Commercial Real Estate investment properties can certainly present very real opportunities for profit, but how do you know what to look for if you’re not a seasoned investor? While finding the right CRE opportunity can be tricky, it’s not impossible for those looking to branch out into Commercial Real Estate for the first time. Here are a few things a first time investor should consider when gauging a commercial property listing:
Determine the NOI (Net Operating Income)
Determining the net operating income isn’t as complicated as it might sound. It’s really just a fancy term for the annual revenue stream that a property should generate. NOI is determined by subtracting the operating expenses of the property from the gross revenue obtained through the property. Simply put, NOI is the revenue that you should expect from a commercial property on an annual basis. Debt service is not included when calculating the NOI because it can vary by investor based on the terms of their financing. Also unique to each investor is the revenue stream needed to make the investment property a sound decision. Some seasoned investors can endure a season of negative NOI for investments they know will turn a profit in the long run, while other investors prefer to see a positive revenue stream on a property right off the bat. Although properties that have room for improvement often see the most returns in the long run, not every investor has the tolerance to make major improvements on a property prior to returns.
Another important thing to look at when considering a commercial real estate investment property is its vacancy rates. Looking at how much of the space is currently leased, for how long, and the duration of the current tenants can be key indicators of how well a property is renting. All properties should expect to experience some vacancies, it’s an inevitable part of leasing out space. However, if a potential investment property is experiencing a high vacancy rate, it’s important to determine why and what can be done about it prior purchasing the space.
The DSCR (Debt Service Coverage Ratio) is the ratio between the annual cash flow of a particular property to the annual principal and interest paid on it’s debt. To calculate the annual debt service coverage ratio (DSCR) on a particular property you’ll need to divide the NOI by the annual debt. Although commercial lenders may use the debt service coverage ratio to determine if there is sufficient or insufficient cash flow to cover a mortgage, and investor can use this number to determine if they can truly afford the property. For example even if a property has a positive NOI and low vacancy rates, the particulars of the financing options available to you may determine if the property is the right investment for you. Looking at the DSCR should help you determine if there is enough cash flow after the debt service to achieve your commercial real estate investment goals.
Although there is a lot to consider when determining if an investment property is right for you, looking at the NOI, vacancy rates, and DSCR are certainly an important place to start.