Looking for 4 easy steps for analyzing commercial real estate?
Most of us will begin with running the numbers first. We want to grab that income expense statement and analyze the deal as fast as we can to find out whether it fits or not. When you do that, you’re using the cap rate, cash-on-cash or gross multiplier to qualify the deal. Yes, this is a very important step, but there’s a more important item to consider first when analyzing commercial real estate.
When analyzing commercial real estate, before you jump into applying these 4 easy steps, you need to first analyze your return requirements.
We all invest in commercial real estate because of the benefits that we want to receive, we want to replace earned income, grow net worth, and achieve financial independence. If you haven’t analyzed your own situation first, analyzing a commercial deal won’t do much for you because you need to know if the deal fits your requirements.
Think about it, you want to find out if the deal is going to grow your net worth, but if you don’t know what you want your net worth to be, how do you know if the deal is actually going to work for you or not. So the first thing you need to do is to identify what you want your net worth to be.
Once you do that, you can then see if the deal is going to move you there.
Does the deal throw enough cash flow to replace your income? If you’re still working for a living and you want your commercial real estate to replace that earned income, then you need to know exactly how much cash flow you’re going to need coming in on a monthly basis from that investment in order to get you out of your job.
Does the deal get you closer to financial independence? Does it allow you to leave your job, and to have the flexibility and freedom to grow your portfolio even further? If you don’t know what these numbers are first, analyzing the commercial property is not going to do you any good.
Before you go through these four steps, please, pause the video and take a moment to write down what you think those answers might be. Once you’ve answered these questions, you can analyze a commercial property and know whether it meets your requirements.
Here are the four critical steps you should always follow to make sure your bases are covered:
Step 1: Begin by understanding the market location and demand drivers for the property. You probably thought I was going to tell you to look at the numbers first, but there’s a process you need to go through.
First, understand the market and the location. If you don’t understand who wants to use the space that you’re buying … and remember, you’re in the space business, you’re renting space to people. If you don’t understand who wants it and why they want it, then you’re not going to understand how powerful the rent can be and how powerful the return can be from that investment. Take a step back and ask yourself, “How do I understand the market?” first. This will help you in your financial analysis.
It also means that you’re taking a moment to take a look at the property itself. Is it well located, are there any environmental conditions that you need to consider, how’s the property condition, what shape is it in, does it have favorable zoning? These are the types of thing you want to look for.
Step 2: You evaluate the quality of the income stream. Does the property provide a durable cash flow that can service annual expenses, debt service, and meet your cash-on-cash return requirements?
This second step is critical. You want to make sure that you have a durable income stream. If you’re buying a property that’s 100 percent vacant, make sure you fully understand step one, the market location and the demand drivers because you are going to be making a big play on betting if that demand is going to show up and drive that investment forward.
Step 3: Analyze the expenses. Are the expenses realistic and in line with the market? Is there an opportunity for you to streamline or reduce expenses to increase your return and property evaluation? Now the classic example of this is to look at the expense structure on a property, and you’re going to see that sometimes an owner is paying too much money for trash removal. You might know that you can get a better deal on it. You could say move that trash removal cost down by two, three, 10 thousand dollars a year. You’re going to create instant equity, an additional value in that property by doing that.
Step 4: Qualify the owner. Why is the owner selling in the first place? If it’s such a great deal, why don’t they just keep it? If you cannot identify more than one pain point, for example, it could be, “I need to sell to buy”, “I’ve been laid off”, “I’m getting a divorce”, then you need to think about the deal because you may not necessarily get the price that really makes sense.
By the way, where should we send your FREE email mini course? It’s 100% commercial real estate investing focused and you can get it here.