1. The Inconvenient, Unanchored Strip. This center typically averages 40,000 to 50,000 square feet. It is not located at an intersection and may have inconvenient curb cuts. Centers of this size are usually too small to accommodate a supermarket anchor and too large to be filled with the typical convenience stores that succeed in small strips (pizza restaurant, beauty salon, dry cleaner, convenience food store, sub shop, and drug store). It has been found that once a center is leased to convenience-type tenants—and it is hard to go beyond 20,000 square feet in these classifications—it is practically impossible to fill the balance with apparel classifications or other specialty stores that prefer to be in a more focused specialty center. As such, the 40,000 – 50,000 square-foot center often finds itself caught in the middle.
The inconvenient curb cuts that frequently plague properties of this size typically arise from a visibility problem. A curve in the road, a building blocking the visibility of the curb cut, or even a situation where there are numerous curb cuts in the immediate area that are not clearly identified, may prevent the consumer from seeing the curb cut until it is almost too late to pull in. As such, the consumer may find it easier to pass by.
2. The Center With No Focus. Retailers going into unanchored strips of under 50,000 square feet usually seek centers where the tenant mix is complimentary. A specialty center with a complimentary tenant mix will pull from a wider radius than a similarly sized property with a mixture of convenience tenants, which pull from a very short radius, and specialty shops. Centers with such a mixed personality are usually doomed for failure, with the specialty shops falling first.On the other hand, an unanchored 50,000-square-foot retail property can succeed, even if it is located away from the intersection, if it is a focused center. For example, Brunelli recently leased a 40,000-square-foot center with great exposure to a variety of home fashion-oriented tenants. These included stores specializing in bed/bath, mattresses, carpets, tile, fans, picture frames, and juvenile furniture.
Centers featuring a variety of auto after market tenants have also emerged as a viable option. Another possible theme for small centers is a children’s grouping with a toy store and shops specializing in children’s clothing, books, juvenile furniture, and room furnishings. This could be rounded out with a children-oriented restaurant where birthday parties are consistently held.
Today’s typical consumer loves the idea of one-stop shopping. This is especially true for the woman who is working as well as maintaining a home. This consumer who has little time to run from center to center. Developers and brokers should keep the consumers needs in mind.
3. The Not-Visible Center. This center could be almost any size. The problem is that 80% of the stores at the site have less than 30% visibility. To discuss this, “visibility” needs to be defined. A freestanding store facing the street, set back a short distance on a flat former cornfield, would have 100% visibility to traffic traveling in both directions on the road. That same store with its storefront and all signing facing only one direction of traffic would have 50% visibility.If buildings are blocking the view of stores that are further from the street (which is usually the case in a center built perpendicular to the highway) as drivers approach the center, the storefront signs may be visible only for a brief glance as the drivers speed along the highway. The briefer the glance, the lower the visibility rating and most likely sales volume. Most perpendicular centers typically offer 20% or 30% visibility to their tenants.
The only way the visibility problem can be overcome in a perpendicular center is if the site has terrific anchor tenants at the back of the property that can draw large numbers of customers. In that scenario, the satellite stores with poor visibility to the roadway have a better chance of success as their storefront visibility to the consumers shopping the anchors will be passed regularly and typically will offset the problem.
Unfortunately, most small chains and mom-and-pop retailers do very little advertising. Therefore, the visibility of their storefronts and signs to the street becomes their most important presentation to the public. Developers saddled with a retail property that lacks good visibility are advised to create an on going advertising program with the tenants to let consumers know what products and services are being offered at the center.
4. The Two-Story, Mixed-Use Center. Developers are often tempted to put a second story on their shopping centers. The cost of constructing a second story is a fraction of constructing the ground floor. As such, developers figure they will be in a win-win situation, in which tenants will be clamoring to get into the upper level at a lower rent while they enjoy increased profits.With the exception of locations in cities or in certain very densely populated suburbs, it has been found that this approach can instead degenerate into a lose-lose situation. Retailers generally refuse to lease second-story space, contending that consumers are too lazy to walk up a flight of stairs. In virtually all cases, this puts the developer in the position of designating the upper floor for office space.
Although this all sounds very logical, problems can arise in attracting tenants for either level. Retailers fear that employees of second-story office tenants will clog the parking lot from 9 A.M. to 5 P.M. every day, thus inconveniencing shoppers and robbing them of potential sales. To make matters worse, office tenants dislike the idea of parking their cars in the spaces that are allotted for retail stores, fearing that their cars will get banged up by the consumers throughout the day.
Of course, in some cases where land prices and population density are extreme, a two-level center can work. But good planning is essential. One approach that has proven successful is to design a facade where the front of the structure appears to be strictly retail—for example, no windows for the office tenants in the front. The entrance to the offices would be limited to the rear, where adequate parking designated for office employees and visitors would be provided.
5. The Enclosed-But-Too-Small Center. This type project will attract enough consumers into the mall area on a steady basis and support the satellite mall tenants, this generating sufficiant rents to make a viable addition to your real estate portfolio.Perhaps in the snowbelt states, where the winters are especially bitter, consumers may appreciate a small center with a climate controlled mall area. But in the more typical US climate, experience has shown that consumers visiting a small center prefer to park as close as possible to the entrance of the stores in which they intend to shop.
In the northeast, an enclosed mall with fewer than three major department store anchors, or less than 500,000 square feet of gross leasable area, has typically proven to be a disaster. In fact, foreclosure action against such properties has been common place. Currently the thinking is to clear out the few remaining mall tenants and convert the entire mall area into category killers; a wholesale club and/or discount department store with additional Big Box Tenants and to face the entrance’s toward the main parking field. Obviously, a lot of people have paid dearly for that project to get to this point.
6. The Center With Too Many Satellites. This situation is a real shame: a center with a great neighborhood location at a strong intersection, yet with an unsupportable ratio of anchor tenants to satellite stores. A reasonable rule of thumb in today’s difficult world of financing and leasing would call for three square feet of anchor tenant for every square foot of satellite store space.A prime example of a property with too many satellites can be found in a 180,000 -square-foot center recently developed in the Northeast. Built less than four years ago, this center houses a successful 60,000-square-foot supermarket and was designed to accommodate two or three sub-anchor tenants, such as a large variety store or a large off-price apparel store. Being in a neighborhood location, however—as opposed to a more heavily trafficked community location—it has made it impossible to attract such sub-anchors.
All of the convenience uses typically adjoining a powerful major supermarket have been filled and pushed to their limits at this property—for instance, a 2,000- square-foot dry cleaner instead of the 1,200 square feet typically allotted for this use, or a 4,000-square-foot pizzeria instead of 2,400 square feet. Unfortunately, it may be impossible to find suitable tenants for the remaining 40,000 square feet at this center. An experienced developer or a knowledgeable retail broker would have planned less square footage for this site.
7. The Unnecessary Center. The unnecessary center can be built with 100% exposure, great architecture, attractive landscaping and signage. The problem: it may be located in an area where there is either, (1) not enough population or, (2) too much competition. As such, this otherwise well-planned center may be rendered unleasable.While inadequate population is more of a problem than too much competition, it is usually some combination of both that results in the development of the unnecessary center. The only effective way to discover if a planned center will be needed is simple: pre-lease it! If a substantial number of tenants can not be secured before the center is built, it should not be built.
In the wake of the problems of the past decade, most financial institutions now require that substantial pre-leasing take place before construction loans are granted. Indeed, too many loans were granted based on the personal guarantees of developers with strong financial statements who ultimately got caught with too few tenants.
As the banks have learned, a project must be economically feasible based on the merits of the projected secured income, not on the merits of the developer’s financial statement. Market studies alone are not sufficient. In fact, they often make projections that are required to make the person paying for the study happy. The best “market study” is a stack of signed leases that have followed an actual marketing program.
8. The Center That Is Too Deep. This condition usually occurs in small strip centers where an inexperienced developer tries to cram as many square feet as possible onto five acres or less. Typically configured in an L-shape, this problem center can house anywhere from 10,000 to 50,000 square feet of gross leasable area.After the developer proudly announces that every last square foot possible has been squeezed out of the planning board, he or she finds a broker who delivers the bad news: In small strips the typical store size needed is 1,200 to 2,000 square feet. Because the minimum frontage that most stores can live with is 20 feet, it becomes impossible to deliver stores less than 2,000 square feet when more than 100 feet of depth exists.
Using the example of a 30,000-square-foot center, the problems of a site of this type are magnified in the corner, or crotch, of the L. This section has between 5,000 and 10,000 square feet of space with 30 feet of frontage. Stores flanking the corner have depths of more than 100 feet. To make matters worse, immediate parking is usually nonexistent in this corner area.
Often the only tenant that will consider going into the crotch is a health club. To attract such a tenant, the developer may have to essentially “give the space away,” in addition to building out the club and typically putting in a pool. Although a health club can be a fine anchor for a small strip, the developer should weigh the economics of such a deal in advance of construction. Equally important, the developer should take great pains to scrutinize the financial and operating history of the health club. Although the industry’s failure rate is not all that different from that experienced among restaurants or among mom-and-pop retailers, the developer usually has a good deal more at stake due to the high up-front cost of building out the space for this special use.
All things considered, developers who are in the planning stage are best advised to design centers with not more than 70 feet of depth. If possible, all of the stores should face the street. As all too many developers have discovered, a fully leased 30,000-square-foot center can be a lot more profitable than a 45,000-square-foot center with a 30% vacancy factor.
9. The Center With Too Little Parking. Different centers require different parking ratios. It would be safe to say, however, that an appropriate rule of thumb would be that five spaces should be provided for every 1,000 square feet of retail space. Four of these five spaces should be directly in front of the store, as opposed to around the sides or in the back.Small strip centers that are convenience-oriented can usually work well if four rows of parking are provided between the storefront and the street. This scenario creates a setback of about 160 feet, however, sometimes only two rows of parking are necessary. Although exposure considerations may override parking considerations, a configuration with only one row of parking across the front, and the a balance of parking at the sides and the rear, should always be avoided unless the center is a home-furnishings center, for example, where a very low parking requirement is necessary.
Another key consideration is the thorny issue of employee parking. It is often argued that the spaces in the back are best suited for employee parking. Unless the developer writes leases that require the tenants to force employees to park in the rear, the employees will park in the front, as close to their store’s front door as possible—gobbling up spaces that should go to shoppers. Further complicating this issue is the fact that most retailers would prefer that their personnel enter through the front door so as to curb the pilferage that may result from employees entering or exiting through a rear door.
Unfortunately, this is a problem without any easy solution. At best, one should encourage employee-designated parking to be located as far from the front doors of the stores as is reasonably possible.
10. The Inconvenient Convenience Center. Picture a densely populated suburb with local arterial roads carrying significant traffic. These arterial roads, which serve to tie together various subdivisions, are met by other arteries, with traffic lights situated at each intersection.The most convenient place to locate a convenience center in communities with a road system of this type is at intersections where a light will allow for right and left turns onto either of the arteries. But when a community is already developed, all four corners are usually taken up by gas stations, fast food restaurants, and convenience centers built by people who had the foresight to purchase the land at some early stage of the community’s development.
What follows in such situations is the development of middle-of-the-road sites where small strips are built, often on speculation, and then leased to unsophisticated mom-and-pop retailers who live in the area. If there already is a dry cleaner, convenience store, video store, bank, and sub shop in the center on the corner, the same lineup of tenants at the inside location –where left-hand turns may be inconvenient, if not impossible—will have a very difficult time competing.
Sometimes these middle-of-the-road centers work because a developer has found a piece of property with a lot of frontage, and has lined up powerful tenants that can compete with the corner location because of their size. For example, a Blockbuster Video in 8,000 square feet will certainly outdraw the more conveniently located mom-and-pop video store in 2,000 square feet.
But such cases are in the minority. Unless they can attract a dominant tenant of Blockbuster’s type in the pre-leasing phase, developers are best advised to steer clear of middle-of-the-road convenience centers along community-oriented arteries.
Are you a project manager looking to try your hand at a role in the construction industry? At first glance, you may think construction project management takes the same skillset as any other PM career. Sure, it follows the traditional five phases of project management: initiation, planning, execution, performance and monitoring, and closure. But that’s where the similarities end. Construction project management diverges from a typical PM role by demanding and incorporating extensive knowledge of the construction industry, a unique and complicated field. Construction PMs average around 120 responsibilities, according to The Construction Management Association of America, which means they have to be more strategic and thoughtful in working with a slew of moving parts and constant change.
To ensure each responsibility is met and every architect, contractor, and supplier remains on schedule and budget, effective construction PMs should utilize tools and strategies that streamline their work. Fortunately, construction management has become more technical with the development of new tools to simplify many processes. It’s how you implement those tools that counts. These five strategies go beyond PM basics to prepare you for the intricacies of the role and direct your efforts toward success.
1. Create a flow of communication: Among the most important elements of all project management, communication is essential to every phase of any construction project. Good news and bad news are equally important when preparing and implementing a build, so you need to establish a flow of communication with everyone on the ground — and every stakeholder and supplier in the plan. This transparency will make the process smoother and will reduce the number of emails and phone calls whenever a problem arises.
One of the simplest ways to create a flow of communication is a collaborative work management (CWM) tool. By syncing comments, attachments, and calendars, you can monitor news, budgets, and scheduling changes as they occur. A good CWM tool also allows you to relay these changes to other managers and accounting offices in real time, providing a nearly email-free method of project management. That means more time for you to spend at the construction site meeting contractors to coordinate the next stage of work.
2. Make a habit of continuous planning:Planning may be the second of the Project Management Institute’s five phases of project management, but construction project managers should start planning long before actual construction begins, and continue revising and developing plans until the project ends. The design, pre-construction, and procurement stages of a construction project each require extensive planning — and each may need to be revised as the next stage unfolds. Anything can happen at a construction site. If you encounter unexpected environmental problems during the pre-construction phase, the design may need to change. Even slight adjustments can affect the overall plan and timeline.
This remains true during the actual build. You will be working with seasoned professionals, often with decades of experience in electrical engineering, plumbing, scaffolding, and carpentry. While your contractors should be trusted, they still need focused direction to coordinate their efforts with each other. You’ll often need to work with them throughout the timeline to develop and refine plans as delays and equipment failures arise. Like any PM, you will execute and monitor developments, but the planning never ends in construction project management. Collaboration shouldn’t either.
3. Observe and ask questions:There is no industry in which PMs will be found just sitting at their desks, removed from the project and his or her team. Every good project manager becomes an integral part of the process, working figuratively and literally alongside others. Construction project management requires more attention and integrated effort than most industries, because the work is so physical. Field elements can drastically affect the workflow of construction projects. There will be many times when you need to actually see an issue in person before you can resolve it.
Familiarizing yourself with the construction site and the duties of every professional working under you will make you a better project manager. Construction is a constantly evolving industry, with new equipment, practices, and advancements every year. You need to continually educate yourself and learn from others in order to administer and manage a successful project. A great deal of communication may be streamlined, but the work still requires regular site visits and conferences with the contractors and designers on the ground.
4. Use tools to monitor costs and budgets:Most PMs have to think about money constantly, but the permits, wages, materials, and equipment of construction projects in particular are often exchanged between an array of financial sources. From the initial bidding process to the project closeout, construction PMs are responsible for tracking and monitoring all costs, especially as they relate to initial budgets. Ideally, you will have an accounting department for managing contractor invoices, but even then, you have to work alongside your accountants to ensure all direct and indirect costs are recorded.
Considering every other responsibility of a construction project manager, tracking and monitoring finances manually without the assistance of software isn’t practical — or feasible. Even relatively small construction projects contain hundreds of moving parts and individual costs, so to remain effective you need to use software that can also manage costs and budgets. A good CWM tool should allow you and other collaborators to input costs, budget changes, and other calculations to keep track of your project’s finances, alleviating the need to coordinate with every participant or to calculate your budget.
5. Implement automated reporting systems:No construction project manager has the time to reply to hundreds of emails a day — or use the phone to call and address every question about budgets and progress. In addition to concentrating comments and schedules on one CWM, you can cut down further correspondence by implementing automated reporting systems. Construction project management requires the weekly distribution of various spreadsheets and status reports, and automated delivery tools will save significant time over the span of the build. This automation will ensure the right reports go to the right people on time, allowing you to focus on other tasks and communication. Other reporting systems, like Safety and Health Management, can prevent hazards, track incidents, and streamline worksite analysis when issues do arise.
Buying a piece of property is a give and take process. The seller quotes a price and the buyer counters with a lesser price or seeks certain concessions. Negotiations take place until both parties see eye-to-eye and agree on the terms. If both the buyer and seller believe a good deal was made, then negotiations were successful.
Maurice "Moe" Veissi, president elect of the National Association of Realtors says that the first step in negotiating a fair land deal is to make sure that it’s a clinical, not an emotional purchase. When it comes to a land purchase it is not unlike buying a car, he says. For example, would you purchase a new car without knowing what it is you want, what price are you willing to pay, and what the average purchase price is for the car you are eyeing?
"When you walk into a dealership you have a pretty good idea what you want to buy and what your budget is, whether it's $20,000 or $50,000," explains Veissi. "Some people walk out owning a car that they can't afford (and getting financing terms that are not favorable). Often that is because they bring emotion into the buy." In addition, you need to hire professionals with a good track record—an engineer, appraiser, realtor, and real estate attorney. You will avoid a lot of headaches once you start negations, he adds.
There are several considerations that go into buying a piece of property, the greatest of which is of course what the land is going to be used for? Is it to build office space or a retail shop? How critical is traffic flow among cars and/or pedestrians. What kind of competition is in the surrounding area?
Before you head to the negotiation table, ask yourself what you are aiming to achieve out of the land deal. In particular what are your wants versus your needs since the two are comparably very different. As with the car buying scenario, you may want drive an Italian two-seater sports car but you really need a four-door compact vehicle.
Here are five tips to help you land the best deal for the property you want to buy.
1. Review the property.
The asking price may not always be the agreed-upon purchase price. You may try to negotiate a lower price upon review of the current title of land for sale. In reviewing the property, look at the vesting deed (available from the county clerk's office) and the appraisal, advises Veissi. Real estate property interests are usually conveyed by a deed. Sometimes people sell or transfer partial interests in a property. Check the deed to see if there are any easements or rights that have been granted for use of the property without having to own the property. Either the seller or buyer (even both) may order an appraisal. Ask the appraiser for a like property analysis, Veissi suggests. Meaning, request to see a list of like properties that have sold in the area and compare those prices to see if the asking price for the property you seek is reasonable.
2. Obtain a copy of covenants and restrictions.
Ideally, you should employ a realtor and real estate attorney that know what restrictive covenants there are and what you can and can’t build on that piece of property, says Veissi. "But you still may need to do some grunt work. Find out how the property is zoned." Zoning ordinances and regulations are laws that define how you can use the property. Depending on your needs, will you have to change the zoning? For instance, if the property is zoned for an industrial warehouse or office building and you want to build a retail outlet. Also, zoning ordinances will typically limit the total height of a building or require a certain number of parking spaces for a commercial building. Opposition to zoning changes by local residents or other invested parties can be fierce—time consuming and costly.
3. Do a cost analysis.
Calculate all of the costs to bring the land up to the condition you would like. What is it going to cost you to build out the property? That is the cost of acquiring the land, the entitlement, the cost of construction of the land, the cost of marketing to people to build it up if it is a retail space, plus the cost it takes to secure any money (i.e., loans)? You also have to factor in a reserve for costs associated with things such as air conditioners, wall coverings, and so on, says Veissi. "Those things have a shelf life, so, they are going to take x amount of time before they need to be replaced."
Say, the property is going to cost you $150 per square foot to build and you expect a return on your investment at 10 percent. So, 1,000 square feet at $150 equals $150,000; which means you expect to get $15,000 back after your expenses, including management fees and debt service on the property, and some reserve. "Although in today's market, the return on investment is less than 10 percent and more like 6 percent. Calculate the most you are willing to pay the seller based on the outcome of your cost analysis," Veissi advises. Once you have done all of the analysis and appropriate planning, he says, you still need a contingency. You can think you have it nailed down and all of a sudden something crops up, unsettling your plans, he explains.
4. Don’t create problems.
"I've seen both buyers and sellers do this to try and gain some type of advantage in negotiations," says Robert King, a land agent with AlaLandCo; a native of Clay County, Alabama, he has over 10 years experience in marketing and selling property. "It rarely, if ever, works, and absolutely serves to drive the parties further apart." Also, don’t make a laundry list of everything that is wrong with a property you are trying to buy, cautions King. "You must like the property, or you would not have spent all that time figuring out everything that is wrong with it. That just puts the seller on guard and creates a personal barrier." When you impart your wealth of knowledge of all of the property's shortcomings to the other party, you are not likely to make a friend of the seller, says King. You want to be on friendly not adversarial terms with anyone you are negotiating with for the land deal.
5. Make a fair offer.
There may be some back and forth with the seller. You may offer a lower amount than the asking price and the seller in turn will counter with an offer higher than yours. The key is to head to the negotiations table with your well conducted research in hand. Don’t waste time playing games or questioning the seller’s integrity, warns King. "If you educate yourself about the market, you can determine if an offer is a good deal or not. You won’t get taken for a ride."
Settle on a price that is acceptable to both parties. But don’t exceed the price you initially set as your maximum amount to pay. No property is worth paying more than you can afford. "Decide what a transaction is worth to you. A property may be worth more in value to you than the actual appraisal. Take the emotion out of it and deal with it in terms of dollars and sense," confers King. And, "don't be afraid to walk away from a deal, just do so with a handshake and a smile and do not burn that bridge."
No. 1: Texan Bank
Commercial real estate lending for Texan Bank grew by 94.1 percent since 2012, totaling $26.9 million in the first quarter. Meanwhile, all of Texan Bank’s real estate loans grew by 74 percent, totaling $48 million in the first quarter. 72.8 percent of the bank’s loans are currently in real estate.
No. 2: Texas Advantage Community Bank NA
With 92.3 percent in growth from 2012 to 2013, commercial real estate lending grew by $22 million for Texas Advantage Community Bank NA in the first quarter. The bank’s real estate loans grew by 32.2 percent year-over-year to $36 million. Currently, 54 percent of the Houston bank’s loans are in real estate.
No. 3: The Bank of River Oaks
Commercial real estate loans for the Bank of River Oaks grew 41 percent year-over-year to $61 million during the first quarter. All real estate loans grew 20.4 percent to $118.4 million year-over-year, while 49.3 percent of the bank’s loans remain in real estate.
No. 4: Post Oak Bank NA
Post Oak Bank NA saw commercial real estate lending grow 40.3 percent year-over-year to $217.8 million, while all real estate loans grew 31 percent to $414.3 million in the first quarter. Overall, 75.5 percent of the bank’s loans are in real estate.
No. 5: Commercial State Bank of El Campo
Commercial real estate loans grew 36.1 percent year-over-year to $33.2 million in the first quarter for Commercial State Bank of El Campo. Their real estate loans show 64.9 percent growth year-over-year, totaling $93.5 million for the first quarter. Commercial State Bank of El Campo currently has 69.3 percent of its loans in real estate.
No. 6: Vista Bank Texas
Vista Bank Texas had commercial real estate loans grow 35.4 percent year-over-year to $183.6 million during Q1. Its real estate loans grew by 33.6 percent, totaling $346 million. 69.5 percent of the Houston bank’s loans remain in real estate.
No. 7: Prosperity Bank
Commercial real estate loans for Prosperity Bank grew 34.8 percent year-over-year to $1.9 billion in the first quarter. Its real estate loans grew 31.9 percent, totaling $4.3 billion. Overall, 82.4 percent of the bank’s loans are currently in real estate.
No. 8: Integrity Bank SSB
Integrity Bank SSB saw commercial real estate loans grow by 34.3 percent year-over-year to $98.2 million during the first quarter. All of its real estate loans also grew 42.5 percent year-over-year to $220.5 million, while 67.9 percent of its loans remain in real estate.
No. 9: Allegiance Bank Texas
Commercial real estate loans for Allegiance Bank Texas grew 28 percent year-over-year to $275.9 million for Q1. All real estate loans grew 27.8 percent year-over-year to $419.6 million in the first quarter, and 69.9 percent of the Houston bank’s loans continue to be in real estate.
No. 10: Preferred Bank
Preferred Bank’ s commercial real estate loans grew 26.1 percent year-over-year to $20.7 million in the first quarter, while all of its real estate loans grew 7.9 percent, totaling $73.6 million. Overall, 90 percent of its loans are currently in real estate.
Note: This data is extracted in year 2013.
What are the key indicators if an apartment building is a good deal? This will provide the 3 main indicators and rules of thumbs to find out.
You are interested in apartment building investing, and you see a numerous of multifamily properties on sale. You are even considering of making an offer. But how do you know if the asking price is reasonable & fair? And if it’s not, what methods do you use to determine if its a fair market value?
The 3 Key Ratios for Valuing Commercial Real Estate, The are 3 main ratios for estimating the value of an apartment building are:
Key Indicator #1: The Cap Rate
The Cap Rate To determine the fair market value of a building, we need to evaluate its “cap rate” and its “NOI.”
The NOI is the net operating income, and this is the income generated after all expenses but before debt service (i.e. the mortgage payment).
The cap rate is a multiplier that is applied to the NOI to determine the value of a building. When you hear the building is valued at “10 times its net operating income.”The cap rate is the rate of return if you were to purchase the building entirely in cash. Most likely you wouldn’t do that, but this is the simpler way to measure the returns and value of a building.
Imagine you have a property that makes $100,000 per year for you after all expenses (maintenance, fixed cost, utilities) . So the NOI of this property is $100,000 per year.You then find to a group of people who are interested in acquiring your property. You ask them, “What is their offer for your property?” One buyer might say, “One million dollars,” and you question how he came up with this number. He communicates that if he buys your property for $1M and it produces $100,000 in income, then that is a 10% cash on cash return on his money. And this sounds like an excellent investment to this investor.
Another investor increases the offer to $1.1M. The property sells for $1.2M. This generates an 8% return to the buyer if he paid in all cash.In mathematical formula, the cap rate is a ratio consisting of the NOI divided by the price (or value) of the property.In the case of the propery, the cap rate is 8% ($100,000 divided by $1,200,000).
When you are in the market of comparing properties to invest in, you could quickly compare one with another by using the cap rate. If the prevailing cap rate for property is 8%, then you can quickly calculate it’s fair market value if you know its income. Lets imagine our broker brings us a deal and tells us that “buildings in this area typically trade at an 8 cap.” This means that you can use a cap rate of 8% to calculate the fair market value of a property in this area, like this:
Suppose your broker shows your property that shows a net operating income of $50,000. Applying an 8% cap rate, our building will be worth $625,000:The cap rate is useful for determining the fair market value of a building because buildings in the same area tend to share a similar cap rate.In general, the better the area, the higher the prices and the lower the cap rates, typically 7% and under. Conversely, properties in not-so-nice areas have lower prices and therefore have higher cap rates.
How do you determine the cap rate?
The cap rate requires information of the NOI and sales price of comparable properties in the area. The key people who know about both of these are commercial real estate brokers and appraisers.Start by obtaining from the listing agent what the prevailing cap rate is for buildings of this kind and in this area. Utilize that cap rate. If it gets more serious (i.e. you’re going to make an offer), then get a second opinion from several other brokers. Its best to call an appraiser; it’s their business to determine the value of buildings every day, and they’ll be able to give you an unbiased opinion.
What cap rate should I look for?
The rule thumb is to purchase properties at a cap rate of 8% or higher in our current market environment. Note that this is only a rule of thumb, as cap rates can vary from area to area.
Also be aware that for the cap rate to give you an accurate value, you have to base it on ACTUAL financials. Many times you see a marketing package advertising the deal at a 9% cap rate (great!), but then you discover that the expenses are low.
Well, shoot, what value is the cap rate if the expenses aren’t accurate?
That’s why I advise that you use the “50% Rule” for expenses: Assume the actual expenses are at least 50% of the reported rental income. Use that figure and you’ll get closer to the truth.
Let’s talk about the second key indicator, the cash on cash return.
Key Indicator #2: Cash on Cash Return
Cash flow is always king, and the cash on cash return measures how much cash you’re generating every month based on how much cash you invested.The cash on cash return is the cash flow after ALL expenses (including debt service) divided by the total cash invested. So if our annual cash flow after expenses is $20,000 and we put $200,000 into the deal, then our cash-on-cash return is 10%.
How do you determine if this is a good Return on investment?
It depends on your investment criteria, but you should seek for properties with at least a 12% return after you’ve “stabilized” the property.“Stabilized” means that it has an occupancy of at least 90%. This means you could buy a deal with only a 5% cash on cash return in the first year, but your target is at least 12% after you’ve filled up all the units.
Key Indicator #3: Debt Service Coverage Ratio
This is a ratio most often utilized banks to determine the risk level of the building if they were to grant a loan to you. The debt service coverage ratio (DSCR) measures the ratio of net operating income to the amount of annual debt service you need to pay. Typically, banks look for a debt coverage ratio of at least 1.25.
Lets assume that the net operating income is $50,000 and that the annual debt service (principal and interest) is $40,000.
Since we’re above the bank’s minimum debt coverage ratio of 1.25, then 1.3 looks good.
You should look for deals where the DSCR is at least 1.5, which is more conservative and is more likely to keep you out of trouble.
ConclusionNow you know the 3 main indicators for figuring out if an apartment deal is a good one or not. Stick to these 3 metrics, and it will help you narrow down the field of deals and give you a margin for error.
BUT having said that, these 3 metrics (and the rules of thumb) are a bit of an over-simplification of the process of evaluating apartment building deals. That’s because if you buy a value-add deal, for example, where the vacancy rate is low or expenses are high, your 3 indicators may be low, but it may still be a good deal overall. In other words, if we’re going to evaluate a “value-add” deals, we may have to break our rules of thumb for the 3 key indicators.
An Intro to the Three ClassesIt is highly likely you will see something marked as Class A, B, or C, when looking at commercial real estate. However, if you are newer to commercial real estate you may not be clear as to what exactly those classifications mean. These particular classifications were established by the Building Owners and Managers Association, and they have been used to help both tenants and investors in their decision processes, when trying to identify whether to purchase or lease a particular space.
What Are Class A Buildings?Class A buildings are considered the nicest and most valued properties to have. This is true for two reasons. The first reason is because the buildings are in good condition. The second reason is because the buildings are in a good location. Some of the similarities you will see among Class A buildings include the following:
What Are Class B Buildings?Class B buildings aren’t quite as nice as Class A buildings. The main differences are that Class B buildings are usually older, and not quite as up-to-date as the newer Class A buildings. You may have seen these buildings while visiting a major shopping destination. On the main street, there are often great attractions, high quality hotels, restaurants, malls and the sort. Then, when you go off a side street, you may see some nice buildings, but they are not quite at the same level of quality you saw on the main street. This is a good example, to show the difference in the step down from Class A to Class B. They are still nice, but not quite as nice as Class A. You can safely expect Class B buildings to include the following commonalities:
• Fairly good parking lot
• Decent architecture
• Reasonably comfortable conditions, due to elevators, HVAC, possible security, etc.
• Well maintained, but not necessarily abundant with building amenities
Having Class B space can be a benefit, because it isn’t as expensive as Class A space, but it can still be rather nice. Also, Class B locations are certainly nicer than Class C locations. An additional positive aspect about having a Class B building is that you can potentially restore or upgrade it, so that it takes on a Class A quality. If done well, an investor may be able to make a good profit with a property like this.
What Are Class C Buildings?A Class C building is considered to be the lowest valued type of property available on the market. This is because Class C buildings are typically in poor physical condition, need repair and are not located in the most ideal location. Here are some of the common things you could expect to find with a Class C building:
Applying this InformationIf you are looking to invest in a building, a space within a building, or becoming a tenant, it’s a good idea to identify your business needs. Do you need something top-notch, and are you willing to pay the difference for a nice location? Is having a Class A or B location not necessary and saving money by going to Class C a smarter move for you? Do you want to invest in a B or C Class property, and then upgrade it to Class A or B status, making a profit through your upgrades? These are questions you will want to ask yourself when determining your business goals and identifying how best to invest your money.
Commercial real estate investments have the potential to provide investors with hassle-free high NET yields and healthy capital growth potential. This is a draw for any investor. There are, however, some key questions to ask to ensure that you’re working with a quality and secure investment.
1. Is There Sustained Demand?Demand is one thing, but sustained demand quite another. When investing in commercial real estate, you are targeting a specific demographic for tenancy. This makes assessing demand straightforward. When it comes to student housing, for example, there are a number of critically under-supplied cities, where demand will remain high for many years. Despite current demand in other cities, relatively high saturation and a large number of new developments will see demand waiver at some stage in the years to come.
This is a crucial aspect of any development as high, sustained demand will ensure that your investment remains attractive in the long-term, maintaining yields, ensuring ease of exit and improving capital growth potential.
2. Is It A Good Location?It goes without saying that location is a key component of any real estate investment. The same is true for commercial real estate, although the rules are slightly different.
A city that is attractive for a residential real estate investing may not necessarily be profitable for things like student housing, self-storage, car parks or other commercial assets. Thorough due diligence must be conducted to deem why a location is able to attract high occupancy and thus high profitability. In addition to selecting a suitable city for investment, it is also important to ensure that the positioning of a development within that city is attractive, with the different factors impact various sectors.
3. Do The Guarantees Make Sense?The first thing to consider with regard the security of a property’s guaranteed income period is to ensure they make sense. Make local comparisons with other properties regarding rental demands and assess the demand for such a property in a specific location.
4. Can I Trust The Developer?Regardless of how good a location might be, if the developer is of poor quality or inexperienced in their trade, the property may have limited profit potential. The available yields in commercial real estate have attracted a lot of new and inexperienced developers, who must be avoided.
It is also worth looking at the performance of past developments (ideally in the same sector) in order to ascertain whether they have a good track record.
5. What If I Need Access To My Money?A flexible exit strategy is an absolutely crucial element in any commercial real estate investment. Although the sustained attractiveness of your investment property is a major element of this, the specific investment conditions you agree to also have a huge influence.
Long guaranteed income periods (with attractive yields) represent the best conditions to ensure a flexible exit strategy. They provide investors with the opportunity to leave at any stage during the investment cycle, while presenting buyers with attractive conditions on a fully operational and proven development. Healthy capital growth of up to 40% is also highly achievable, with initial high yields suggesting a below market value investment level – often the case with new builds especially. Such flexibility is not available with shorter guaranteed income periods, due to less attractive investment conditions being available at resale.
Another common investment condition is guaranteed buy-backs. Although these can still provide flexibility, they have to be heavily scrutinized before investing. Any guaranteed buy-back should be based on a tried and tested business model and not mere projections.
6. Does It Fit With My Objectives?Two key elements of security that some investors overlook is:
7. What Are The Risks?A key aspect of a successful investment is mitigating risk. In commercial property, this can be achieved by considering all of the above, while also ensuring that contracts are robust and asset-backed (it is common for developers to set up third-party shell companies through which they underwrite guarantees – this is highly insecure, as they commonly have zero assets).
It is always a good idea to consider the worst possible scenario. What impact will this have and what security is in place for you to protect you against it?
1. Underestimating the Project:
One of the most common – and costly! – reasons a construction project may fail is due to inaccurate estimates. Miscalculations, specification errors, omissions, excluded permits, and changing market conditions (e.g., prices of materials and labor) can all lead to costly overruns, leaving the contractor stressed and the client unhappy.
Tips for Better Estimates
Good project managers double and triple-check their numbers to prevent errors and cost overruns within projects. Have a detailed checklist and project plan to make sure you prevent omissions and catch errors in specifications. Before placing any orders, review your estimates to make sure no prices have changed and that you didn’t overlook anything. By doing this, it gives you ample time to catch raises in cost and either inform the business owners or adjust the pricing to stay within budget.
2. Scope Creep
Scope creep describes the process in which the amount of work grows beyond the original agreement. The three main causes of scope creep include:
Avoiding Scope Creep
Encouraging a client to do their due diligence at the beginning of the project allows the process to go much more smoothly and provides clear objectives to both parties about what needs to be done. Clearly identify what the scope of work is to your client in terminology they understand. Many times, scope creep doesn’t happen out of ill-will, it happens because the client thinks what they’re asking is a part of the work you agreed upon. Another good way to avoid scope creep is to communicate that while you’re capable of handling their extra requests, there is a premium for add-ons. Above all else, get everything in writing so that you have a reference point.
Government approvals, site regulations, and permit delays slow down the timeline for your project and can cause costly overruns if not accounted for correctly. Depending on your location, you may need to consider union requirements and area-specific rules such as building codes. Making sure you have the right licenses before beginning a project is also essential to preventing delays.
Keep Your Project on Track
During the planning process, it is important to understand the site area and any regulations, rules, or requirements that need to be considered before beginning the construction process. Thorough site surveys and in-depth investigations can prepare you and allow for proper planning so that any delays won’t cause the project to run overtime and cost you more money.
4. Surprise Conditions
Conditions unknown to the project manager can quickly become a problem and run up the costs of a project. Natural disasters, asbestos, mold, and design or structural issues are the main culprits and can be hard to plan for during the bidding process. However, overlooking these potential issues can result in higher costs and risks associated with the project.
Failure to Plan is Planning to Fail
Some of these conditions cannot be controlled such as weather or natural disasters. Having proper insurance in place can help minimize the damage, but the best way to avoid these surprising costs is by hiring an experienced contractor who can identify some of the informative signs associated with these problems. Check for a Concealed Conditions clause and prepare a pricing plan structure to account for the unknown costs so that you have a safety net, should you need it.
5. Unclear Specifications
Clients don’t always understand everything that needs to be fleshed out in order to make sure necessary objectives are clearly identified and the construction project runs smoothly. Unclear specifications can become very costly, especially when the owner’s and contractor’s interpretations differ significantly.
Open the Lines of Communication
When dealing with a client, make sure they understand and are overly specific about the products they want, how they want them to be installed, descriptions of the material they want to be used, and how they envision the end product to look. By doing this, you eliminate rework and eating extra costs that could have happened if the owner wasn’t happy with the final product you chose. Also, by hiring a contractor to make sure every objective is clearly specified and met can prevent this issue from happening.
6. Financing Issues
You’ve agreed to the scope of work and a timeline for the project. Things are going smoothly until unexpectedly, the owner runs out of money to finance the project. Construction is stalled and delays the project. You lose out on a significant amount of time and money as a general contractor because that business might not come back if they can’t provide the funds.
Create a Sound Budget
A clear plan that details expenses and projected costs gives the owner an idea of if they can afford to go ahead with the project or not. It’s important to also establish a consistent plan for payments that provide clear expectations for the owner. The more detailed and upfront you can be with your client, the more success you are going to have.
7. Unreliable Workers
A lack of qualified workers or a team that is unreliable is a recipe for disaster when it comes to construction projects. It is especially important to vet your subcontractors, who can tarnish your reputation if they don’t do their part or, even worse, don’t pay their suppliers. Because the job relies so heavily on other people, it is important to know who you’re working with and if they can be trusted to do a good job.
Building Relationships Improves Performance
Working with repeat subcontractors that you’ve done business with in the past is a smart way to help minimize the chance of these issues occurring because you’re already familiar with their work ethic and capabilities. If you don’t have the option of using someone you’ve previously done business with, then it is necessary to evaluate potential workers by looking at their recent projects and checking for their contractor’s license to properly deduce whether or not they would be a good fit. As your business grows, it becomes harder to use only workers you trust. To account for this, evaluate comparable work in the area and look to hire people that were involved on that project.
8. Communication Gaps
Effective communication is extremely crucial to the success of a any project. When any of the parties involved aren’t getting the right information at the right times, it can become a very costly issue. It is important to establish a chain of command to make sure that all parties are getting the necessary updates in regards to changes on the project, design, plans, specs, or timeline.
Regularly Update Parties Involved
By establishing a chain of command, you know exactly who your point of contact is to communicate any changes, requests, or problems that may come up during the duration of a project. Everyone is held accountable for their specific duties and makes sure the message gets transferred to the corresponding parties involved. For example, the owner may communicate with the architect who will then share the information with the general contractor so that everyone is on the same page. Clear and concise communication can either make or break your project.
9. Improper Planning
Tight, inflexible schedules are common in construction projects. If you don’t account for surprises or delays, a project can take longer and cause cost overruns. It is extremely important to constantly monitor project tasks closely to ensure they’re matching up with the assigned duration given when planning. Issues can frequently arise, so making sure the details get incorporated into the plan and communicated with the necessary parties (i.e., client, architect, contractor, etc.) is critical.
Before any successful commercial hotel construction project begins, an “A Team” should be assembled: lender, architect, and contractor. The team works together with the owner to ensure a successful project and supports the owner in decision-making. Some critical elements of all construction financings include sufficient capitalization and budget, timelines of the build-out, and the quality and strength of the contractor and architect.
When the lender “builds” the project, a number of questions must be answered. Is the contract inclusive? An experienced lender checks contingency, permits, scope of work. What is and is not included as part of the project? Landscaping, security systems and phone generally are not included in the contract. Is the property properly zoned or does it need to be subdivided? What are the timelines on zoning and permits? What fees must be paid?
Many municipalities require money up front to review drawings, go through the planning process and issue permits. What is the deadline for closing on the land or building? Many times, a lender will provide a “bridge” loan to carry the project until the permit is issued. How many months will construction take? An experienced lender will add additional months into the financing to cover any delays.
Who will be monitoring the construction process? Will qualified inspectors look at the project while it is under construction? It is in the best interest of the owner to have qualified inspectors review the work as it is completed.
PaymentsIn addition, inspections allow for a timely payment schedule to the contractor. How much retainage will be held? Retainage is a percentage of the contract that is held back by the lender on each “draw,” or request for payment. Retainage protects both the owner and the lender from liability as well as ensuring punch-list completion. Once all of the final punch-list items have been completed to the owner’s satisfaction, the retainage is paid to the general contractor.
How is the contractor paid? How does one ensure against mechanics’ liens? Mechanics liens are filed by the subcontractor or general contractor against the project collateral. A qualified lender will have a set payment procedure in place to ensure the contract is met and the contractor is paid in a timely manner. Generally, a contractor will be paid once an unconditional lien release is received by the bank. This ensures that a mechanic’s lien is not filed because the contractor is acknowledging that he is being paid the amount due at the time and agrees not to file a lien.
If a mechanic’s lien is filed, a lender cannot disburse any additional funds until it is cleared. This can cause significant delays to the project. Does the bank require a bond or another type of performance guaranty? If so, there are costs to the owner on these options that need to be included in the project. How does the bank approve a contractor? Lenders who specialize in construction will want to see a statement of the contractor’s qualifications, references and financials for approval of the contractor.
It is essential that a contractor and architect have hotel experience. Without it, the building will be completed to code and general commercial specifications but might not be the building the owner is 100 percent happy with; issues such as flooring, HVAC and insufficient plumbing and electrical can cause cost overruns or a miscommunication between the parties.
Finally, what type of loan will best fit the owner’s needs? Before determining loan type, the lender will need to know what type of hotel is being constructed. A conventional loan is usually the first type of loan requested by an owner. Conventional loans are completely driven by loan to value (LTV) requirements. Conventional loans on hotel projects are generally granted up to 75 percent LTV. This means that if a property appraises for $10 MM, the maximum the bank can lend is $7.5MM. The owner would essentially be required to have a down payment of 25 percent plus all additional soft costs.
If the appraisal came in lower than the $750,000, the owner would be required to put additional money down to make up the difference. Conventional loans for a construction project are allowed a maximum LTV and may or may not include an interest reserve to pay loan payments during the construction period.
Fees also may not be included as part of the project. These loans may or may not be fully amortizing and contain a call feature as part of the permanent financing. When possible, a permanent loan should be in place before starting a construction project.
ProgramsThe SBA 504 loan program will allow the lender to include all costs of construction. The 504 program will allow up to a 90 percent advance rate on multi-use properties and an 85 percent advance on special-use properties. This program is for “hard” assets only and will not include working capital, inventory or short term equipment. The appraisal requirement on the 504 program is for the building-to-value with all costs included except equipment. If the appraisal were to come in low, the same rules apply as to conventional loans in that the difference of the cost versus appraisal will be covered by the owner.
The 7a loan program will cover all of the costs of construction but will also allow other uses to be part of the request, such as working capital and inventory. These loans automatically convert to permanent, are fully amortizing and do not have call features. The 7a loan is not a loan-to-value-driven program and there is no maximum LTV.
The key to a successful construction loan is to ensure that qualified people are on the team. Although the owner may receive cheaper bids, using professionals who specialize in hotel construction will end up costing less and ensure that the project is completed on budget and on time.