, warehouses, and hotels. It differs from residential real estate, which refers to property used for living purposes like houses and apartments. Commercial real estate is typically used to generate income through rent, lease, or sale of the property.
How does it differ from residential real estate?
Commercial real estate and residential real estate differ in many ways.
Tenants: Commercial real estate tenants are typically businesses, while residential real estate tenants are individuals and families.
Leases: Commercial leases are generally longer and more complex than residential leases.
Financing: Financing for commercial real estate is typically more difficult to obtain and is often more expensive than financing for residential real estate. It’s not just a mortgage.
Income Potential: Commercial real estate has the potential to generate higher income than residential real estate through rent or lease.
Appreciation: Appreciation of commercial real estate is typically more stable than residential real estate, and it is less affected by market fluctuations due to the longer leases mentioned.
Taxation: The taxation of commercial real estate is different from residential real estate, and it tends to be more complex.
What is the difference in risk between commercial and residential real estate investing?
The risk associated with commercial and residential real estate investing can differ in several ways.
Tenant Risk: In commercial real estate, the tenant is typically a business, and if the company goes bankrupt or closes down, the property may be left vacant or “go dark,” resulting in a loss of income while you scramble to find a new tenant. On the other hand, residential real estate has a higher likelihood of being occupied by a tenant since everyone wants a place to live, reducing the vacancies.
Financing Risk: Financing for commercial real estate is typically more difficult to obtain and is often more expensive than financing for residential real estate. This can increase the risk of default if the property is not generating enough income to cover the loan payments.
Appreciation Risk: Appreciation of commercial real estate is typically more stable than residential real estate, and it is less affected by market fluctuations; hence the risk of loss of value is comparatively less. In residential real estate, location is the most significant factor for appreciation over time. In commercial real estate, however, the existing lease and its terms determine the sales price.
Taxation Risk: The taxation of commercial real estate is different from residential real estate, and it tends to be more complex. This can add a layer of risk for commercial real estate investors.
What are the key things to do when evaluating commercial real estate?
When evaluating commercial real estate, you should consider several key things:
Location: The property's location is one of the most critical factors when evaluating commercial real estate. It should be easily accessible and in a desirable area with good visibility and foot traffic.
Condition of the Property: Inspect the property thoroughly and evaluate the state of the building and any improvements that may be required. This will help you determine the cost of repairs or renovations and the potential for increased income from the property.
Income Potential: Evaluate the property's potential for generating income. This includes the potential for rent or lease, the property's occupancy rate, and the tenants' creditworthiness.
Expenses: Consider the ongoing expenses associated with the property, such as property taxes, insurance, and maintenance costs. These expenses should be factored into your analysis to determine the property's net operating income and potential for profitability.
Market Analysis: Research the local market conditions and trends. This will give you an idea of the demand for commercial properties in the area and the potential for appreciation.
Zoning and Use Restrictions: It's essential to understand the zoning regulations and use restrictions of the property and surrounding area. This will help you determine what type of business can be operated on the property, and if it complies with local laws.
Legal and Financial Review: Before making a purchase, it's important to have a legal review of the property's title and any liens or encumbrances on the property. Also, consult with a financial advisor or accountant to evaluate the economic feasibility of the investment.
Considering these key factors, you can make a more informed decision when evaluating commercial real estate and determine if it is a good investment opportunity.
What part of the evaluation can I do when I first see a commercial real estate listing?
As you begin investing, you’ll spend a lot of time reviewing materials on sites like LoopNet, broker websites, and emails from your favorite contacts. You’ll look at tens, if not hundreds, of properties daily.
When you first review a commercial property listing, one-pager, or offering memorandum (OM), you should always consider the following:
Location: Check the property's site, and research the surrounding area. You won’t know the details, but use your experience to consider the local demographics, traffic patterns, and nearby businesses or amenities that could draw potential tenants. As you do more commercial real estate investing and review more properties, you’ll become better at this.
Photos and Description: Look at the pictures and read the property description. This will give you an idea of the condition and layout of the property, as well as any improvements or features that are included. Remember, the seller is putting the property in the best possible light, so consider whether anything looks edited and take all tenant information with a grain of salt.
Income Potential: Review the property's potential for generating income. Look at the rental or lease rate, occupancy rate, and creditworthiness of the tenants.
Expenses: Review the property's expenses and compare them to the income generated. This will give you an idea of the property's net operating income and potential for profitability.
Cash Flow: Can you afford this property with the provided income and expense information? You may need more cash to buy the property outright. In this case, you’ll need to get financing. Will your net operating income (NOI) help you cover the loan payments? Do you have enough for the down payment?
Remember that this is just an initial evaluation, and a more detailed property analysis is necessary before making investment decisions. However, this will give you a good idea of the property's potential and if it's worth taking a closer look.
How does CREBake help with the commercial real estate evaluation process on LoopNet?
LoopNet is the place to go as you begin your commercial real estate investing journey. You’ll get an understanding of the area you’re investing in and the brokers who are most active in the region.
While reviewing properties, you’ll be making calculations to determine the current cash flow and the type of loan you’ll need to make things work for your financial situation. It’s not that difficult with a pencil, paper, and calculator. But you’ll be doing it ten or more times every day. And that will slow you down as you look at the properties in an area.
The CREBake Chrome Extension for LoopNet helps by adding a button to LoopNet while you search, so you can calculate key metrics, like down payment, monthly payments, and resulting net operating income (NOI). This way, you’ll know if the property will have positive cash flow for you before you perform more diligence.