Investing in real estate is a complex and sometimes very confusing process. There are many variables to take into consideration before making an investment in real estate. Firms like Nelson Partners specialize in these types of investments, but it can be an intimidating prospect for the average investor.
These variables range from Market Conditions, Annual Return Estimates, Cash Flows, and Profitability of the Investment. It can be difficult enough to understand all of these factors when you are analyzing a single property, but when you start to consider deals that involve multiple properties, the analysis becomes even more complex.
Here are some basic principles to keep in mind when analyzing a real estate investment:
Market Conditions
Market conditions can have a major impact on the success of an investment. It is important to identify if the market is trending up or down because this will significantly impact your projections and final returns from the investment. It is best to invest when prices and demand are trending upwards and with high rents and occupancy rates. On the other hand, if your projections indicate that prices will be going down in the future, you should avoid making an investment.
Annual Return Estimates
It is important to estimate what return on your investment you can expect from a commercial real estate project. It has been typical for investors to get a 6% – 8% return on their investment, but this can vary widely depending on the situation. There are many different factors that will impact your returns, like rental rates, vacancy rates, and financing costs.
Cash Flows
Cash flows are the amount of money you receive in addition to your initial investment in a real estate transaction. This can come in many forms, but the most common is cash flow from rentals. Cash flows can either be stable or variable. Stable cash flows are predictable and come in regularly like monthly rental payments where as variable ones are less reliable and volatile, like sales proceeds.
Profitability of the Investment
Profitability is what you end up with after expenses, and returns have been added together. If you are able to establish that your return projections and cash flows will lead to profitability, then it is usually a good idea to move forward with the investment.
ROI
ROI is a common acronym that stands for Return on Investment. It is important to know your ROI in order to decide whether or not an investment will be worthwhile. The formula for ROI is:
ROI = (Net Proceeds and Returns and after-tax Cash Flow x 100) divided by the Capital Invested in the Project.
Net Proceeds and Returns
Net proceeds are the total amount of cash you receive from the investment after all associated costs have been deducted. This includes purchase price, closing costs, financing expenses, etc…
Final Thoughts
Commercial real estate investing can be very profitable if you are able to identify consistent cash flows and estimate an overall ROI. If you are considering making an investment in commercial real estate, make sure that it is backed by sound fundamentals before moving forward.