15 Oct Investment Property Analysis – Commercial Property Purchase
I started my career in real estate like most do, reading books. I read everything from residential to commercial, books for real estate agents and for regular investors, learning a lot in the process. It wasn’t until I handled my first real commercial deal that I put that knowledge to the test. I was in for a shock. There isn’t a better teacher than experience. With that in mind, I wanted to share my inside experience with the readers, and pass along some valuable lessons I learned along the way.
Understand your local real estate market and explore the fundamentals of commercial real estate investing. I can say this was the easiest step in my journey. I spent countless hours perusing MLS and driving around the neighborhood in search of properties and evaluating the area. My accounting background was helpful in reading and understanding real estate terminology, ratios, return on investment, and cap rates. In this area, research is key here. You absolutely must know the fundamentals, research areas you have an interest in, and Identify properties that will provide positive return on your investment. I spent three years researching the market, finding the winners, putting in offers, and getting rejected along the way. They say you make your money when you buy, not when you sell, so this step is crucial.
My motivation was to find an investment property to use as my office for Alba, CPA while earning money from any rental units attached to the space. After spending countless hours and coming up empty, I was ready to throw in the towel. I decided to end the search and settle for renting space instead of buying. I found a property in Lodi that had just come up for rent, called the agent/owner, and inquired about the space. The property wasn’t listed for sale, but I decided to ask the owner if she would consider an offer, much to my surprise, she said she would be interested for the right price. The key lesson here is that if you don’t ask, you will never receive. Always ask for what you want, even if it sounds outrageous in your head, who knows what position or mindset the seller is in; remember not everyone involved in the commercial real estate market is an expert, use this to your advantage.
With the pebbles out of the way, I had to make room for the stones in the buying process. Once we identified the property, the investment property analysis and negotiation process began. I gathered all required information from the seller and entered it in my investment property analysis tool for review (can be purchased here). The investment property analysis tool analyzed all the information and based on my required CAP rate, it calculated the appropriate price that I should pay for the property in order to generate a healthy return on my investment. Armed with the knowledge and the investment property analysis, I made an offer to the seller; and, after the standard back-and-forth negotiating, we settled on a mutually agreeable price. One gem that I found crucial during the negotiation process and used to my advantage is: It’s good to know what motivates a seller, and use that ammunition in the negotiations. You don’t get what you deserve, you get what you negotiate.
Basic fundamental ratios to know:
- Loan-To-Value (LTV): A ratio of how much money you’re asking from a lender vs. the total value of what you want to purchase.
- Debt Service Coverage Ratio (DSC): Operating income over total debt service. Basically how much of the debt you can afford to cover with the property income.
- Capitalization Rate (Cap Rate): Income of the property divided by the total value of the property.
- Cash on Cash: Annual income over how much you actually invested.
- Vacancy Rate: Percentage of property that is vacant in a time period.
Refer to the following tool for further details regarding basic ratios.