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Commercial property can be an investment property, a place to operate your business or both. Regardless of it's use, an investment property is real estate purchased to generate passive income (earn a return on the investment) through rental income or appreciation. Investment properties are typically purchased by a single investor or a pair or group of real estate investors.
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ROI - Return on Investment Real estate investors often see positive cash flow with their investment properties in today’s market, but the savviest investors calculate their approximate return on investment (ROI) rates before purchasing a property. To calculate your ROI on potential property investments, follow the steps outlined below:
Search for similar properties currently up for rent in your area. Find an average monthly rent for the type of property you’re interested in and multiply that rent price by 12 for a year’s worth of income.
Estimate your potential annual rental income then calculate your net operating income. Your net operating income is equal to your annual rental estimate minus your annual operating expenses. Your operating expenses are the total amount of money it takes to maintain your property every year.
These expenses include homeowners insurance, property taxes, maintenance and homeowners association (HOA) fees. Don’t include your mortgage loan or interest in your net operating expense calculation. Subtract your operating expenses from your annual rent estimation to find your NOI.
Finally, divide your NOI by the total value of your mortgage to find your total ROI. Your ROI helps you understand whether you should invest in one property over another. It can also give you an idea of your real estate investment’s profitability.
ROI Example Calculation
If you buy a $200,000 property you can rent out for $1,000 a month. Your total potential income is $1,000 × 12 months for a total of $12,000. If you assume that the property costs about $500 a month in maintenance fees and taxes the following would calculate the ROI.
If you buy a property in a solid area and know you can rent to reliable tenants, a 3% ROI is great. However, if the property is in an area known for short-term tenants, a 3% ROI may not be worth your time and effort.
There are primarily three methods to calculate commercial property value when evaluating real estate for business:
Cost Approach
The cost approach incorporates the current value of the land the building sits on, as well as construction costs if you were to rebuild the property from scratch. You would also need to take the building’s depreciation into account, considering the age of the building, any needed maintenance or other indicators of wear and tear.
Here’s a basic formula illustrating the cost approach: Cost to replace building – accrued depreciation + land value = Commercial property value
Sale Comparison (Comp) Approach
The sales comparison approach depends on transaction data from recent sales of similar properties in the area. The recent sales data would show how much the property in question may be worth, as long as details such as the size, age, location, neighborhood demographics and condition of both buildings are similar. You’ll need to take any major differences into account.
This sample formula shows the sales comparison approach: Price of comparables +/- adjustments for differences = Commercial property value
Income Approach
Typically reserved for income-generating properties, the income approach gives investors an idea of how much they could earn from the property. Investors usually combine data from comparable properties and any costs associated with generating revenue, such as regular maintenance to keep the building functional. The income value would be dependent on the property’s capitalization rate, or cap rate, which represents the rate of return on the property. To find the cap rate, you would divide the property’s net annual rental income by the current value of the property.
The formula you could follow for the income approach is relatively simple: Present value of income streams = Commercial property value
There are many types of loans available for commercial properties, and the best fit for you depends on your investment strategy. Here are three broad categories of financing available.
Permanent financing is a type of loan that remains in place for an extended period of time. It's commonly used to finance the acquisition of commercial properties or to refinance existing debt. Types of permanent financing include bank loans, loans from government-sponsored entities like Fannie Mae and Freddie Mac, HUD loans, and other types of loans depending on the specifics of the commercial property.
Construction financing, also known as interim financing, is used to finance the cost of construction for commercial properties. It is usually a short-term loan that covers the cost of land development and building construction. Once construction is completed, the borrower can typically convert this into a permanent loan or pay it off with a new loan.
Bridge loans are a type of short-term loan that can be used to cover costs in the interim period between the end of one loan and the beginning of another. They are typically used in commercial real estate to finance the transition between construction financing and permanent financing. Bridge loans generally have higher costs than most other financing options and are often interest-only and non-recourse.
At Pathway we offer a one time close loan. This One Time Close (OTC) Construction loan allows borrowers to combine financing for a lot purchase, construction and permanent mortgage into one first mortgage loan.
