Friday, December 8, 2017

The MOST Important Part of a Commercial Real Estate Investment

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Many of you reading at home own a business.

Your business address - if it's not your spare bedroom or a corner of your garage is found at a manufacturing building, a suite of offices, or a retail storefront.

You either lease or own your location.

If you lease the commercial real estate you occupy, you have a landlord.

Said landlord - the commercial real estate investor - is the subject of today's post.

Landlords come in all shapes and sizes. Some own very few buildings and have invested their own savings in a commercial real estate investment. While others are funded by Wall Street or a pension fund and are extremely bureaucratic.

Regardless of a landlord's holdings, their source of funding, or sophistication - the one thing they share is their reliance upon a property's net income. The income stream - rent less operating expenses, or net income - provides their return on investment.

I believe the income stream is the MOST important part of a commercial real estate investment - otherwise, you don't have an investment - you own an empty building.

A commercial real estate investor - AKA a landlord - considers many aspects of his investment.

The stability of the income stream. Is rent paid by several tenants or one? If an investor owns a 10,000 square foot building with ten tenants and one tenant moves out - nine other rent paying tenants remain. Manageable. Conversely, if the 10,000 square foot space has one occupant - the income is dependent upon the health of that tenant. If business ebbs, a costly vacancy may occur. Also, when does the lease(s) expire? A short term lease - less than three years - creates a potential transition much quicker than a ten year lease.

Is the income stream above or below the current market. Rents have sky rocketed within the last few months. If a lease was signed two years ago, chances are the rent may be below the market rents today. This is good news if the buildings goes dark and you must replace the tenancy - you'll get more rent. However, if we experience a dip, you may find yourself owning a building with an unsustainable rent - quite costly if your tenant vacates.

What sort of return does the income stream provide. Generally, the net income - rent less expenses - provides a nice return on the money invested - typically 4-6%. A simple example. Net income is $10,000 per month - $120,000 per year. If this $120,000 per year provides a 5% return - the building is worth $2,400,000. Your return may be drastically different. Let's say you bought the building ten years ago and paid $1,500,000. The same $120,000 in annual net rents yield you an 8% return.

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