Commercial Real Estate Section 2

1. Commercial Real Estate
Section Two
Comparing and Valuing

2. 1. Comparing Properties
a. Finding Data
i. MLS – Good source for Residential Income only
ii. LoopNet – Comps not very good
iii. CoStar – Comps fair, but very expensive

3. 1. Comparing Properties
b. Use active listings for rough estimates of a market
(sold comps are hard to find and expensive).
c. Generally closer is better
• Exceptions – gas stations, Walgreens, etc.
d. Remaining Lease Term

4. 1. Comparing Properties
e. When in an unfamiliar area consider:
 Look at Google Maps (street level)
 Metropolitan Service Area (MSA)
 Population, distance to major city, service area
 Household Income
 Local Economy – employment, diverse economic base is best
 Competing properties – age/rents

5. 1. Comparing Properties
How easy is it to build
in this area?
 Available land
 Community attitude
toward development
 Vacancy in other
similar projects
 Population growth

6. 1. Comparing Properties
f. How to Compute Vacancy Factors
 Multifamily by units
 Office space by square footage
 Commercial by units/bays OR by square footage
 Average vacancy (by money or time)

7. 1. Comparing Properties
g. Absorption/Turnover Rates
 How fast vacant space is re-rented?
 Turnover is a plus for some residential income
• Rent control areas – turnover means higher rents
(about 15% in West Hollywood/Santa Monica)
 Turnover is a negative for most commercial

8. 1. Comparing Properties
h. If a Developer is “guaranteeing” rents, be
suspicious!

9. 2. What Motivates the Investor
a. Appreciation - asset growth without additional
capital
b. Tax Benefits
c. Leverage
d. Cash Returns

10. 3. Types of Investors
a. Speculator – flip and sell
b. Value added – fix and sell
c. Income – cash return
d. Involvement – likes to mess with it
e. Developer – usually land, but sometimes underutilized
shopping centers
f. Pride of Ownership - May be the most powerful force in the
buyer, but they will never admit (nor probably understand) it.

11. 4. Terms Used to Value and Compare
Investment Properties
a. Income and Expenses
 Gross Scheduled Income – if everything was 100%
rented
• Ask if income is based upon current rents or
potential rents – big difference if rent controlled

12. 4. Terms Used to Value and Compare
Investment Properties
 Effective Gross Income – Scheduled income less
vacancy
 Gross Income – can mean either Scheduled Gross
Income or Effective Gross Income – be sure you
understand which!
 Net Operating Income (NOI)
• NOI = Actual Income (not projected) less actual expenses
less potential (differed) expenses

13. 4. Terms Used to Value and Compare
Investment Properties
Operating Expenses
 Fixed – taxes and insurance
 Variable – utilities and maintenance
 Reserves – replacement – carpet, roof, building
paint, pool equipment, etc. Reserves are often
overlooked when valuing apartment buildings.

14. 4. Terms Used to Value and Compare
Investment Properties
Do the Expenses Consider:
 On/Off site management
(especially off site)
 Does owner do
maintenance?
 How much deferred
maintenance?

15. 4. Terms Used to Value and Compare
Investment Properties
 Calculation of expenses does NOT include interest and
principal payments
 Do NOT include tenant deposits in the income (they
ARE a liability the buyer may assume)

16. 4. Terms Used to Value and Compare
Investment Properties
NNN
• Income is “Net” of taxes
• Income is “Net” of insurance
• Income is “Net” of
maintenance
• In short, the tenant pays
everything
NN
• One (or more) of the other
“nets” is being paid by the
landlord .

17. 4. Terms Used to Value and Compare
Investment Properties
c. Cash Flow means the amount of money a
property generates.
• Cash Flow can be computed many ways:
 Annual Cash Flow – Income less expenses (same
as NOI)
 Cash Flow yield on invested capital – Cash
after expenses and interest (return before principal).

18. 4. Terms Used to Value and Compare
Investment Properties
 Net Cash Flow (cash on cash) – after principal and
interest
 Cash Flow before tax – Cash Flow after tax
 Cash Flow before depreciation – after
depreciation

19. 4. Terms Used to Value and Compare
Investment Properties
Actual vs. Pro-forma
 Pro-forma is usually nonsense
• If there is rent control, rents usually cannot be
raised
• If NOT rent controlled, why didn’t the owner
already raise the rents?

20. 4. Terms Used to Value and Compare
Investment Properties
 Property Sale Cash Flow (at sale of property)
 Net, Net Proceeds after Sale – Usually after income
taxes

21. 5. Common Factors to Compare
Investments
a. GRM (Gross Rent Multiplier) – Simple index
often used to compare apartment buildings (best for
apartment buildings 5+ units). NOT used with
commercial properties.
GRM= Price/Gross Scheduled Income (as if all units
are rented).
b. Price per Unit/Price per Door

22. 5. Common Factors to Compare
Investments
CAP = Net Operating Income/Price (a snapshot of
one year’s return)
i. Hard to figure for Residential Income
ii. Easier to figure for commercial (especially if tenant
reimburses expenses)
iii. Very easy to compute when NNN or even NN
CAP = Income/Price
PRICE = Income*CAP(*100)

23. 6. What the Investor Actually makes on
the Investment
a. Depreciation
• Does NOT include land value.
• Price + cost – land = tax basis.
• Tax Basis declines as property is depreciated over time
• Usually 39 years for most commercial (building only)
• Component Depreciation – depreciates each component of the
building separately (for instance, HVAC at 10 years, Fire Alarm at 5
years, etc). Some accountants don’t like this method.

24. 6. What the Investor Actually makes on
the Investment
b. Time Value of Money
 Present Value of Money – $100 today is not the same as $100
five years from now
 Discounted Cash Flows – different than CAP because it
considers annual net cash flows and appreciation
 Discount Rate – assumed interest rate on Discounted Cash
Flows
 Internal Rate of Return – Complex formula for expressing
the ultimate return on and off the investment over time (too
complex for this class – just know it exists).