by Prince Licaylicay | Jun 30, 2021 | All Articles, Buying, Investing
When you plan to purchase commercial real estate as an investment, you always analyze cap rate whether the property is a good deal. You weigh all the factors to determine if it’s truly worth investing in. As a diligent investor, you consider potential returns using different metrics before making a decision. After all, no one wants to risk money on a property that won’t yield strong returns.
One important metric in evaluating a commercial real estate investment is the Capitalization Rate. In this article, we will explain what a cap rate is, why it’s important in commercial real estate investing, how to calculate it, and how to assess whether it’s good or bad.
What is a Cap Rate?
In commercial real estate (CRE), the Capitalization Rate, or “cap rate,” is a metric used to assess the potential return on an investment. It measures the rate of return based on the property’s Net Operating Income (NOI) and is expressed as a percentage, usually between 3% and 20%.
Simply put, a rate represents the yield of a property over a one-year period, assuming the property was purchased without a loan. It gives investors a factual snapshot of the property’s expected return.
How to Calculate Cap Rate
Fortunately, calculating a cap rate is straightforward. You only need two elements:
- Net Operating Income (NOI) of the property
- Purchase Price of the property
Using these, you can apply the following formula:
Capitalization Rate = (NOI / Purchase Price) x 100
For example, you divide the property’s net operating income by its purchase price. Then, multiply by 100 to get the cap rate as a percentage.
Breaking this down, NOI represents the income minus expenses, while the purchase price is the assessed sales price. If the purchase price isn’t available, you can use the current market value or appraised value instead. Typically, rates have an inverse relationship with property value—the higher the cap rate, the lower the property value, and vice versa.
Why is Cap Rate Important?
The cap rate helps investors decide whether to pursue a commercial property. It’s also a useful baseline for comparing investment properties in a particular market.
For instance, if you compare properties in your market, one might have a cap rate of 6.75%, another 7.35%, and a third 7.50%. If the property you’re interested in has a cap rate of 7.10%, this indicates it’s fairly comparable to others in terms of expected returns and sales prices.
However, if you notice properties with lower rates, say 4-5%, this could signal a red flag. Why would the property you’re eyeing sell for such a low price compared to its potential income? Is there something wrong with the property?
Cap rate can also signal potential risk. Properties with higher cap rates tend to be in developing areas and come with higher risks. Conversely, properties with lower rates are often in stable, high-demand areas, which explains their higher purchase prices.
What is a “Good” Cap Rate?
A common question asked by those new to real estate is, “What is a good cap rate?” The answer depends on how the cap rate is used. If you’re selling a property, a lower cap rate is beneficial because it means a higher property value. On the other hand, as a buyer, you’ll likely seek properties with higher cap rates, which indicate lower initial investment costs.
That said, cap rates shouldn’t be the only factor in making a purchase decision. A good investor considers all the factors that make up a property, not just the rate.
It’s also important to remember that different cap rates represent different levels of risk. Low cap rates usually indicate lower risk, while high cap rates come with higher risk. Therefore, the “ideal” rate depends on your personal risk tolerance as an investor.
Need assistance with your 1031 Exchange or DST? We’ve got you covered!
We’ve prepared a comprehensive, free e-book designed to guide you in achieving your long-term business goals or acquiring that dream property you’ve been eyeing.
Meet The LeveragedCRE Investment Team
Phill Tomlinson and Eric Butler are seasoned commercial real estate brokers with over 44 years of combined experience. They lead the LeveragedCRE Investment Team at Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, specializing in investment sales and tenant/landlord representation across the Phoenix and Scottsdale submarkets.
The team leverages their extensive knowledge and expertise to help investors and property owners maximize their returns and navigate complex real estate transactions with confidence.
Stay informed with the latest in Commercial Real Estate strategies designed to enhance your income property investment results by bookmarking www.leveragedcre.com. Let us help you stay ahead in the market!
by Prince Licaylicay | Jun 16, 2021 | All Articles, Investing
We all dream of making investments that generate income, produce steady cash flow, and appreciate over time, right? When executed well and with due diligence, real estate investments can offer significant returns in the long run.
While both residential and commercial properties can present great investment opportunities, this article will focus on commercial real estate investment. We’ll explore strategies you can use to build a diversified portfolio in the commercial real estate market.
Why Choose Commercial Real Estate Over Residential?
If you’re wondering why commercial real estate might be a better option than residential, let’s explore some key advantages.
1. High Income Potential
Investing in commercial real estate often yields higher income potential than residential properties. Annual returns on commercial properties typically range between 6% and 12%, compared to residential returns, which are usually between 1% and 4%. That’s potentially three times the return!
In a triple net lease, you, as the property owner, only need to cover the mortgage. The lessee handles all other property expenses, including real estate taxes. This setup allows you to enjoy low-maintenance income while maximizing your returns.
3. Stability and Safety
Every investment carries some risk, but commercial real estate offers more stability compared to other investment options like stocks and bonds, which fluctuate in the market. Commercial properties are tangible assets, providing a level of security and safety that many investors seek.
Tips for Becoming a Successful Commercial Real Estate Investor
While it’s tempting to jump into commercial real estate right away, remember that successful investments take time. No investor builds a diversified portfolio overnight. By learning the basics and practicing consistently, you can become an expert in this field.
Here are some essential tips to help you on your way:
1. Educate Yourself
Gain knowledge through multiple sources:
- Read commercial real estate books and articles.
- Stay updated on industry trends online.
- Watch educational videos on platforms like YouTube.
- Network with other investors to share insights.
- Join real estate investment groups.
2. Choose Your Property Type Before Strategy
It’s helpful to decide which type of commercial property you want to invest in before settling on an investment strategy. Commercial properties are classified into five major categories:
- Multi-family (apartment buildings)
- Office Space
- Retail (malls, strip plazas, grocery stores)
- Industrial (warehouses, pharmaceutical facilities)
- Hospitality (hotels, medical centers)
3. Assess Your Risk vs. Reward Tolerance
Determine how much risk you are willing to take in exchange for potential rewards. As they say, “The bigger the risk, the bigger the reward.”
4 Key Strategies in Commercial Real Estate Investing
Investors use various strategies to purchase commercial properties, depending on their risk tolerance and financial goals. Here are four major strategies:
1. Core Assets
Core assets are the most conservative and stable investments. These class-A, institutional-quality properties are well-located and occupied by high-credit tenants. Because core assets are low-risk, their returns are also lower, typically ranging from 6% to 8%.
2. Core-Plus
Core-plus investments carry slightly more risk than core assets. These properties are fundamentally strong but may require some improvements, such as lease expirations or minor renovations. As a result, core-plus investments generate slightly higher returns, usually between 9% and 12%.
3. Value-Added Assets
Value-added investments involve properties that need larger renovations or operational improvements. For example, an apartment building built in the 1990s might require major interior updates. While this strategy carries more risk, the potential returns are higher, typically between 13% and 16%.
4. Opportunistic Investments
Opportunistic investments are the riskiest strategy in commercial real estate. These properties often require significant renovations and may have high vacancy rates. Opportunistic investments include ground-up developments or land purchases. Although they come with a higher level of risk, they offer the potential for the highest returns, with the possibility of generating 15% or more.
Key Takeaways
Investing in commercial real estate can generate income through rental revenue or appreciation over time. Commercial properties are classified into five categories: multi-family, office space, retail, industrial, and hospitality.
Different strategies offer varying levels of risk and return. To build a diversified portfolio and succeed in the real estate industry, it’s essential to gain knowledge, select the right property type, and understand your risk tolerance.
Need assistance with your 1031 Exchange or DST? We’ve got you covered!
We’ve prepared a comprehensive, free e-book designed to guide you in achieving your long-term business goals or acquiring that dream property you’ve been eyeing.
Meet The LeveragedCRE Investment Team
Phill Tomlinson and Eric Butler are seasoned commercial real estate brokers with over 44 years of combined experience. They lead the LeveragedCRE Investment Team at Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, specializing in investment sales and tenant/landlord representation across the Phoenix and Scottsdale submarkets.
The team leverages their extensive knowledge and expertise to help investors and property owners maximize their returns and navigate complex real estate transactions with confidence.
Stay informed with the latest in Commercial Real Estate strategies designed to enhance your income property investment results by bookmarking www.leveragedcre.com. Let us help you stay ahead in the market!
by Prince Licaylicay | Jun 8, 2021 | All Articles, Investing
A Balloon Payment is a large, one-time payment made at the end of a loan term. In a Balloon Payment Mortgage, also known as a Balloon Loan, borrowers make smaller monthly payments compared to a traditional loan. These payments typically cover only the interest.
Balloon loans usually have shorter terms, ranging from five to seven years. They offer borrowers lower monthly payments in the early stages of the loan. However, these payments do not fully pay off the loan. As a result, a large payment is due at the end of the term, which is where the term “balloon” comes from, referring to the inflated size of the final payment.
Risks of Balloon Payments
Despite the lower initial payments, balloon loans carry higher risks than traditional loans. The large final payment can be difficult to manage. As a result, these loans are typically available to creditworthy borrowers or businesses with stable income streams. Some sellers offer seller carry loans with balloon payments to attract buyers who may not qualify for traditional loans, giving them more opportunities to close a deal.
Pros and Cons of Balloon Payments
Balloon loans can be beneficial in certain financial situations, but they also have downsides. Here are the key pros and cons:
Pros of Balloon Payments
- Low Monthly Payments
Balloon loans are ideal for start-up companies looking to minimize monthly payments during the early phases. They are also helpful for businesses or consumers who need to invest without making large initial payments. - Short-Term Mortgage
Investors looking to minimize short-term loan costs and free up capital might find balloon loans appealing. - Filling Financing Gaps
Borrowers facing immediate financial needs but expecting future income can benefit from balloon loans. These loans reduce financial pressure in the early stages of development.
Cons of Balloon Payments
- Higher Long-Term Costs
Balloon loans can cost more overall since the lower monthly payments often only cover interest. As a result, the total loan cost may be higher than traditional loans. - Risk of Losing Property
If a borrower cannot make the large balloon payment at the end of the loan term, the lender may take back the property. This risk is significant for buyers who are unable to generate the required funds. - Difficulty Refinancing
Refinancing a balloon loan can be challenging because these loans typically have interest-only payments. Since the principal balance or equity isn’t being paid down, refinancing options can be limited.
Balloon loans offer lower monthly payments but come with high risks due to the large final payment. It’s important to weigh both the advantages and disadvantages before choosing this option, especially if refinancing or long-term affordability may be a concern.
Need assistance with your 1031 Exchange or DST? We’ve got you covered!
We’ve prepared a comprehensive, free e-book designed to guide you in achieving your long-term business goals or acquiring that dream property you’ve been eyeing.
Meet The LeveragedCRE Investment Team
Phill Tomlinson and Eric Butler are seasoned commercial real estate brokers with over 44 years of combined experience. They lead the LeveragedCRE Investment Team at Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, specializing in investment sales and tenant/landlord representation across the Phoenix and Scottsdale submarkets.
The team leverages their extensive knowledge and expertise to help investors and property owners maximize their returns and navigate complex real estate transactions with confidence.
Stay informed with the latest in Commercial Real Estate strategies designed to enhance your income property investment results by bookmarking www.leveragedcre.com. Let us help you stay ahead in the market!
by Prince Licaylicay | Jun 1, 2021 | All Articles, Investing
In today’s economy, there are numerous investment options available for those looking to grow their wealth. One great option is investing in Commercial Real Estate (CRE). Many people believe that only wealthy or experienced investors can engage in CRE, but that’s not true. Knowing when, what, and how to invest in CRE can be the key to owning your first commercial property, regardless of your financial status.
So, to answer the underlying question: Can anyone invest in Commercial Real Estate? Yes, anyone can invest in CRE.
Benefits of CRE Investment
There are several advantages to investing in Commercial Real Estate, making it an attractive option for many.
Steady Cash Flow with High Earning Potential
The most compelling reason to invest in CRE is its income potential. Compared to stocks, bonds, equities, or even residential properties, CRE investments typically offer higher annual returns, ranging from 6% to 12%. Additionally, longer lease terms secure your profit for years, making CRE a stable and passive income-generating investment.
Stability and Less Risk
Market fluctuations can have a significant impact on other investments, but CRE provides more stability since it is a tangible asset. Owning commercial real estate gives you more control over your investment, making it a safer option compared to stocks or bonds.
Asset Appreciation Over Time
It is widely recognized that CRE properties appreciate in value over time. This appreciation results from both internal factors—such as property improvements, renovations, and age—and external factors like supply and demand in the market.
Tax Benefits
Owning CRE offers various tax advantages. These include deductions on mortgage interest, property taxes, and operating expenses. Moreover, if you decide to sell your commercial property, you may be able to avoid capital gains tax through a 1031 Exchange.
Drawbacks to CRE Investment
While there are clear benefits, it’s important to understand the potential drawbacks of CRE investing as well.
High Costs and Illiquidity
Acquiring commercial property usually requires substantial capital upfront. Additionally, because CRE is illiquid, it may take time to sell or access your money, making it difficult to exit the investment quickly.
Time-Intensive Management
Managing a commercial property can be stressful, particularly if you have multiple tenants or leases to maintain. The property’s upkeep and maintenance are time-consuming, so CRE investing often requires a significant time commitment.
Vacancy Risks
Vacancy can lead to a loss of income. Properties with only a few tenants are particularly vulnerable, as losing even one tenant can significantly impact the overall profitability of the property.
Key Questions to Consider Before Investing in CRE
If you’re still considering whether to invest in Commercial Real Estate, it’s important to reflect on a few critical questions before diving in:
- Why do you want to invest in CRE? What are your reasons or motivations?
- What type of CRE property are you looking for? Are you considering office spaces, retail properties, or industrial buildings?
- Why is the location of the property important? Have you analyzed the area’s potential growth?
- Do you have knowledge and skills in CRE? Are you willing to learn more about the industry?
- Do you have the time and commitment required for CRE? Managing commercial properties can be demanding.
- Are you prepared to take risks in CRE investing? Are you comfortable with the potential risks?
- How much work and capital are you willing to put into a CRE property?
- How will you finance the property? Do you have good credit standing?
- Are you mentally and financially ready for a sizeable investment like CRE?
Final Thoughts
Investing in Commercial Real Estate is a significant commitment, but it offers many benefits, including high income potential, stability, and tax advantages. However, it’s essential to weigh the potential risks, such as vacancy and management challenges, before making a decision. By answering the key questions and doing your due diligence, you’ll be better prepared to make a smart and informed investment in CRE.
Need assistance with your 1031 Exchange or DST? We’ve got you covered!
We’ve prepared a comprehensive, free e-book designed to guide you in achieving your long-term business goals or acquiring that dream property you’ve been eyeing.
Meet The LeveragedCRE Investment Team
Phill Tomlinson and Eric Butler are seasoned commercial real estate brokers with over 44 years of combined experience. They lead the LeveragedCRE Investment Team at Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, specializing in investment sales and tenant/landlord representation across the Phoenix and Scottsdale submarkets.
The team leverages their extensive knowledge and expertise to help investors and property owners maximize their returns and navigate complex real estate transactions with confidence.
Stay informed with the latest in Commercial Real Estate strategies designed to enhance your income property investment results by bookmarking www.leveragedcre.com. Let us help you stay ahead in the market!
