Finding a Good Commercial Real Estate Deal
Commercial property owners love the additional cash flow, the beneficial economies of scale, the relatively open playing field, the abundant market for good, affordable property managers and the bigger payoff from commercial real estate.
But how do you evaluate the best properties. And what separates the great deals from the duds?
Like most real estate properties, success starts with a good blueprint. Here's one to help you evaluate a good commercial property deal.
- Learn What the Insiders Know
To be a player in commercial real estate, learn to think like a professional. For example, know that commercial property is valued differently than residential property. Income on commercial real estate is directly related to its usable square footage. That's not the case with individual homes. You'll also see a bigger cash flow with commercial property. The math is simple: you'll earn more income on multifamily dwellings, for instance, than on a single-family home. Know also that commercial property leases are longer than on single-family residences. That paves the way for greater cash flow. Lastly, if you're in a tighter credit environment, make sure to come knocking with cash in hand. Commercial property lenders like to see at least 30% down before they'll give a loan the green light.
- Map Out a Plan of Action
Setting parameters is a top priority in a commercial real estate deal. How much can you afford to pay? How much do you expect to make on the deal? Who are the key players? How many tenants are already on board and paying rent? How much rental space do you need to fill?
- Learn to Recognise a Good Deal
The top real estate pros know a good deal when they see one. What's their secret? First, they have an exit strategy – the best deals are the ones where you know you can walk away from. It helps to have a sharp, landowner's eye – always be looking for damage that requires repairs, know how to assess risk and make sure to break out the calculator to ensure that the property meets your financial goals.
- Get Familiar With Key Commercial Real Estate Metrics
The common key metrics to use for when assessing real estate include:
- Net Operating Income (NOI)
The NOI of a commercial real estate property is calculated by valuating the property's first year gross operating income and then subtracting the operating expenses for the first year. You want to have positive NOI.
- Cap Rate
A real estate property's "cap" – or capitalisation – rate, is used to calculate the value of income producing properties. For example, an apartment complex of five units or more, commercial office buildings, and smaller strip malls are all good candidates for a cap rate determination. Cap rates are used to estimate the net present value of future profits or cash flow; the process is also called capitalization of earnings.
- Cash on Cash
Commercial real estate investors who rely on financing to purchase their properties often adhere to the cash-on-cash formula to compare first-year performance of competing properties. Cash-on-cash takes the fact that the investor in question doesn't require 100% cash to buy the property into account, but also accounts for the fact that the investor will not keep all of the NOI because he or she must use some of it to make mortgage payments. To uncover cash on cash, real estate investors must determine the amount required to invest to purchase the property, or their initial investment.
Like any business, customers drive real estate. Your job is to find them - specifically those who are ready and eager to sell below market value. The fact is that nothing happens - or even matters - in real estate until you find a deal, which is usually accompanied by a motivated seller. This is someone with a pressing reason to sell below market value. If your seller isn't motivated, he or she won't be as willing to negotiate.
A great way to evaluate a commercial property is to study the neighborhood it's located in by going to open houses, talking to other neighborhood owners, and looking for vacancies.
Be adaptable when searching for great deals. Use the internet, read the classified ads and hire bird dogs to find you the best properties. Real estate bird dogs can help you find valuable investment leads in exchange for a referral fee.
The Bottom Line
By and large, finding and evaluating commercial properties is not just about farming neighborhoods, getting a great price, or sending out smoke signals to bring sellers to you. At the heart of taking action is basic human communication. It's about building relationships and rapport with property owners so they feel comfortable talking about the good deals - and doing business with you.
Whether to Buy or Lease Commercial Property
Although there are many variations, the buy or lease decision typically arises in the following circumstances:
1. A business requires new or additional space. Its needs can be satisfied by leasing space or by constructing or buying a single-tenant or a multi-tenant building.
2. A business is currently leasing satisfactory space in a single-tenant or a multi-tenant building and has the opportunity to purchase the building. The decision is a three-part process: the market analysis, the financial analysis and other considerations.
In making the buy or lease decision, the financial analysis is used to identify the financial advantage of one alternative over the other. The principal focus of the analysis is to choose the alternative that will provide the needed space at the least net cost. To determine this, the present value of the after-tax cost and benefits of owning the property is compared with the after-tax cost of leasing the space. All other things being equal, the course of action with the least net cost is chosen. Because lease payments, operating expenses, depreciation and interest are deductible expenses, the analysis is usually made on an after-tax basis. When the choice is between buying or constructing a multi-tenant building and leasing space, the consequences of becoming a landlord are added to the analysis. By investing sufficient equity to purchase or construct a multi-tenant building, the owner acquires the present value of the after-tax income stream from the building’s other tenants and the present value of the building’s after-tax cash flow from resale and avoids the present value of the after-tax cost of leasing space.
Because most leasing literature concerns leasing business equipment, such as a truck, the buy or lease decision usually is treated purely as a financial decision. Whether leased or purchased, there is no difference in the truck’s ability to do the job. Thus, the decision of whether to buy or lease a truck is about determining the most financially advantageous way to gain the use of the truck for the analysis period. The decision of whether to buy or lease real estate is much more than a financial decision, although the financial analysis is important. The following points must be considered:
1. Business enterprises need space to conduct their business activities, but in most cases, real estate is not their principal business. If the firm leases needed space, it can adjust the amount of leased space as market requirements change. If the firm owns real estate, adapting quickly to changes in the market may be more difficult because of the time required to plan and construct a property or to buy a property when more space is needed or to sell the property when less space is needed. A retailer, for example, may prefer to lease space so that store locations can be changed in response to market shifts. On the other hand, an owner may enjoy greater flexibility in using the property than a tenant. As space needs change, an owner can make choices that support these needs.
2. If a multi-tenant building is constructed or purchased, the business also becomes a landlord. Aside from the other consequences of owning real estate, how will being a landlord fit in with other business activities?
3. An existing building can be inspected to determine its quality and its suitability for the business enterprise before it is leased or purchased. In certain markets, an existing building’s market value may be less than its replacement cost; if the space is suitable for the business, it can be obtained at an attractive price. How does buying an existing property differ from constructing the property? A newly constructed property should have no functional (or other) obsolescence and should be designed especially for the user’s needs; however, when completed the new building may be unsatisfactory and may have cost more than planned or both.
4. Balance sheet issues may be important to a company making the buy or lease decision. For example, future borrowing restrictions resulting from real estate debt may be a concern; if so, leasing to keep real estate off the balance sheet may be an attractive option. The buy or lease decision melds the market and financial analyses with other business considerations. This might result in a decision to lease even though purchasing the property appears to be financially advantageous. The possibility of such an outcome emphasizes the difference between purchasing real estate and other business assets.
Reasons to Go Commercial
Business Bay is the only Central Business District (CBD) in the city of Dubai, on par with Manhattan, with a very unique location indeed, right next to DIFC, Freehold areas, the world's tallest tower Burj Khalifa, the largest canal project to be connected to the sea and not to mention, state of the art commercial and residential towers. Thus it is not surprising that some of the World's biggest corporations are moving their head offices to Dubai, making it an ideal location to invest.
In terms of time, now is the best period since commercial offices in Dubai are currently under priced. However, Dubai is heading towards maturity of offices and businesses which are destined to pick up. Comparing to mature markets of top cities around the world where offices are under supply.
Calculating today's price of cost of land plus cost of construction, it can be seen that prices are very reasonable and have a long way to increase and appreciate. Prices for commercial offices in Business Bay reached over AED 5000 for some off plan projects prior to the crisis. Now it is still possible to get a decent office space for an average of AED 1500/ sq. ft. As experts, we can say that a much better ROI can be expected when renting an office as opposed to renting a residential unit particularly when the right office has been rented out to a reputable company, investing in offices offers a more stable income stream.
Many non-experts who are not specialized in real estate might say: Go Residential. However, when asked for the opinion of professionals who witnessed and lived the ups and downs of the market will tell you that, not many people know about the great advantages of buying commercial property today.
In our professional opinion, and with Dubai ranking 23rd out of 50 for the global office market list* out of which Business Bay is one of the two key locations to contribute to the boost of office spaces in Dubai following the successful Expo 2020 bid*, now is the time to Go Commercial.