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Investing in Commercial Property

One key factor for successful real estate venture is cap rate. Unfortunately, it is often misunderstood by many investors.

Good morning! Today Peter is exploring Investing In Commercial Properties, let me know if you would like to guest post on Make Money Your Way.

The real estate investors have every reason to cheer! The market is looking up. Population growth has made it more profitable to invest in real estate business. The experienced investors are well aware of the market condition and vital aspects of property business. The novices, however, need to educate themselves regarding different aspects before risking their money in real estate business.

One key factor for successful real estate venture is cap rate. Unfortunately, it is often misunderstood by many investors. Before venturing out, cap rate is likely to be your first consideration.  However, you can make a good use of it only if you have good understanding of what is meant by cap rate and how it can do value addition.

Cap rate is a trimmed form of capitalization rate and calculated as a ratio of the first year’s net operating earnings and purchase price of the property. The ratio integrates three variables – interest rate percentage, net operating income and value and expressed as a percentage. Investment measure is an indication of what percentage of cash purchase an investor is likely to gain in the first year.

The capitalization rate percentage and your net operating return in the first year are directly correlated with each other. An amazing correlation can be found in another aspect. If interest rate drops, the rate is less likely to follow the decline. However, if interest rate slides up, the rate will soon to follow the footprint.

What is the significance of cap rate?

This question is more related to the application of cap rate. The investors use this rate to quickly calculate the return from an investment. This helps them decide whether a real estate property is worth a consideration. You can also apply cap rate to typify the marketed assets. For example, if you know the sale price and cap rate, it will take only a few minutes to determine your estimated net operating income.

Is there any shortcoming of cap rate approach?

There is no doubt that cap rate is important but only if it is accurate. You should know the pitfalls of cap rate approach. Many unscrupulous property market dealers overrate it to exaggerate the investment potentials. In some cases, wrong net operating income assessment is the reason for faulty cap rate calculation. The wrong calculation and inflated figure make it more unlikely for you to discern the actual investment potential.

To be a successful investor in real estate property business, you need to understand that cap rate, in spite of its high significance, does not reveal other details that are equally or more important to measure investment potentials. It does not consider your debt, taxes and other transaction expenses.

To be on safe side, you need to understand a target cap rate which is specific to your situation that involves your debts, taxes and cash return estimation. An accurate result can guide you in making safe investment that is immune to market trends. The advantage of owning a calculation procedure is your estimation regarding property valuation and net return calculation will be more closure to accuracy.

 

Peter Christopher

Peter Christopher

 

 

Peter Christopher is the owner of Finance Care Guide, a personal finance blog about money management tips.

 

 

Our other real estate posts:

Why real estate is the best way to build wealth

Things to consider when buying your first rental

Renting part of your house or basement long term

Things to be aware when investing in American real estate

How to analyze a property as an investment

Have you invested in commercial property? Would you like to?

This post was featured on the Common Cents Wealth, thank you!

 

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Lovely comments

  1. Financial Independence says

    Commercial property has the advantage of less landlord responsibility – I’m not sure about the US, but in Australia commercial property is rented as an empty shell. It’s up to the tenant to fit out the space, even air-conditioning and lighting are the tenant’s responsibility. Anything goes wrong, the landlord isn’t responsible. By comparison, residential property is rented out with lighting, dishwashers, hot water services all the responsibility of the landlord.

    Additionally, its not uncommon to see a 5 or 10 year tenancy agreement on commercial property compared to an annual agreement for residential property. Securing a tenant for a decade at a time provides pretty solid security!

    Unfortunately commercial property is too expensive for me – the barriers for entry are too high at the moment.
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  2. Liquid says

    I’m interested to invest in commercial property as well. Too bad property taxes are generally higher for commercial real estate than a residential building of the same value. Looking at the cap rate is a great way to start the research process. Depending on the type of building I also like to look for locations with high foot traffic and accessibility. I don’t have enough money right now to make an investment in this space but maybe in the future 🙂
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  4. DC @ Young Adult Money says

    I can’t envision myself getting into the commercial property business, just because I know some people who got burned in the real estate collapse a few years back. At the same time, real estate both residential and commercial has had its ups and downs. If I had the money I would probably just invest in residential rental real estate.
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  6. GetRichWithMe says

    Interesting post – and its good that people can consider other investments apart from residential rentals, index funds etc.
    But is commercial property suitable for the average investor ? probably not.Potentially long empty periods, and difficulty selling property on would not be good for people without a large portfolio.
    Also a high % of your assets tied up in one property isnt good
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  7. Kim@Eyesonthedollar says

    I own half of the commercial building where my optometry practice is. It was a no brainer investment because I had to pay rent anyway, might as well pay myself. If you have a long term business as a tenant. I think commercial real estate is a great deal. Like Financial Independence said, you are only responsible for major things like the roof or furnace, not every little detail with a residential rental.

    I would also add that as a commercial landlord, you need to treat a good tenant like gold. My satellite office was always in a rental space because property values were so high in that area. We were in the same spot for 12 years and were model tenants. When I sold that business, the buyer wanted to stay, but the landlord was horrible to her so she bailed. He lost the best tenant he ever had because she has grown the business even more since then. I think since there were other vacant spaces in the building, he tried to stick some crazy expenses on her, which ended up giving him another vacant space.
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  12. Al -- Reliance says

    Understanding property management may be challenging but it is important to know these things to find success in the business. There are a lot of potential in this kind of investment.

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