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COMMERCIAL REAL ESTATE INVESTMENT — LOOK AT THE FUTURE

5/16/2013 5:26:50 AM

If we take long term view, developments of internet and high tech will cause the employment  rate and commercial real estate difficult to recover to their previous glory. High tech will reduce the employment opportunities, while online sales will grab shares from retail stores.

 E-books and high-definition videos lead to closings of bookstores and movie rental stores. Many service providers are working at home, or outsourced to foreign countries, thereby reducing the number of stores and the need for commercial real estate. The only bright spot is medical care and that is due to aging of the population.

In trying to make money in the commercial real estate, in addition to paying attention to the trends mentioned above, examination of the list below is also important. In the commercial real estate contract, there is a stipulation that will allow a period of inspection. The buyer, before closing the deal, has the ability to choose either to cancel, to renegotiate the price or to complete the deal. Here is the list:

1. On the ground inspection: Obtain the original architectural blueprint; study the location; the environment; check the building inside and outside (including additional structures, if any); and make estimates on repair costs.

2. Legal issues: Check whether there are defects relating to property rights,  building code violations, zoning issues and environmental regulations; what are licenses required for operation;  what maintenance contracts have been  signed by the previous owner; insurance issues; and incidences recorded by police.

3. Number crunching: Lease verification; financial statements; forecast of future incomes and expenditures; tax records; cash flow and calculation of CAP ratio.

One has to bear in mind that not all information provided by sellers can be trusted, in particular the Performa statements of estimated revenues and outlays. This writer is accountant/broker, and is available to provide consultation on the analysis and verification on numbers. The basic idea is Estimated rental income-Vacancy-Moving Costs=Net income (NOI). NOI-Mortgage -Tax=Income After Tax. Based on the above calculation, CAP rate is determined. The common method is NOI/Purchase Price(CAP Rate). It has to be higher than cost (loan interest) to have a profit. For example, if the first year's NOI is $120,000, and the purchase price is $150,000, then the CAP rate is 8%. In current market condition, 8% is a starting number, on which adjustment should be made depending on the condition of the building. There are more accurate methods to calculate CAP rate, and one  is presented below:

First year cash to cash: first year income before tax/down payment: Internal rate of return. Take accumulated income after tax and compare to down payment; use compound interests to calculate annual return.

Net present value: take opportunity cost and inflation rate (CPI) into account, convert the future after tax income into current value and compare with initial down payment. If it is higher than down payment, then it is worth investment.