Here at the Commercial Academy, many of our alumni started out investing in residential real estate. One of the biggest differences, and greatest benefits, many of them have found when transitioning from residential to commercial investing is that the two do not treat competitive properties in the same way.
In residential real estate, the value of your property is based heavily on the market which the home resides in. When homes are selling for higher prices, other homes in the area will have the opportunity sell at a higher price as well.
This valuation is often referred to as the “Sales Comparison” approach. Where the perceived value from the sale of a competitive property can either detract or increase the perceived value of a neighboring property. Often times this can lead to overpayment on assets in boom and loss of value during periods of recession.
Commercial assets do not operate in the same fashion. Why? Because the value of curb appeal is nothing when compared to the value of a strong rent roll.
When you invest in a piece of commercial real estate, you are not just investing in a building and the land it sits on. More often than not, you are investing in the capital which the property can generate through its leases.
This is the primary focus used by appraisers, loan officers, and commercial real estate investors when determining the market value of any asset. Although sales comparables, or “Comps” as they are referred to in the industry, can help you asses the status of the market you are looking at investing in, they should not determine the price you are willing to pay for an asset.
As an example, imagine you are looking at purchasing a twenty unit apartment complex. The broker representing the seller may state that recently another twenty unit apartment complex sold for $500,000. The buildings are similar in age and have the same amenities. If you were using the sales comparison approach, the property which you were looking to procure should also have a value estimated somewhere in the ballpark of $500,000.
Wrong! If the property which sold for $500,000 had a rent roll with 80% occupancy and the one on the market had a rent roll with 40% occupancy the values would be very different. Also, maybe one property has an incredible national tenant like TJ Maxx or Aldi, with no signs of slowing down and a solid leasing agreement, which would also have an impact on perceived value.
What the example is meant to demonstrate is that no two pieces of commercial real estate are exactly alike. There will be dozens upon dozens of items which you will have to consider when evaluating the market value of any commercial asset. Your initial decision for pursuing the purchase of a commercial asset needs to be determined by the facts (numbers) for the property you are interested in, not market comparables.
If you would like to learn the methods of evaluating the real value of any commercial asset, please sign up for one of our upcoming Commercial Property Academy live events. During the course of these four day seminars, we will cover specific topics on the many items which will either improve or detract from the value of any piece of commercial real estate to make sure that you are finding the right asset that can help you accomplish your financial goals.