How do I evaluate a commercial property to purchase?

As a commercial real estate investor, it is crucial that you know how to properly evaluate a property before making an offer. You may be eyeing a commercial property to purchase, but before investing it is critical to know how much the property is actually worth. What will be the rate of return on the property? Is the asking price a good deal? The last thing that you want is to not hit your investment targets because you failed to properly evaluate a purchase on the front end.

The steps to evaluate the financial viability of a cash-flowing commercial real estate property (a property rental or lease income) are fairly simple. You need to calculate all of the expenses of the property and subtract that from all income the property generates. That number will be the net operating income of the property. The critical part of this evaluation, however, is to be sure that you account for all income and all expenses.

For income, you will add all of the rental income the property receives and any other revenue the property may generate through on site laundry services, parking passes, or other amenities that the property provides tenants.

The expenses are often the trickier part of the calculation and it’s sometimes easy to overlook items that cost you, the owner, money. Be sure to account for (when applicable) property taxes, insurance, utilities, repairs, estimated repairs, ongoing maintenance, landscaping and lawncare, trash service, janitorial, property management, and anything else that the tenant(s) of the property are not responsible for paying. Another big factor to consider is your time, especially if you are self-managing the property. You should calculate how much your time is worth and estimate the amount of time per week that you will be spending managing different facets of the property.

Once you have calculated the net operating income, divide that number by the asking price of the property, multiply by 100 and that will give you the capitalization rate (%) of the commercial property. That cap rate is usually a good indicator on whether the property is a good deal or a bad deal.

When evaluating commercial real estate property to invest in, your key consideration should be on the income yield rather than the property appreciation. Always consider appreciation lagniappe on your investment.

Mathew Laborde, CCIM
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