There are three ways to build wealth in commercial real estate: Cash Flows, Debt Principal Reduction, and Appreciation. Cash Flows
- Net Operating Income
- Operating Revenues – Operating Expenses = NOI
- Maximizing NOI is most important aspect of asset management
- Market assumptions have big impact on NOI projections
- Impact of debt on cash flows
- Key cash flow return criteria:
- Capitalization rate
- Cash-on-cash return
- Varies depending on capital structure
- Even most institutional buyers use leverage
- Enhance returns by “positive leverage”
- Compare loan constant vs. cap rate
- Diversify holdings by increasing purchase capacity
- Each month principal balance is reduced
- Lowers risk
- “Make money in your sleep”
- Importance of loan terms
- Amortization, maturity, perm/short-term, recourse/non-recourse, prepayment ability, stated vs. effective rate
- Driven by demand
- Driven by increases in replacement costs
- Important as commodity prices increase rapidly
- Appreciation higher in U.S. in costal cities
- Depreciation risks
- Functional obsolescence
- Changing market fundamentals
- Unexpected occurrences
- Construction, traffic patterns, natural disasters
- Sales comparables approach
- Good for quick benchmark
- Hard to get “apples to apples” in commercial RE
- Cost approach
- Know “top of market” pricing not to exceed
- Good philosophy = buy below replacement cost
- Income capitalization approach
- NPV, IRR, Capital Accumulation
- Instinct
Click here to see the entire Valuation of Commercial Real Estate.
Contributor:
Aaron Mesmer
Acquisition & Sales
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