Breaking Down The Commercial Real Estate Investment Analysis Process

Before sinking funds into an asset or an idea, it must be researched, vetted, and analyzed from every possible angle to determine its true potential. Certain markers and identifying traits always indicate why one project may succeed over another. Informed investment decisions rely heavily on several layers of core fundamentals for market and real estate analysis, which include the following themes.

It’s easy to get attached to a project or idea that you hope will be successful. Or a property that you have in mind but no true vision for what is possible. Let the market tell you what it needs and where. Conduct your due diligence for the area, the economy, and the community values to determine what the healthiest investment looks like for that market.

Is the area in a growth state? Does the population span a wide range of age groups? What about median household income? Median income per single-income family in the U.S. tops out at $90k in Maryland, rests in the middle at $66k in Texas, and bottoms out at $48k in Mississippi, according to recent data from World Population Review.[1]

Which direction is the unemployment rate trending? These are all questions that help determine the health of any given location and the viability of the commercial real estate market.

While many market trends are cyclical in nature, the right project in the right place can be a good investment at any time. A strong market analysis ensures your investment has the best possible chance of a profitable outcome.

Multifamily, retail, industrial, and hospitality are some of the most lucrative projects in the commercial space. They all generate cash flow, high asset values, and tax benefits. The type of investment property you pursue must be based on your market research and detailed financial analysis.

Analyze similar properties and businesses in the area to confirm viability. What are the local vacancy rates for this type of property? Are there similar projects already in development? Who would your competition be? What market trends indicate there is demand for this type of investment?

This analysis will reveal the viability of your commercial property investment. If the numbers don’t support the projections, this property type or direction should be reevaluated.

No matter the location or the type of project, local and state requirements must be followed. These restrictions could impact location, future growth, property value, lease terms, and potential liabilities. Learn the zoning laws, property title processes, environmental regulations, and building codes for the desired location to determine possible risks.

The history of the target parcel or building will be factored into the market and financial analysis. Has it been vacant for long? When was the building constructed? If it’s bare land, does it have all the necessary utilities or capacity to install them? Has there been a high turnover in this location? What is the sales history of this property? What is the range of tax valuations over the last several years?

Ownership and vacancy patterns tell a story of the overall viability of the property. If it has a history of chronic under performance, there must be a reason why. This could be a prime opportunity if that reason can be overcome with the right business plan. If not, that may be a crucial marker for a poor investment.

The location and type of project have been selected; now, we assess the value and potential of a specific property based on the market data, the current owner’s motivation to sell, building analysis, projected performance metrics, and other influencing factors.

The projected performance metrics will include:

• NOI / Net operating income (tenant rent, cash flow, etc.)
• Property valuation (current and future market value)
• Operating expenses (seasonal upkeep, maintenance, property management, etc.)
• Capitalization rate (CAP rate, potential return on investment or ROI)
• Other expenses (property taxes, insurance, remodeling costs, etc.)

The detailed Pro Forma paints a picture of the future potential of a well-planned investment based on detailed market research, property analysis, and meticulously executed due diligence.

To adequately leverage the tax benefits and calculate tax requirements, you must evaluate the tax implications of the project. This analysis clarifies where you can optimize returns and mitigate financial liabilities. A strategic approach to tax planning will help you take advantage of tax deductions or credits and depreciation and appreciation benefits while reducing tax liability and capital gains taxes.

Commercial and industrial real estate properties attract tenants who are committed to longer leases, which provide stability for your investment. Investigate each tenant’s rental history, legal history, yearly and monthly revenue, desired lease terms, and overall compatibility with the property. The more reliable and self-sufficient your tenants are, the more stable and passive the project will be.

• NOI / Net Operating Income: Total income after expenses are subtracted
• Cash-on-Cash Return: The percentage of cash returned in relation to the timeline it is paid out. If all of your money is returned within two years, the cash-on-cash return is 50%.
• Capitalization Rate / CAP Rate: This is calculated as the net operating income divided by the sale price of your finished project.
• CRE: Abbreviation for Commercial Real Estate.
• SWOT: This refers to the strengths, weaknesses, opportunities, and threats of a project.