Commercial Real Estate Investing For Dummies. Peter Harris
target="_blank" rel="nofollow" href="#fb3_img_img_b59fee9a-5855-54ce-a1c7-5f771059e0cb.png" alt="Tip"/> We recommend that you hire professional management and a maintenance staff to take care of your property. You won’t get wealthy doing low-level work that you can hire specialists to do for you.
To see how this issue could affect you, take a look at this example: if the expenses are under reported by just $10,000, and we’re using a .07 cap rate, then the property valuation is going to be off by $142,857 (in the seller’s favor). That’s quite a difference.
How the Commercial Property Evaluator Works
You can make copies of the Commercial Property Evaluator (as seen in figure 3-1) and fill in the blanks to use some algorithms we’ve developed over the years to tell you the estimated property value.
The online version provides even more information, telling you:
If the deal is worth pursuingAn appropriate purchase priceA suggested initial offer price
The Commercial Property Evaluator helps you determine whether a deal is worth pursuing by comparing the actual value to the asking price. If the property is way overpriced, the online version provides a red light telling you not to waste your time. A yellow light indicates maybe there’s a deal here. When you see a green light, that means go! You’ve come across a great deal and need to move quickly to get it before someone else does.
Here’s the data you need to enter into the Commercial Property Evaluator:
The number of units
The asking price
The unit mix (how many studios, one-bed, and two-bed units)
The average rent per unit type
The claimed expenses (because they are highly suspect)
The cap rate shown in the listing (since it’s not likely to be accurate)
Any “proforma” information (which includes projected claims about future income)
FIGURE 3-1: The Commercial Property Evaluator is a tool that helps you evaluate a property’s worth. It’s available on CommercialQuickStart.com.
Because cap rates are higher or lower depending where you are investing, and can change over time, you can adjust the cap rate you prefer to use in your market. Any good commercial broker can help you determine which cap rate to use for your market. After you decide on this, make sure to use the same cap rate to value every property in the same class. You can fill in the cap rates for your market in Table 3-1.
TABLE 3-1: Cap Rates
| Property Class | Typical Cap Rate | Cap Rate for Your Market |
|---|---|---|
| Class A | 3.5 to 4.5 | |
| Class B | 5.0 to 6.0 | |
| Class C | 6.5 to 7.5 |
The Commercial Property Evaluator will determine the leased up, stabilized value of the property for you using the following default settings, which is what we are currently using for most Class C apartment buildings:
5% vacancy
45% expenses
.07 cap rate
If you’d like a look under the hood, Table 3-2 displays the formulas used by the Commercial Property Evaluator along with some actual numbers from the 50 unit “Courtside Apartments” so you can see how this works.
TABLE 3-2: Courtside Apartments Example
| Step | Description | Courtside Apartments | Shortcut to Next Step |
|---|---|---|---|
| One | Total Monthly Income | $80,000 | Get Annual Income (Multiply × 12) |
| Two | Total Annual Income | $960,000 | Remove 5% Vacancies (Multiply × .95) |
| Three | Effective Gross Income | $912,000 | Remove 45% Expenses (Multiply × .55) |
| Four | Net Operating Income (NOI) | $501,600 | Apply Cap Rate (Divide by .07) |
| Five | Property Value | $7,165,714 |
Using the online version our mentoring clients also enter the market rents to come up with a “Proforma” value so we know what the property will be worth when we increase the rents up to market value. To do this yourself with the Commercial Property Evaluator here in the book, take an extra step and enter the market rents instead of the actual rents. This will give you the proforma value of the property.
We then compare these three values to give us an indication of what the upside looks like and whether it’s worth our time to pursue the deal:
Asking price from the seller
Actual property value
Proforma value
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