The Ultimate Guide to Analyzing Commercial Real Estate

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As private investors increasingly discover the advantages of investing in commercial real estate (CRE), they are also noticing the contrast between CRE investment and other financial ventures.

While CRE investment through real estate investment trusts (REITs) is similar to buying shares in the stock and bond markets, direct real estate investing—in which buyers purchase buildings on their own, via a third-party manager, as part of a group investment, or through an online platform like RealCrowd—is quite different.

These transactions require evaluating and analyzing properties to determine if they match with the investor’s financial goals.

Investors who are new to CRE may be unfamiliar with how to go about analyzing real estate for investment purposes. The process is unlike house or apartment hunting; rather, it entails a deeper level of due diligence to discern an asset’s ability to generate return on investment.

Direct investing on one’s own versus in a group or via an online syndicate requires a different degree of analysis. Those who invest alone reap all of the benefits of ownership; however, they also must take on all of the due diligence and assume all of the risk.

When investing in a group or with an online platform, the rewards, responsibilities, and risk are spread out amongst multiple investors.

Below is a helpful guide for all direct investors to follow when analyzing commercial real estate properties for investment.

How to Analyze Commercial Real Estate Properties for Direct Investment

1. Learn the market.

Before investing in commercial property, understanding the market in which the property is located is key.

To gain this understanding, researching fundamentals including the vacancy rate, rental rate growth, amount of construction, and prices of comparable properties in the area is essential.

Similarly, having a firm grasp on the economic and real estate drivers in that market, such as economic, job, and population growth and major industries and employers in the region, is also crucial in guiding real estate investment decisions.

Assets in markets with favorable fundamentals and strong drivers are more likely to generate higher investor demand and thus deliver lower returns than assets in markets with less robust investor interest.

Related: 4 Reasons to LOVE Owning Real Property (Over Stocks, REITS & Notes)

2. Study the asset.

Thoroughly vetting the asset under consideration before investing is vital.

The physical attributes of the asset correlate directly with its viability for investment. Attributes such as when the property was built, how recently it was renovated and to what extent, which amenities it has on site and nearby, and how large the capital-improvement budget is are all significant checkpoints. Also consider the aesthetic appeal of the property as part of its ability to attract and retain tenants.

The location of the asset within the market is another important concern. Is it centrally situated, easily accessible to major transportation corridors, walkable to shopping and daily needs? Accessibility and walkability are major factors in tenants’ leasing decisions today, which makes them essential for investors to consider, as well.

Touring the property, doing online research using online direct-investing platforms, hiring a due diligence firm, and speaking with the developer or seller are smart ways to learn as much as possible about an asset before buying it.

3. Ensure the right property manager is in place.

The quality of a building’s property management team can make or break a commercial real estate investment.

Investors who buy property on their own either manage the property themselves, hire a property manager, or keep a current management team in place. Group investments are usually managed by an outside source. Regardless of who shoulders this responsibility, certain attributes in a property manager are extremely important.

Successful real estate managers are responsive to tenant requests, in tune with what real estate occupiers in the market want and need, and effective at providing it. Quality management is also adept at cost-effective measures and works in partnership with property owners to achieve tenant satisfaction while remaining within budget.

While management can be replaced, a building that has been properly managed has a distinct advantage in the marketplace and can potentially demand a higher value than one that has been poorly managed.

Related: Investment Face-Off: Rental Property With 6% Cap Rate vs. REIT With 8% Return

4. Evaluate the risk factors.

Every type of investment brings some risk, and commercial real estate is no exception.

The market, the asset, and the management of a property all introduce risk into the transaction. Understanding each of these factors, as explained above, can help reduce investment risk and provide a better scenario for risk-adjusted returns from the investment.

In addition, it’s wise to understand the risks involved in the capitalization of commercial real estate transactions (how the transaction is financed). Generally, the more conservatively a CRE investment is financed, with a lower loan to value (LTV), the lower the risk. As debt increases, so can risk.

When investing in a group, how an investment partnership is structured affects risk in CRE transactions. The structure of the investment documents determines how the property will operate on a day-to-day basis and includes factors like the treatment of cash flow from rental income, refinancing, and sales proceeds.

Structure also affects how investors will receive return on investment and—based on the total amount of capital invested by the manager—how much of the profits will go to the manager. All of these variables affect the investment’s overall risk and should be considered in advance.

Direct investment in CRE is a time-tested strategy for investors to achieve their wealth-growth and preservation goals. The more educated an investor is about the market, the asset, the manager, the capitalization, and the structure of a particular CRE investment, the better prepared that investor is to make wise decisions regarding that property for the near- and long-term.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.