Wednesday, August 21, 2013
The commercial and residential real estate markets are two different animals. Commercial real estate relies on valuation based on the performance of the business while residential real estate relies on the performance of the market, or what the buyer is willing to pay and can afford to pay.
We've heard for years now that the commercial market would bounce back much later than the residential market. And if you understand the fundamentals of the commercial market, you'll understand why this makes perfect sense.
What has held the commercial buyer back over the past several years has been their ability to sell their home in order to have the funds to buy a lodging business. But with indications of an improving economy and growing consumer confidence, the lodging buyer has been more successful in selling their home in the past year, more or less, and is now ready to push full steam ahead on the next step in their plan. Buyers have accepted the "new today" and realize that their assets are worth what they're worth, and in all likelihood they're only going to get better. Some have decided to reinvest their 401k's or retirement funds by a self directed IRA or something similar and are in a position to move forward now rather than wait.
When a commercial property sells, the gross revenue multiplier (GRM) and cap rate are considered. We take the sale price and divide it by the gross revenue (without sales tax) and come up with our GRM. We take the sale price and divide it by the net operating income (NOI) and come up with our cap rate. As buyers are willing to pay more and more, these indicators will slowly improve over time.
This might explain why I'm working with more buyers right now than I ever have before....and I'm ready. Bring it ON!
Wednesday, August 14, 2013
When we hear the question "have you pre-qualified your clients?" in a residential transaction it usually means that your buyer has been in touch with a lender, submitted their personal financial statement and received a "pre-qual" letter from the bank. This letter would state that based on the buyer's financials and their job income, they are capable of purchasing something in the $xxx range.
But in a commercial transaction it doesn't happen like this. Since commercial deals are almost always based on the financial performance of the business and analysis of the net operating income, until a buyer can submit the financial statements for the business they're interested in pursuing, the lender can't give them any type of pre-qualification.
What we, as buyer brokers, do is we vet our buyers to determine what their available cash will be for a downpayment, what their cash reserves might be so that we know realistically what property might or might not work for them. Not what price range necessarily (as in a residential transaction) but what their available cash for downpayment might afford them.
While a $250,000 downpayment might afford a $750,000 if the property's NOI is high enough, it might better afford a $1,000,000 property if the NOI is strong enough. Here's an example:
This is a scenario I have with current buyer clients of mine. They wanted to put down a good chunk of money on a lower priced property to not have a large mortgage. But with a lower priced property often comes a lower gross income and lower NOI. So here are two properties where their $250k downpayment shows a much better cash flow (owner paycheck) if they purchase ABC Inn over XYZ Inn. We can also see that if they put much less than $250k down on XYZ Inn, the DCR would be too low, in other words, there wouldn't be as much to cover the mortgage and give the owners money to live on and the banks want to see this DCR in the 1.25-1.3 range. That was explained in greater detail in a prior blog post.
So ultimately, you (buyers) want your money to work for you. The best way to do this is to tell your broker what you have for available cash. Your broker will discuss what you can afford based on the performance of each business you inquire about. So focus will become "what is the gross income?" and "what is the NOI?", not really "what's the asking price" or whether or not you are pre-qualified for a purchase. Your broker will be able to tell you and other listing brokers if you are qualified to purchase ABC or XYZ Inn.