The Journey of Building Wealth, Part 2

The Journey of Building Wealth, Part 2

I would take this part 2 as a Commercial Real Estate Orientation Meeting between me and Molly (find the Wealth Building Part 1 on our website) and it’s pretty cut and dry with analysis for the most part. There are many commercial products, and we would focus on a couple main products in this blog: retail, office, warehouse/flex space, and apartment. We will touch the NNN properties and will focus less on land and specialty categories (gas station, hotel, mobile home park, church…)

Before you get into commercial real estate investing, you need to know how a business works and makes money, and its basic accounting and familiarize with theses acronyms:

• GCI (Gross Operating Income): includes rent, parking/garage/storage rental, vending machine, billboard rental…
• OE (Operating Expenses): all expenses paid on the building by landlord including property tax, utilities, property management, accounting, and legal expenses, etc
• NOI (Net Operating Income): NOI = GCI – OE
• Cap rate: the rate of return that is expected to be generated on a real estate investment.
  Cap rate = NOI/Purchase price
  You would ask what a good cap rate is. It’s subject to the market (4% in California but 7% in Ohio for instance), area (the more challenging the area, the higher cap rate it can be), product type (office during Covid has higher cap rate than warehouse because of its low demand), property class (C class has higher cap rate than A class, however A class would have higher appreciation and demand), property condition (brand new or updated condition would have lower cap rate). A NNN investment has lower cap rate than an investment that the owner needs to be more hands on. In a nutshell, it’s a correlation between risk and return when you evaluate cap rate.
• Cash on cash return: used to calculate cash income earned on the cash invested in a property.
  CoC = (NOI – Mortgage)/Total cash invested
  This is probably the most important real estate ROI calculation because you want to compare how much you make on your own money (cash for down payment, renovation, etc)
• DCR (Debt Coverage Ratio): this is used by commercial lenders to see if the deal is able to pay the mortgage and some
  DCR = NOI/total annual mortgage
  Lenders want to see this at least 1.2 or more. If this is 1, it means the net income equals the mortgage and no cash flow left over. Hence, it’s not a good deal.

What you should pay attention to when you invest in a specific commercial real estate product:

• You choose the product that you’re familiar with. If you’ve been investing in residential homes, then apartment would be your natural next step. If you’ve been leasing retail spaces for your business, then retail could be your next purchase.
• Commercial loan lenders look at different factors for approval, very different with residential loan lenders. While residential loans pay attention to credit score and debt ratio of the borrowers, commercial loans pay attention to the income generated by the building first (unless it is owner occupied). Hence, it’s important to use the return calculation above to analyze the deals before sending them to the lender to take a look on its loan-ability and before submitting a Letter of Intent. Lenders (and sellers) tend to look into the buyer’s Financial Statements and experience to decide if the purchase is a good fit for buyers before they decide to lend/sell the property to buyers. Each lender also has their own comfort zone when it comes to certain product or certain buyer so it’s important to find the lender that fits your needs and understands your situation to be able to guide and help you through the finish line.
• Letter of Intent is similar to an offer in residential real estate. It outlines all the terms and conditions of the transaction, have both buyers and sellers sign on it and a purchase contract will be followed by a real estate attorney.
• Where to find commercial real estate listings? Unlike residential listings which you can find virtually on any real estate company websites, a big portion of commercial real estate listings can be found on Loopnet.com yet many of them are not visible to the public. Commercial real estate agents pay for a subscription to multiple real estate portals to get listing alerts and present the listings back to the buyers. Many commercial real estate transactions are done off market, too. It’s very important to hire a commercial agent to work for you to understand your goals and criteria to actively look for listings that fit your investment needs.
• NNN (Triple Net) Investment: the most hands-off investment, also considered “mail box money”. Tenants are supposed to pay all expenses including real estate tax, building insurance, and maintenance. Other types of commercial net lease include A Single Net Lease (tenants pay property tax), and Double Net Lease (tenants pay property tax and insurance).
• The Property Manager: Unless you are a full time real estate investors and plan to manage all your properties yourself, it’s important to be referred to a great Property Manager to take care of all the month to month operation. We could connect you to a great Property Manager who specializes in the product you own.

You could have more questions after reading this article. Contact us to schedule a meeting to answer any specific questions about your investment goals. We’re here to get you on that wealth building path!