Finding Gems in Commercial Property Debris
Smart shoppers always keep an eye out for bargains. That holds true whether they’re shopping for clothing or for investments.
Right now, some experts contend that there are real bargains in the real estate market--apartment buildings, small shopping centers and industrial complexes that are selling cheap.
But as every true bargain hunter knows, low prices don’t always signal a good deal. Sometimes prices are low because the product isn’t worth much.
And that certainly holds true for many commercial properties, which have fallen in price because the recession slashed rental rates and occupancy rates and made potential property appreciation look like a pipe dream.
Still, some seasoned real estate experts maintain that a number of jewels were buried in the debris when this market collapsed. Buyers with cash can make a killing, said Sanford R. Goodkin, president and chief executive of Sanford R. Goodkin & Associates in San Diego and publisher of an industry newsletter called Goodkin on Real Estate.
The trick is finding the jewels.
How do you find an apartment, commercial or industrial building that’s worth its weight in gold?
The first step is finding a location. Most experts suggest that investors stick close to home, choosing investments in nearby cities and counties. That gives them an edge when it comes to evaluating projections on the area’s growth, rental rates and future prospects.
Proximity also makes it easy to subscribe to a local newspaper. The paper should serve two functions. It can tip investors off to changes in the investment scenery. But, mostly, investors need it to look at the advertisements.
Advertisements can provide a wealth of information about a community, including tips on how affluent residents are and what kind of employers and employment prospects are in the area. All these things could have an impact on your investment, so the more you know, the better you can invest.
You should also scrutinize the ads for properties similar to those you’re considering. Visit them and make mental notes about neighborhoods and types of buildings you feel most comfortable with.
The second step is getting professional opinions about the prospects for the area and type of property you’re considering. The newspaper is no substitute for a consultant or economist who does this type of work for a living.
Finally, you need to financially evaluate each property you’re interested in. The easiest way is to break the evaluation into two parts. The first looks at the building’s cash flow.
Would the rental income from the building pay the monthly mortgage, utilities, insurance and maintenance expenses, assuming you put in only a 10% or 20% down payment? If the building has been around for a while, the seller or the seller’s agent should be able to provide you with the pertinent information, such as number of tenants, rents, insurance and maintenance costs.
If the insurance policy is to expire soon, call an insurance agent and get a new estimate of what it will cost to insure the same building. In some cases, you’ll find that rates have gone up substantially.
Also determine from the building’s condition whether maintenance costs are likely to remain relatively constant or whether they will rise. If you’re very serious about a particular property, it’s also wise to hire a building inspector to take a more careful look at all the details you may have missed.
If the building’s cash flow will not pay your mortgage, you have to figure that any monthly costs not covered by rents are adding to your original investment.
Now consider how much you could earn on your down payment--and on any monthly negative cash flow--if the money were invested elsewhere. While it is unrealistic to calculate for double-digit returns on alternate investments, you should expect a commercial property to yield a better rate of return than less risky options such as Treasury securities, certificates of deposit and most types of investment-grade bonds.
Generally speaking, a commercial property is going to rise in value if--and only if--rents and occupancy rates rise. It’s wise to calculate what you believe the building would be worth based on highly conservative hikes in rents and occupancy rates and then on slightly less conservative estimates.
Obviously, you also must be familiar with any local laws that would restrict rent increases.
If the cash flow and appreciation on the building you’re considering are likely to generate a healthy return, you may have found one of the market’s jewels. But make sure you take the time to scrutinize your choice closely enough to know that it’s not just a very pretty piece of junk.
