style="font-size:15px;"> Job growth: This trend makes perfect sense: Where the jobs are, people are. And where the people are, demand exists for apartment rentals, office space, and consumer goods. Job growth is an excellent indicator of a healthy real estate market.The best place to start in researching job growth is to contact your local economic development department or chamber of commerce and ask for historical and current job growth data.
Development: This trend is all about supply and demand. After all, if a shortage of office space or apartment housing is evident, you clearly have a demand for new development. On the other hand, if you see that the city is overbuilding, it’s an indication for you hold off and reassess.
In the path of progress: It isn’t too difficult to spot this trend with your own eyes. Whenever new building and development is either coming your way or surrounds your property, you’re in the thankful path of economic development. You can feel the “buzz” of prosperity around you.
Chapter 3
Evaluating Commercial Real Estate
IN THIS CHAPTER
There’s a rumor around town that you need to be an accountant with an Ivy League degree to evaluate and analyze office buildings, retail centers, and apartment complexes. Don’t believe the hype. We know you can count and do some basic math; you’ll have no problem figuring out what your cash flow and return on investment are for any piece of commercial property.
In this chapter, you’ll get the inside scoop on our Commercial Property Evaluator. This tool will help you figure out what a commercial property is worth without any fancy calculations or spreadsheets. You’ll discover a super quick method to analyze an apartment building and a shopping center like a pro. This chapter also explains how to know a good deal from a bad deal and provides invaluable guiding principles of investment that will keep bad properties out of your portfolio — guaranteed.
Talking the Talk: Terms You Need to Know
Throughout this chapter, we use some terminology that you need to be familiar with. Having these terms under your belt is crucial on two fronts:
We presume you’re reading this book because you want to invest in commercial real estate. Most likely, you’ll be using a real estate broker to help you locate and close the deal. Real estate brokers know — and use — most of the terms mentioned here. Gaining a thorough understanding of the terms levels the playing field. If you can speak their language, you gain instant credibility and a relationship advantage over someone without your knowledge and understanding.
Just by increasing your word power, you gain increased confidence, which enables you to make sound, efficient investment decisions, and gives you an increased ability to hold your position, especially in negotiations.
Here are the words you need to know to navigate this chapter and talk the talk:
Capitalization rate: Your capitalization rate is your net operating income divided by the sales price. Also known as the cap rate, it’s the measure of profitability of an investment. Cap rates tell you how much you’d make on an investment if you paid all cash for it; financing and taxation aren’t included:Cap rate = net operating income ÷ sales price
Cash flow: Your annual cash flow is net operating income minus debt service. You also can figure monthly cash flow by dividing your annual cash flow by 12:Annual cash flow = net operating income – debt serviceMonthly cash flow = annual cash flow ÷ 12
Cash-on-cash return: To find your cash-on-cash return, divide your annual cash flow by the down payment amount:Cash-on-cash return = annual cash flow ÷ down payment
Debt service: Debt service is calculated by multiplying your monthly mortgage amount by 12 months:Debt service = monthly mortgage amount × 12
Effective gross income: You can find your effective gross income by subtracting vacancy from gross income:Effective gross income = income – (vacancy rate % × income)
Gross income: Gross income is all of your income, including rents, laundry, or vending machine income, and late fees. It can be monthly or annual.
Net operating income (NOI): Your net operating income is your effective gross income minus operating expenses:Net operating income = effective gross income – operating expenses
Mix: When a commercial investor says “What’s the mix?,” they’re asking how many studios, one-bedroom, or two-bedroom units the property has.
Operating expenses: Your annual operating expenses for the property typically include taxes, insurance, utilities, management fees, payroll, landscaping, maintenance, supplies, and repairs. This category doesn’t include mortgage payments or interest expense.
Vacancy: A vacancy is any unit that’s left unoccupied and isn’t producing income. Remember: A unit that’s vacated and re-rented in the same month isn’t considered a vacancy; it’s considered a turnover.
Vacancy rate: Your vacancy rate is the number of vacancies divided by the number of units:Vacancy rate = number of vacancies ÷ number of units
THE TECHNICAL MEANING BEHIND THE NUMBERS
Cap rate, cash flow, cash-on-cash return, and net operating income are investment terms that we explore in this chapter, but what do they really mean to you as an investor? Here’s the in-depth explanation:
Capitalization rate: A cap rate is used as a measure of a property’s performance without considering the mortgage financing. If you paid all cash for the investment, how much money would it make? What’s the return on your cash outlay? Cap rate is a standard used industrywide, and it’s used many different ways. For example, a high cap rate usually typifies a higher risk investment and a low sales price. High cap rate investments typically are found in low-income regions. A low cap rate usually typifies a Iower risk
