Question: How to evaluate commercial property?

Question

I am a currently an Owner/Operator of a Gas station but do not own the property. I have been there for nine years and recently my landlord has given me the option to purchase the property from him as he wants to get into other ventures. On the property is my gas station and fast food restaurant with a combined rental income of $6000 a month. This does not include property taxes and/or CAM. The purchase price will be between 700-750K with a 20% down @ 20 years. I am not sure yet of the expenses and have not adjusted for vacancies( I don't foresee any vacancy due to the fact that i have been here for the past 9 years and the restaurant has been here for 12).

My question from the subject line is "how do I evaluate commercial property?" What are the values I should look for to figure out what is the current value of the property, what will be the value or appreciation of this property 10-15-30 years down the line?

Lee I. · Answer

The property won't appreciate like residential.  It is mostly based on the NOI (rent minus expenses), quality of lease/tenants (how likely is the tenant going to stay and is able to pay), and cap rate investors are looking for.  So as the NOI increases on the property, the value will increase.  Also you have potential for cap rate compression.   To be simple, let's say you buy this thing at 700k and you're clearing $63,000 after all expenses (except debt service) every year, so you're getting a 9 cap.  Let's say in a few years, the market is hot in your area and investors are willing to buy at a 7 cap.  If there was no change in rent, your property is now worth $900,000 just because investors are willing to accept a lesser return.

Of course, the opposite could happen too and maybe investors aren't as willing to invest in the area as they were and now expect an 11 cap.  Now your property is only worth about $570,000 if the rent is the same.  Might not matter too much if you are long term and want the cash flow, but if you wanted or needed to get out of the property in the short term, that'll cost you.  This is where the quality of the neighborhood can factor in.  Investors want a higher return for more risky areas.  If your area is on the decline, the cap rate might go up (bad if you are a seller).

The only way I can think of the value appreciating, but not tied to the NOI is if you just have an amazing, unbelievable location, the neighborhood is becoming super hot, and some developer has an idea that would make much more money than the current gas station/restaurant.  He might pay more than market cap rate for your property just because he can tear it down and create something of greater value and he wants to scoop it up before another developer.  But this is so rare, I wouldn't factor this (or any appreciation, my opinion) into your purchase decision and how much you are willing to pay.

Lee I. · Answer

I'm not sure that it will have a direct effect on the value of your property since commercial property is all about how much income the individual property is producing.  The other factor comes into play as far as it can give you a general idea about what is happening to the area overall.  Why was it auctioned?  Was it foreclosed on, did the owner die, etc.?  If it was foreclosed on, why wasn't the owner able to make payments?  Has the plaza been losing tenants and been unable to refill?  Since being sold last year, have the new owners been turning the place around or has it been getting worse?  In general, is this area gaining or losing population, increasing or decreasing average household income, crime rate, etc.?

But again, that's all secondary to what your property is doing.  You can still make money in an area that others are losing in.  You're in a good position in that you know exactly how your business is doing and you probably have an idea of how things look going forward.  Are you planning to keep the property, sell the business, and just landlord; or will you sell the business and land together?  If landlord, do you feel your business has good projections going forward and do you feel confident that the buyer will be able to run it at least as well as you were since you will be relying on him for half of your income?  Does the lease on the restaurant allow the landlord to see their financials?  As part of your due diligence, you will want to see how they are doing.  The restaurant has been there 12 years, but have sales been dropping the last two?  Hopefully they are still doing well and maybe even increasing sales.

As @Howard Abell said, talk to a CPA (look for one with real estate and business experience, ideally with other clients that are gas station owners) and get an idea of how much you will be paying per month for this property vs what you are currently paying in rent.  If you are paying less in mortgage than in rent, in my mind that's a strong reason to buy because you are in a great position even if you don't end up selling the business.

Josh Bakhshi · Answer

paul, looking at the numbers you are taking about they don't look that great. But if you like I can refer you some agent That I use for my commercial properties in snellville

Jake Clopton · Answer

Paul, the easiest thing for you to do would be to get an unbiased 3rd party opinion of the value. You may want to just pay the $ and get the property appraised on your own, that will give you the best idea of value because at the end of the day, a property is only worth what someone will buy it for. Sounds like you think you would be buying at a 9 cap, however you need to consider if the rents are market, expenses are normal, etc... I've seen gas station trade all over the place as far as cap rates, what really makes a gas station profitable is a good operator, not just real the real estate. With that loan amount I would go for an SBA 7a loan from any bank, it'll give you a 5 year fix/ 25 year am at a fair rate with good leverage.

Jake Clopton

Lee I. · Answer

Best of luck Paul.  Make sure you fully understand all your expenses, including capital expenditures, to get a true picture of your NOI.  Don't hesitate to get professional help with understanding the leases, expenses, and purchase contract.  Give us an update whatever your choice is.

Paul Singh · Answer

@Lee I. Thank you for answering my stupid questions. I have a better understanding of how a commercial property works now. I will take everything into consideration and go from there.

If I have further questions, I will follow up in the post.

Paul Singh

Paul Singh · Answer

@Howard Abell

@Lee I.

If i purchase the property - I know that I will sell the business to a veteran operator and stay on as a landlord. As far as the financials of the restaurant, they have better monthly sales than my inside store sales. Also I believe that the restaurant's lease has just been renewed but not sure for how long. The rent from my side is $3500 for next 2 years and an increase of $500 to $4000 after that for the next 5 years. The restaurant's just increased to $2500. I believe the property taxes are 5-6K for the year.

Does a commercial property's value increase similarly to a residential value or is it based of off different values, or does it really not matter if the value increases? The reason for me asking is that my landlord purchased this property in 1994 for 700k and built the gas station on top with the rental space for the restaurant.

Paul Singh · Answer

@Lee I. - the purchase will not be owner financed, I will have have to take a loan. As far as my business, this property is related to that. If I purchase the property I will sell the business and and reap the 9% cap rate.

Here is a new bit of information that I just learned, one of my friends that owns a business on the same street just notified me of a retail plaza with seven shops, sold last year on the Auction block for 240K.

What kind of an affect will this have on the value of the property I am looking at.

Howard Abell · Answer

You need to lock down what the net operating income (NOI) is by subtracting the taxes and CAM from the total rental income. With that in hand you can determine the Cap rate of the price at 700-750K. You need to do some research or ask a broker to give you an idea of the comparable cap rates for gas stations or similar mixed use type of properties in the area. You should be talking to your CPA to determine if this would be an advantageous move for you and your business. It probably would be. Figure out what the amortization would be for the note you will be paying and compare that with your rental now. You might be paying less in monthly output but again you should be talking to a CPA.  What would be the interest rate on the 20 year note? Will the owner seller finance? If not you  might be eligible for an SBA loan as an owner/user of the property. Good luck.

Lee I. · Answer

You want to look at the total income ($72,000) minus the expenses, then divide that by the purchase price to get your cap rate.  Determine if that is an acceptable cap rate to you and see how it compares to the area.  Of course as a owner-operator, you will have other considerations, such as never worrying about rent increases or losing your lease, etc.  There might even be some tax benefits.  Is "700-750K with a 20% down @ 20 years" owner financing?  At what interest rate and is it fully amortized? I saw in another post that you were selling your business.  Is this still the case?

Question: How to evaluate commercial property?

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