After getting rattled during the Great Recession that erupted in 2007 and lingered for several years, the commercial real estate (CRE) sector has not just recovered lost ground, but it has reached to new heights. For example, in 2018, commercial banks in the U.S. held $1.63 trillion in commercial loans, which was 3 percent more than the previous peak in March 2007.
Overall, the size of the U.S. commercial real estate market has surged to around $6 trillion, comprised of retail properties, hotels, office buildings, apartment buildings, industrial complexes, schools, and vacant land for lease.
If you are looking to enter the commercial real estate space, then here are four best practices that could help you minimize your risk and maximize your ROI according to William S. White of Winnetka, IL. William S.
White is a successful entrepreneur with a strong financial background who started his career at Lehman Brothers and private equity firm Northstar Capital Investment, before co-founding the Montessori Academy of Chicago, which is the city’s only school accredited by the American Montessori Society with students from infant to eighth grade.
1. Understand Local Market Dynamics
Before deciding to invest in a commercial real estate property, it is important to thoroughly understand local dynamics, such as significant employment drivers and other labor market aspects, tax rates, land inventory, environmental issues (e.g. remediating land, disposing of hazardous waste, etc.), proximity to public transportation, and so on.
All these details significantly impact the likelihood of whether an investment will be rewarding — or regrettable. William S. White Winnetka explains that his hometown has a strong commercial real estate market that will likely become even more robust if the proposed Skokie Lagoons boathouse project secures necessary funding and moves ahead. This is an example of how an external factor can influence and impact the value and profitability of a commercial real estate investment.
2. Get Your Financing In Order
The good news is that compared to a decade ago, commercial banks are “open for business.” However, the bad news is that getting approved for financing can be challenging and take significantly longer than many new investors anticipate. This is especially the case when investors plan on using operating cash flow to fund future capital needs.
William S. White Winnetka notes that commercial real estate investors need to do their homework to understand the key differences between larger banks and smaller local banks, since they have surprisingly different business models and financing packages.
Investors who can deliver a compelling fact-based proposal, and who can also bring some cash to the table — 20 percent often is the sweet spot for many lenders — are also more likely to complete deals.
3. Understand Key Metrics
Investors who are new to the commercial real estate investing space can feel like they have turned back the clock and are back in a college finance class. This is because mastery of key metrics is essential for success, such as (but not limited to):
- capitalization rate (cap rate) rate to determine the value of income-producing commercial properties;
- net operating income (NOI) to calculate whether gross operating income will be higher than operating expenses;
- cash-on-cash return (CCR) to compare initial year performance of competing properties;
- gross rent multiplier (GRM) to determine how many years it would take for a property to pay for itself in gross rent received;
- internal rate of return (IRR) to calculate a project’s profitability.
William S. White Winnetka explains that commercial real estate investors who want to calculate the gross rent multiplier for a potential office building would take the selling price and divide that number by the annual gross income.
On it’s own, gross rent multiplier doesn’t mean that much. However, it can be effectively used to evaluate and compare similar properties in the same area. Often — though certainly not always — a significantly lower gross rent multiplier may indicate a profitable opportunity.
4. Work With Mentors And Advisors
Last but certainly not least, new commercial estate investors are strongly urged to work with one or more mentors and advisors, who can provide accurate, reliable and objective counsel — both what to do, and just as importantly, what not to do. William S. White Winnetka adds that building strong relationships with specialists and experts helps to make decisions.
They will make their decisions based on facts rather than assumptions. As the old saying goes, there is no substitute for experience. That is true in all things, but in the commercial real estate world with so much at stake, it is more than a wise suggestion. It is an essential requirement.
William S. White Winnetka concludes that there are many best practices for commercial real estate investing, but he emphasizes the importance of talking to a professional. Even if it is just for a second opinion, that meeting could be the difference in saving you thousands of dollars.
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