What Constitutes a Good Commercial Real Estate Investment?
There are two types of commercial real estate investors: those that simply desire safe, long-term investment returns and those that are speculative, meaning they will take higher risks for the potential to earn greater long-term rewards.
Speculative investing can be exciting and fun, but it can also bring financial distress to property owners. It’s important that speculative investors do their homework and analyze investments before committing to individual purchases.
The most common tool used to compare commercial real estate investment properties is the CAP rate. The capitalization rate compares a property’s annual income, which is factored after all operating and vacancy expenses, and equates it in net operating income (NOI) terms as far as income to sales price ratios. This does not reflect the investment’s return percentage, but will be somewhat close to that number if no financing is involved.
The CAP rate can be obtained by dividing the NOI by the value or price of the property. This is expressed as a percentage. Additionally, hard money lenders and banking institutions tend to focus on the general CAP rate of return for properties when lending financial resources.
A general rule of thumb concerning CAP rates is that if a property investment has solid tenants, long-term leases and a limited responsibility for the new landlord (including low building maintenance repairs, costs, etc.), then an investor may be better offer accepting a lower CAP rate. However, if the property is in an area where the tenants are unstable and the real estate market is continually plummeting, a higher CAP rate is reflected, meaning this is a greater risk for investors.
There are five key factors that help define good commercial real estate investments.
- Income – Commercial properties are by definition, income producing. While most stockholders only see income once stocks are sold, commercial real estate investors receive income through rent payments.
- Capital Appreciation – This simple concept hinges on the fact that if rent values increase, the property value also increases.
- Leverage – By borrowing 70- to 80-percent of commercial investment resources from banks, investors are able to free up other funds for additional investments.
- Security – Stocks are based on price-to-earnings ratios, but real estate is simply based on demand.
- Diversity – Since commercial properties often house multiple tenants, this allows real estate investors to diversify their holdings.
Better Than Loans offers real estate investors’ affordable commercial building loans and apartment loans, as well as providing fast loan funding for commercial transactions.