Commercial units! How do I tell a good deal or not?

Question

How do I know what's a good commercial deal?

Andrew Moore · Answer

This is a very loaded question. What kind of metrics are most important to you and/or your investor? What's the asset class? What are your goals with the property?Some things to consider:Cashflow - Obviously with any property, you want to ensure that the cashflow is there to cover your debt service, operations, and reserves. Cash on Cash return - Depending on your strategy, your target COC return is going to vary. If you are looking for a class a stable investment, your COC might be lower. If you are looking at a value add opportunity, you might be looking for a much different number.Exit Strategy - Are you looking to hold the property for 5, 7, 10 years? The performance of that asset over time will depend on your strategy, but at the end of the day you want to sell the property for more than you bought it for. How much you are looking to make on the sale will determine if what you are able to acquire the property for is a good deal. All this to say, that in order to determine if a commercial deal is good you need to have some clarity on what metrics you are focused on, and what your investment strategy is.Hope this provided some clarity regardless of being extremely vague!

Brad Hayden · Answer

@DaJuan J Harris @Andrew Moore is right. It's a loaded question and hard to answer without more detail, but here are a few questions that might help when evaluating most properties. • What is it worth today (as-is) based on current operations, financials, and market conditions?• What is your investment plan; how will you increase the value? Is it as simple as increasing rental rates, reducing expenses, or addressing economic vacancy factors; or will it require repositioning with different tenants; or perhaps adaptive reuse to a different purpose; or …? How much will it cost, how long will it take, and what impact will it have on current tenants, operations, and cash-flow? • Does it need minor repairs, major renovations, or other capital improvements? How much will it cost, how long will it take, and what impact will it have on current tenants, operations, and revenue? • How will you structure debt and equity of the deal? Will you use a traditional bank loan or private non-bank financing? Will you bring in partners and/or 3rd party investors? How will they get paid? How will you get paid? • Will the local market support your plan? “Build it and they will come” was a great catchphrase for a movie, but local market realities may not be so forgiving. Occupancy trends, population trends, employment trends, competition, traffic patterns, economic development programs and priorities, zoning, and permit filings are some of the factors that may impact your plan and the future value of the property. • What is projected future value? Based on your plan and your best estimate of future market conditions, what will it be worth 2-5 years down the road? • What is your exit strategy and timing? • What is the projected performance of the deal? What metrics will you use? Cash flow, cash-on-cash return, profit, multiple of invested capital, internal rate of return, or …? Will it debt cover with positive cash flow? Will it meet your investment targets? Will it meet your partner's and/or investor's targets? There are a lot of details, numbers, and work that go into answering these questions, but it’s the only way you can truly answer that final crucial question. Is it a good deal … for you? Does this deal fit into your investment strategy? Are the risks associated with the deal acceptable and manageable within your personal tolerance levels? Will it help you achieve your investment / financial goals?

DaJuan J Harris · Answer

@Andrew Moore appreciate your response and taking the time! Your words of wisdom are better than money! They hold value and I will definitely take heed.

DaJuan J Harris · Answer

@Brad Hayden thanks! I'm going to take all of that in.... appreciate the incite and taking your time to answer with that much detail!!

Brandon Hall · Answer

If you're saying "commercial" in the sense of large multis, a commercial building, or mixed use, then arguably the most important metric to initially gauge a deal is Cap Rate. While COC, Cashflow, and Exit are super important as well, each area is usually associated with a Cap Rate that indicates the value of the property.

Steve Georges · Answer

Hi DaJaun. Good question, well answered by the above, especially in regards to thinking about metrics, your goals, strategy, and the goals of all involved. To help me understand the measuring side of all this, I like the book by Frank Gallinelli " What Every Real Estate Investor Needs to Know about Cash Flow..." Reading this helped to focus my mind around the numbers that are super important. Knowing how to measure will help you judge and also provide you with a dose of confidence. One off-beat way to look at a property is ask yourself this: who is going to get paid here, and how? Will it be the tax collector, lenders, insurance company and utilities? Or, will you figure out how to get paid too, while keeping the above at bay? Judging a property's ability to pay you, with confidence, are critical elements in deciding if a property fits yours and your partners goals and strategies. Gallinelli's book is not a crystal ball, but gives you the tools to help decide which way it is likely to go. Good hunting!

Tanh Truong · Answer

I echo what @Andrew Moore @Brad Hayden said. I'll even add to factor in the location. Will the property survive over x amount of years? Do the demographics support growth?