Investment Archives - LeveragedCRE

What is Net Absorption in Commercial Real Estate?

by Prince Licaylicay | Jul 15, 2021 | All Articles

Absorption, or the absorption rate, is a key metric in Commercial Real Estate (CRE). It measures the difference between the amount of space vacated by tenants and the space that gets leased or sold within the same time frame and locality.

Simply put, absorption is the rate at which commercial space is “absorbed” (leased or sold) over a given period in a specific market. This rate can be either positive or negative, depending on market conditions.

Absorption and Vacancy: A Close Relationship

Two important metrics often go hand-in-hand in CRE: absorption and vacancy. Vacancy refers to the percentage or number of units or square feet that are available in a commercial property. A lower vacancy rate usually means higher rental income for the property. Both vacancy and absorption rates play a crucial role for investors when deciding whether to buy, hold, or sell commercial properties.

Gross Absorption vs. Net Absorption

When discussing absorption rates, it’s essential to differentiate between gross absorption and net absorption.

Gross Absorption refers to the total amount of space tenants move into within a specific period, without considering the amount of space vacated.
Net Absorption measures the total amount of space leased, subtracting any space vacated in the same period. This metric is particularly important because it helps investors understand market supply and demand trends.

Focusing on Net Absorption

Since net absorption is the metric most frequently used by commercial real estate investors, it’s vital to understand its implications. Positive absorption means more space is being occupied than vacated, often leading to increased rental rates. Negative absorption, on the other hand, indicates that more space is being vacated than occupied, which can result in lower rent rates as landlords compete to fill vacancies.

Knowing the net absorption rate in a specific area allows investors to forecast cash flow and make informed decisions about their properties.

How to Calculate Net Absorption and Vacancy Rates

Absorption and vacancy rates are often calculated together. For example, let’s assume a commercial property has 24,500 square feet of leasable space, and 2,250 square feet are available across five units.

Vacancy rate is calculated as:

2,250 SF (vacant space) ÷ 24,500 SF (total leasable space) = 9.2% (vacancy rate)

If a new tenant leases 1,200 square feet, the vacancy rate changes:

2,250 SF (vacant space) - 1,200 SF (leased space) ÷ 24,500 SF = 4.3% (new vacancy rate)

This leaves 1,050 square feet vacant, creating an annual net absorption rate of 53.3%:

1,200 SF (leased) ÷ 2,250 SF (available space) = 53.3% (net absorption rate)

Thus, this scenario shows a positive net absorption rate over the year.

Factors That Influence Net Absorption

Several factors can impact net absorption, and understanding these can help investors make informed decisions.

1. Availability

Availability of commercial space in the area plays a significant role. In regions with limited availability, new businesses quickly fill the vacant spaces, resulting in a high net absorption rate. Conversely, in areas with abundant available space, the net absorption rate tends to be lower due to competition among properties.

2. Pricing

Rent rates also influence net absorption. Tenants look for spaces that meet their needs at affordable rates. By pricing your property competitively, you can attract tenants and reduce vacancy rates, leading to a higher net absorption rate.

3. Economic Conditions

The broader economic environment significantly impacts absorption rates. For example, during the COVID-19 pandemic, many businesses either shut down or moved to remote work, resulting in vacated commercial spaces. This shift led to lower absorption rates as companies sought smaller spaces to reduce costs. Economic shifts like these can dramatically affect market absorption trends.

The Bottom Line

Commercial real estate is a competitive market, and understanding metrics like net absorption can be a game-changer for investors. By gathering data, analyzing trends, and factoring in market conditions, you can make more informed decisions that drive the success of your investments.

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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!

What is a Balloon Payment?

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.