Commercial Property Investment Mistakes

The value of commercial properties for sale is determined using a few simple formulas based on the amount of net operating income the property generates each year. So when you see a commercial property for sale, one of the first things you want to ask a broker is an income statement.

Some brokers who have listed commercial properties for sale may refer to this income statement as an IPOD, or income property operating data sheet. Once you get your IPOD, or income statement, you can then compare the information provided by the broker or seller with your other sources to help determine what the real figure is. The challenge when looking at commercial properties for sale is that brokers and/or owners will tend to overestimate the amount of revenue that commercial properties for sale generate while also trying to minimize the amount of reported operating costs.

How to Determine the Value of Property for Sale

The reason is simple. The value of any commercial real estate is based on the amount of net operating income the property generates each year. In fact, each additional dollar of annual income increases the property’s value by about ten dollars, depending on where the property is located, and how old it is. Note that this extra net income can come from getting additional income from rent, or from reducing expenses by managing the property more efficiently.

Once you understand that commercial real estate owners will tend to display unrealistic numbers in an attempt to get a higher price for their property, you’ll better understand why when looking at any commercial property for sale it’s important to know the market you’re in. invest in. When you know what rental rates in an area tend to be or what the typical cost ratio for a twenty-five year old apartment building is then it is much more difficult for a broker or owner of a commercial property for sale to try to pull the wool over your eyes.

Verifying Income and Expenses

The first step in verifying the income of a commercial property for sale is to request a list of leases. A rental list is a list of what each apartment, self-storage unit, mobile home lot, or office space is rented for. Make sure you get an actual rental listing because the owner or broker of a commercial property for sale may try to give you a Pro-forma rental list instead of an actual rental listing. Pro-forma means that there is an expectation, realistic or not, of getting a higher rent than the property is currently earning. My response to this has always been, “If you raise the rent to be pro-forma then we’ll use the higher revenue amount, otherwise we’ll base our assessment on what the property is currently producing in revenue.”

When looking at the expenses of a commercial property for sale, keep in mind that you are trying to calculate the actual amount you would spend operating the property rather than the seller’s expenses. So, despite knowing exactly how much the seller has cost me, I have learned NOT to rely on the information provided by the seller when looking at commercial properties for sale as this information is almost always inaccurate.

Simple Formulas Used for Expenses

Costs will vary depending on the type and age of the commercial property for sale. For example, if you want to buy a Class C apartment building that is at least twenty-five years old, your expenses will range from 45 to 50 percent of your monthly income. The accumulated revenue, known as Effective Gross Revenue, is what remains after the vacancy fee is deducted from the total rental amount on the list of leases of a commercial property for sale.

The final step in determining the value of commercial property for sale is dividing net operating income by the capitalization rate, which varies from about 6 to 12 percent depending on the type of property, age, and location of the commercial property. for sale. The quickest way to get an idea of ​​the capitalization rate you should use when looking at commercial properties for sale is to ask other brokers not involved in the transaction.

Using Escape Clauses to Limit Your Risk

Another way to protect yourself when looking at a property for sale is to make sure that your purchase contract gives you time to walk out of the deal if you’re not comfortable with anything you find. If done right, you can often tie up a property for 60 to 90 days so you have time to determine the true value accurately. This makes it easy to see commercial real estate, because you can get out if you have the right escape clauses.