CRE Report 04.16.12

Commercial real estate investment returns

Bob – Walt let’s talk about Commercial Real Estate Investments returns today.  How do you size up a commercial real estate investment, to make sure it’s analyzed correctly?

Walt  – There are two significant elements you need to consider in determining a successful commercial real estate investment, and they are cash flow and return on investment.

It’s all about cash.  Cash flow is King, at least for some people.  When going into a commercial investment it’s critical to analyze all the expenses including, vacancy loss and the cost of vacancy’s impact on the investment, creating a replacement reserve to plan to replace major items in the

Photo Credit: http://jdfletcherassociates.com/blog/?p=371

future, on going maintenance items, advertising, tenant repairs and one of my favorites, lease commissions.  It is critical to analyze all the costs associated with the property because every dollar that goes on the expense line is a dollar that disappears from the profit line.  So you can create cash flow by raising rents, closely monitoring expenses and or by putting more cash in to the deal.

Bob – Where does the property appreciation show up in that investment analysis?

Walt – Well it really doesn’t in that scenario. And interestingly, it doesn’t come into play in one of the most popular method of investment measurement, which is the capitalization rate or cap rate, which basically analyzes the investment based on one year of net operating income and also

assigns a risk factor to the asset to determine the value.

Another popular and more comprehensive analysis requires looking at the internal rate of return of the property or IRR, which takes into account the purchase price, the current financing on the investment, all income and expenses, property depreciation, and a sale price at the end of a determined time frame usually five years.

Said again, the IRR calculates the dollars in the investment and creates a return calculating the purchase price, annual cash flows and eventual sales price.  We can analyze the return on the cash flow or the appreciation or a combination of both.

Bob – Walt, that sounds like a very detailed approach to analyze a commercial real estate investment, can this be done on any type of income property, regardless of the value of the property?

Walt – It can and it is a great way to analyze commercial investment real estate.  Owners of commercial investment real estate want to know what their property is worth, and the IRR is an excellent way to value all aspects of the property and based on those numbers the Internal Rate of Return is going to provide an excellent analysis of the property’s return to the investor.

Bob – Walt how can people reach you to talk about commercial real estate?

Walt – Thanks Bob, Walt Arnold, 256-1255, website, waltarnold.com also follow me on Twitter or become a fan on Facebook.  If you have a question about your real estate property values, give me a call for a free property evaluation. Thanks Bob, have a great week.