Investing in commercial real estate has become the ideal way to build wealth. It is known to provide some of the highest income streams and massive gains on property valuation. That’s one of the reasons why private investors are eager to learn about the benefits of investing in commercial real estate (CRE). It is far more profitable than other investment options and has less risk. After all, the commercial markets have barely seen a downfall in the past few decades.
Before jumping on this bandwagon, learn about the difference between CRE and other financial investments. Direct real estate investments involve buyers purchasing properties themselves, through a broker, or as part of group investments. Hence, it is pretty different compared to buying shares, bonds, or forex. You must evaluate every potential investment property to ensure it aligns with your strategic financial objectives.
Emerging investors often need help with market analysis and valuation since it involves lots of research based on facts, figures, and data. There is only one thing that you must bear in mind, profitability – how much yield your property will provide to safeguard the investment. For evaluations and analysis, we can show you the ropes.
This article outlines different financial tools and methods for commercial real estate investing.
1.  Assess Market Trends
As the real estate market is versatile, every investor must learn to deal in different ways. Besides bargaining and negotiating, scour the market to determine how it works. Likewise, become familiar with real estate jargon to work your way around deals. Your real estate friends can help, but they can’t teach everything. Hence, the best way would be to enroll in a commercial real estate online course to build your knowledge base.
Next, you must consider general market conditions when evaluating a prospective deal. As an investor, understand where you stand in the market cycle. Remember, it can be risky to invest at a market peak; thus, try to predict when the market will turn with absolute certainty. You can use a few barometers, such as population growth, household income, and economic drivers. After all, a growing population coupled with high income can lead to a real estate market peak.
It does involve a bit of economics, but these analytical skills will go a long way in ensuring the right CRE investments.
2.  Measure Capitalization Rate
One of the assumptions that almost every CRE investor makes is to choose an appropriate capitalization rate when making an evaluation. It might seem like the right approach, but the capitalization rate is never accurate. Simply put, it is the rate of return on real estate – net of value appreciation, applied to the net of investment to determine present value. Let us explain how.
If the property is expected to generate a return of $5 million in the next ten years and the discounting rate is 14%, calculate market value. It would be equal to net operating income over the capitalization rate. In this case, the market value is $35.7 million. Anything below this amount will be a good deal for investors, and anything above will mean you bought the property at the market peak.
So before finalizing any deal, calculate the property’s present value using the discounted rate to determine its real potential.
3.  Discounted Cash Flows (DCF)
Another tool for property valuation is the DCF method. It enables investors to calculate real estate value based on discounted net operating income. Net operating income will reflect the earnings generated by CRE after including all the expenses. For that, you have to divide net operating income by the required rate of return on real estate assets.
After this, DCF will enable you to forecast expected rental revenue by evaluating comparable properties. It will require extensive market research but will let you determine what prices tenants pay in that area. As a result, you can apply similar rentals for your property and account for the growth rate within the formula.
Besides this, conduct a sensitivity analysis or realistic, conservative estimates. The income will be forgone if the asset is not utilized to its total capacity. It is more like a prudency approach as you try to recognize losses before they incur.
4.  Gross Income Multiplier
Investors want valuation results close to accurate, and because of this, investors prefer relative valuation – gross income multiplier. It focuses on the assumption that properties in the same vicinity will get valued proportionately to the gross income they generate.
If a real estate investor purchases a building of 100,00 square feet, determine from comparable property data. A property might charge $8 per square foot, meaning a rental income of $800,000, but what about vacant units? Hence, you must account for the vacancy rate and multiply it by the gross income. Remember to apply a similar approach for net operating income.
The next step is multiplying the asset CRE’s gross income multiplier by gross annual income. You can look up historical data to find this value. Otherwise, assess similar properties’ sales prices and divide them by gross annual income. It will give an average multiplier for the entire region.
5.  Lot & Building Analysis
After technical analysis, focus on due diligence and conduct a comprehensive lot and building analysis. It means looking at the construction site to understand its size and configuration. In addition, it involves investigating the zoning ordinate to determine the property’s allotment and zone to see what you can build on it. At times, properties are zoned for a specific use but don’t let that come in between your investment objectives. After all, you can always redevelop the property for other uses.
Further, become familiar with the entitlement process and seek permission to build the property of your choice. It involves getting different variances and zoning changes to get permits for that location. However, you must carry the entire map covering the acres and units to complete your analysis.
Final Thoughts
Most investors back off from commercial real estate investing due to the complexity of analyzing commercial real estate properties. It might seem challenging initially, but you will get the hang of it once you step into the market. It will take time to learn the industry jargon, but luckily there are enough resources online to help you understand the process. Likewise, you must brush up on your number-crunching and financial skills to conduct a thorough real estate analysis. The more precisely you evaluate properties, the more profitable ones you can buy.
