Traditional Approach to Valuing Commercial Real Estate
Bless your pea-pickin’ heart. Years ago, that was the endearing quip Tennessee Ernie Ford liked to say to the people he met. I’m not sure what the phrase meant then or what it means now but I’m reminded of the saying when I receive a marketing flyer for a new for-sale listing. It’s full of pretty pictures of the property and nice sounding words of the neighborhood. And the most intriguing thing about many marketing flyers are the projected rents and expenses are in no way connected to reality. I can’t help but think to myself, “Bless their pea-pickin’ hearts. They must think I’m stupid.”
I’ve come to the realization that real estate brokers can’t help themselves. They really can’t. In order to be a real estate broker you have to be a cockeyed optimist. There are too many down times in commercial real estate and in order for them to survive they have to be “glass half full” type of people. I get that. I really do. But God bless them, do they really think they are fooling anyone with the “pie in the sky” income and expense projections they conjure up in their marketing flyers?
My Approach to Valuing Commercial Real Estate
The purpose of this article is not to skewer real estate brokers. Bless their pea-pickin’ hearts, they can’t help themselves so don’t mind them. No, the purpose of this article is to give you another approach for valuing a property which I believe is a teeny-weeny bit more objective. It begins by throwing away the meaningless marketing flyer and evaluating the property from three totally different perspectives:
- HISTORICAL PERSPECTIVE – Spread the historical operating statements (preferably two full years plus year-to-date numbers) and the most recent rent roll to find out what’s been going on at the property. How has it performed? Ask the seller to explain the abnormalities in the numbers. Find out the good, the bad and the downright ugly.
- LENDER’S PERSPECTIVE – Once you have an understanding of the real income and expenses then put your lender’s hat on and project how they will underwrite the property. Why do you care? Because the lender is the one who will size the loan. Not you. Not the real estate broker. The lender. So you need to know how they look at the property.
- BUYER’S PERSPECTIVE – Once you understand the property’s historical performance and the lender’s perspective, now is the time for you to let your creative juices flow. What ideas can you bring to this property that will make this property’s performance “zing” that the current owner is totally clueless about?
If you want to try out my approach to valuing commercial real estate I’ve created a 6 page Excel spreadsheet to facilitate the process. And the price is right. It’s free to those who receive my twice monthly blog. Just email me today at firstname.lastname@example.org requesting my free spreadsheet. If you are not yet a subscriber to my blog then click on this link which will take you to the sign up box to register.
This CRE investing spreadsheet will calculate the following:
- The estimated cap rate you’re actually buying the property for based on your projection of income and expenses, not the appraiser’s.
- How the lender will most likely size the loan based on their normal rules of thumb. Applying these rules of thumb typically lowers the projected cash flow before debt service which results in a lower loan amount.
- The monthly mortgage payment for each lending alternative.
- An estimate of how much cash or 1031 exchange equity will be required by the buyer at closing in order to cover the down payment and all closing costs.
- And most importantly, the spreadsheet will calculate a Before- and After-Tax Return on Equity for each lending alternative considered.
Get my free CRE investing spreadsheet, or if you like, you can continue using the selling agent’s marketing flyers. Bless their pea-pickin’ hearts.