Commercial Real Estate Strategies The Quot Columbo Quot Questions

Commercial Real Estate Strategies The Quot Columbo Quot Questions



For the​ astute commercial real estate investor, the​ cap rate [AKA Capitalization Rate] is​ an​ important financial number to​ consider. Here’s why:

Commercial Real Estate Earns Income

One main identifier that defines commercial real estate from other types of​ real estate is​ that it​ earns income for​ its owner. Commercial real estate values are typically based on these current (and/or future) income streams from the​ property under evaluation.

While there are many types of​ commercial real estate, such as​ strip malls, office buildings, condo projects, industrial sites, and​ several other property types, each is​ supposed to​ produce net income.

Each of​ these commercial real estate properties will normally have an​ income stream and​ associated expenses. it​ doesn’t matter if​ it​ is​ a​ mall, hotel or​ a​ trailer park. All commercial real estate properties typically have both income coming in​ and​ expenses going out.

The Raw Land Exception

The one exception to​ this typical ‘rule of​ thumb’ is​ raw land. Raw land will many times not have any income stream, so it​ has to​ be evaluated differently for​ commercial purposes

Evaluating the​ Cap Rate

When a​ commercial real estate property is​ evaluated, the​ buyer does his or​ her best to​ ascertain the​ accurate and​ sustainable income stream the​ property is​ currently producing. the​ cap rate is​ based upon current financial numbers, not future. and​ if​ it​ is​ not being used to​ its highest and​ best use at​ the​ moment, an​ adjustment will also be made as​ to​ its income stream once any problems are corrected.

Income Streams
Income streams can come from a​ variety of​ places, so I won’t make any attempt to​ list all the​ various forms here. There are some common ones and​ some unique to​ a​ given property. Just remember that the​ income stream is​ made up of​ all money received through the​ property.

Expenses Paid Out

The other side of​ the​ cap rate equation is​ the​ expenses that must be paid on the​ prospective property. There can be literally scores of​ different expenses, which can be found in​ any reasonable accounting course, so we won’t go into them here.

The Cap Rate Configuration

Now that we understand that the​ cap rate is​ determined by comparing income and​ expenses, the​ final part we need to​ factor in​ is​ the​ selling price of​ the​ commercial real estate. We’ll use an​ example below:

Income $100,000.00

- Expenses $50,000.00

= Remaining $50,000.00

Selling Price $500,000.00

Cap Rate = Remaining / Selling Price = $50,000 / $500,000 = 10%

Conclusion

Now you understand all the​ pieces of​ the​ cap rate formula and​ how to​ determine it. Again, the​ cap rate is​ very important in​ commercial real estate transactions because it​ puts a​ number or​ “grade” on the​ value of​ the​ deal in​ simple and​ consistent terms for​ the​ investor.

The larger the​ cap rate, the​ better the​ deal is​ for​ the​ investor, so you can draw the​ conclusion that investors prefer high cap rates, and​ the​ higher the​ cap rate is, the​ more the​ investor likes the​ deal.

In fact, some investors set minimum cap rates before they’re interested in​ a​ commercial real estate deal. So you understand why ‘Cap Rate is​ King’ in​ commercial real state transactions.




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