2 Understanding and Evaluating CRE TH

Introduction to Screening Commercial Real Estate

  • The importance of time efficiency in evaluating commercial real estate deals.

  • The goal is to teach how to pre-screen properties effectively to avoid wasting time contemplating unnecessary deals.

Key Concepts in Pre-Screening

  • The significance of pre-screening before comprehensive evaluation.

Five Essential Things to Know Before Further Evaluation

  1. Ask Price

    • Definition: The initial asking price of a property, which may differ from its market value.

    • Importance of knowing the best offer turned down by the seller.

      • Example: If the asking price is 1,000,000 and a previous offer of 800,000 was declined, and the property's true value is 600,000, there exists a 200,000 discrepancy.

    • Days On Market (DOM): Understanding how long a property has been on the market can provide insight into its desirability.

      • Related Note: Often, residential agents withdraw long-listed properties from the market.

  2. As Is Value

    • Definition: The current value of the property in its existing condition, not factoring future potential value.

    • Calculation:

      • Gross Income: Total income generated by the property.

      • Operating Expenses: Comprehensive itemized expenses (e.g., taxes, insurance, maintenance)

      • Formula for Net Operating Income (NOI):
        \text{NOI} = \text{Gross Income} - \text{Operating Expenses}

      • Expense Ratios in Different Property Types:

      • Mobile Home Parks (Park-owned homes): 50\%

      • Mobile Home Parks (Tenant-owned homes): 40\%

      • Self Storage: 30\%

      • Multi-family: 30\%

    • Capitalization Rate (Cap Rate) Calculation: \text{Cap Rate} = \frac{\text{NOI}}{\text{Purchase Price}}

      • Importance of Cap Rate: A high cap rate indicates a better deal for buyers (e.g., purchasing on a 9-10 cap).

      • Example Calculation: If the NOI is 50,000, purchase price would be 500,000 at a 10 cap rate.

  3. After Repaired Value (ARV) or After Developed Value (ADV)

    • Definitions:

      • ARV: Value of the property after necessary repairs.

      • ADV: Value of undeveloped land after improvements are made.

    • Strategies for increasing land value:

      • Zoning changes.

      • Infrastructure investment (streets, utilities).

      • Building developments.

    • Importance of evaluating occupancy levels and market occupancy rates during assessment.

  4. Loan Amount

    • Definition: The total debt tied to the property.

    • Importance of understanding loan amounts to structure seller financing and payment negotiations.

      • Considerations: Outstanding debt amount, interest rates, balloon payments, and length of terms.

      • Example: If a seller has a balloon payment due within a short term, it affects negotiation opportunities.

      • Necessary Information: Property’s first and second lien details, loan interest rates, and service payments.

  5. Repairs and Capital Expenditures (CapEx)

    • Definition: Significant future expenses necessary to maintain or enhance property value, beyond routine maintenance.

    • Factors to analyze: Roof condition, HVAC systems, property age, and grounds maintenance.

    • Importance of pre-allocating funds for recognized future repairs, which informs potential actual pricing for properties.

      • Example: If repairs are anticipated at 150,000, the effective purchase price increases from 600,000 to 750,000.

Identifying Opportunities vs. Headaches

  • Consider the seller's motivation: emotional stress vs. property distress.

  • Understanding both aspects allows for informed decisions to avoid poor investments.

Understanding Market Context

  • Importance of contextual market factors when assessing a property.

    • Investigate local competition and infrastructural development.

    • Assess socio-economic factors affecting the desirability of property types.

  • Key questions include:

    • Is saturation a concern in the local market?

    • What is the location’s appeal and growth potential?

  • Assess whether the investment falls under desirable classifications (Class properties, price points).

Wealth Building Strategies

  • Emphasizes the long-term value of real estate investment.

  • Illustrates the benefits of time; wealth comes from appreciating values, cash flow, and re-investment strategies like cash-out refinancing.

    • Reference to Warren Buffett praises long-term investment philosophy.

  • Cash Flow and Tax Implications: Understanding that cash out refinance proceeds are not taxable unless properties are sold.

Conclusion

  • Successful investments rely on thorough understanding, strategic information gathering, and the ability to assess property value holistically.

  • Continuous education is essential for fostering independence in real estate investment decisions.