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This Old House - Do-it-Yourself

Correct Evaluation of Commercial Real Estate Prior to Its Purchase Can Ensure the Right Returns

Written by Posted On Tuesday, 10 July 2018 18:31

When you are looking for investment in real estate, commercial real estate brings substantial benefits that are more predictable than residential real estate. It is necessary that you give a lot of thought to this investment before you commit your hard earned money to it.

Commercial real estate requires proper evaluation whether you are buying to hold and lease the property or just intend or just sell it in future. The standard method of evaluation in the real estate industry is, converting anticipated cash flows into required capital for purchasing it, based on the capitalization rate in that area. The capitalization or CAP rate is the income produced by the property divided by the cost of acquiring the property. This cost must include the cost of any repairs or other expenses needed to make the property more viable. Evaluation can also be made by comparing it to other properties that have similar amenities and features. If the property is not producing any income, then it can be evaluated by estimating its cost if it has to be replaced in the present time. Here you must include the cost of materials and labor plus any depreciation on the structure.     

The choice of a commercial real estate for investment can also be dictated by its position or location, its ease of approach, surrounding populace and likely customers of any tenants who occupy the building. If the commercial real estate consists of office space, it must be located in an area that is well served by roads and public transport and must also have surrounding development that can serve the needs of offices and the people working in them.

Evaluating a commercial real estate must take into consideration its existing tenants and their abilities to meet their rental and other obligations. The duration of the leases also is an indicator of the value of a property, and long-term leases indicate satisfied tenants who can be a long-term source of income. No evaluation can be realistic until a proper inspection is made of the property and its need for any required capital expenditure needed for repairs to roofs, interiors, approaches, and proper infrastructure for electricity, water, and drainage. You may also need to take a detailed look at HVAC, lifts, security arrangements and others that will require constant maintenance.

It is important that before you invest in any commercial property, you get the building inspected by professionals to understand its structural stability, its present value depending on geographical location and present economic conditions, and it's maintenance requirements that will be a recurring cost in future. You may also need to factor in the costs of any improvements that you think the property may need in order to increase its value and improve its marketability. Get an attorney or other professionals to go through the documentation and also make sure that there are no legal matters or other complications that can become an added cost in future. It may not come amiss to also go through town and city plans for the area, to see if there are any likely improvements or other developments that can have an impact on the valuation of the property that you are planning to purchase.

Property management from Live Love at Home cost also needs to be part of any evaluation that you make for a property whose purchase you are contemplating. You will require some sort of establishment to collect rentals, attend to routine maintenance, paying of taxes, utility bills, managing security, and looking to ensure that you have a constant high occupancy. These costs can be quite substantial and will reduce your returns on the investment.   

Most investment in a commercial real estate is made for generating income that gives returns that are acceptable and greater than that which you will get from investments in other financial instruments. There is also the possibility of capital appreciation due to increase in market value of properties, but this is highly dependent on the economic scenario and must be not given too much of importance while evaluating a property, as downside risks are equally applicable.

To arrive at the right valuation of any commercial real estate it is important that you collect the right data on occupancy rates, rental rates, and operating expenses. It is also good to know the capitalization rates that are prevalent in that area and the likelihood of new construction in that area that can act as competition for attracting your tenants. While high occupancy rates are more a result of providing better amenities and reasonable rents, the estimates during evaluation must be realistic and more in tune with existing conditions. Carry out a survey with the existing lessees to understand what they look for as improvements, or what they perceive as lacunae that need addressing. This may at times call for improvements and changes that can add to capital costs, that must be factored into any evaluation.

It is also necessary to correctly estimate operating expenses that are needed to maintain the property in its best condition. The present operating expenses must be thoroughly analyzed, and any inefficiencies must be spotted to effect any economy. At times they may need to be increased, in case you as the new owner, feel that you will do better if you provide better amenities and facilities that can act to attract or retain tenants. Once the operating expenses are correctly estimated it can give you guidance on arriving at the likely market value, by dividing this with the capitalization rate prevalent in that area, or one that you will be satisfied with.

There are other methods that can allow you to arrive at a proper evaluation for any property that you are contemplating the purchase of. If you are a first-time purchaser consult experts, but if you have been in the business for a time, look back at your previous acquisitions and review their evaluations and see which method comes closest to your investments made in them. Investing in property always carries with it an element of risk, but if you can manage them then the returns can be much higher than that which you would get from other investment avenues.

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James Stevenson

Hi, My name is James and I've been involved in the property and real estate industry for 10 years now. I hope people will like to read about my thoughts and experiences in the industry and please contact me if you want to discuss my articles further!

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