Your CORE Advisor Blog

I get the question often…  So hows Real Estate?  I usually try to be somewhat optimistic in my response.  Still the facts are that values are down a bit and the momentum appears to be continuing downward for the time being.  

Some people specifically ask me about Commercial Properties

Main Street Montrose

There are few commercial comparable sales to show this downward trend like there are in residential property.  Yet all the signs are lurking.

If you look two key factors the increasing vacancy rate, especially on Main St., and the increased pessimism and decreased optimism on the economy then you know that values are dropping.

Currently commercial values are facing a double edged sword.  Increased vacancy means decreased Gross Revenue, which means decreased Net Operating Income.   This means decreased value for the property when looking at a CAP Rate or a ROI valuation method.  These are most commonly used by banks and investors. 

The CAP (Capitalization Rate) is basically the same thing as Return on Investment.   

If a property makes $10,000 per year in Net Operating Income (NOI = Gross Income minus all expenses not paid by tenant(s)) then at a 6% CAP Rate or for a 6% ROI a buyer could pay $166,666 for the property.  Then when they get their $10,000 each year that would be a 6% return on investment. 

The second side of the sword is that the CAP rates or expected return on investment are rising due to the increased perception of risk (the economy, the vacancies, jobs, amercian auto companies, etc.)  That same property making $10,000 per year at a 8% CAP rate is only worth $125,000 and at a 10% CAP rate is only worth $100,000.

So unfortunately for many owners commercial values are just as subject to change as the opinions and faith of the would be buyers just like with residential property, or stocks, or even T-bills. 

The good side is, if you can buy a property from a motivated owner at a 10% CAP rate and then the market mentality changes to accept an 8% CAP rate you can gain a 25% increase in value.  

If you decide to hold on and just rent your properties, you need to keep in mind that you don’t want to lock in lowered rents for the long term that will affect your properties value well into the future.  Instead, offer short term incentives or even credits back or maybe tenant finish, in exchange for better escalators, or more on par rents.  

Also it is always best for the owner to be as close to a NNN lease where the tenant pays, utilities, insurance and taxes because these things can chew away at your Net Operating Income as they increase if they aren’t passed onto the tenant appropriately.

If you are leasing commercial space, obviously a Gross lease is best for you as a tenant, because then your costs are very controlled and predictable. 

Overall it is still the same game, just a different day with a slighltly different perspective.   In my opinion, it is a great time to buy (assuming you have deep enough pockets to ride out the storm)!