Some recent history
A local business owner in my area asked me for some advice recently on evaluating a mixed-use commercial building he was considering purchasing. He appeared to be stuck on the concept of the absolute price he should offer, based on what a commercial building down the block had sold for within the prior year. I had to remind him that with commercial property, cash flow is king in determining market valuation.
In residential home valuation, then comparable sales are the best way to come up with a good market value for a property, as most appraisers will attest. And appraisers are who banks rely upon to give their unbiased valuations so the bank can feel secure in offering a mortgage note for any given loan to value ratio to a borrower. But with commercial real estate, appraisers most commonly use the income approach to market valuation. They’ll analyze closely all expense items, current rent roll, vacancy rates for the area, as well as an amount for maintenance, then come up with a projected income statement to best determine market value for any given commercial property.
Checking your figures
Ultimately, I simply advised this business owner that he must check all figures given him by the seller as to expenses and rent roll (just like an appraiser would). And most importantly, he should not dwell on what the guy down the block sold his building for last year. Apples and oranges, I reminded him. Just look at the cash flow – the most accurate data for a cash flow you can get. Once you have an accurate picture of the cash flow number, you can use general multipliers for your area (usually within the 8 to 12 range, based on desirability of your area) to determine a market valuation.
The owner-occupier’s advantages
In the case of this business owner, he had a leg up…not only on his competition for the building, but for a commercial loan as well. His fast food business was already a tenant of the building, which also included residential apartment units upstairs. This is an excellent scenario for lenders, who look more favorably (read: better terms and interest rates) on giving mortgages for owner-occupied commercial property. In addition, he could possibly qualify for a Small Business Administration (SBA) backed mortgage note. So his options for lending increase, and thus puts a downward pressure on the terms he will be given, helping his overall cash flow as he can obtain the best loan possible. In addition, owner occupied commercial property loans are offered more flexible terms, with longer payback periods…another major advantage over non-owner occupied commercial property.
Non-owner occupied investment property traditionally rely on standard commercial mortgages for their financing. Many do some partial, or even total owner-financing as well. Again, if the owner is willing to offer you excellent terms, then by all means he will get closer to his asking price. As long as the cash flow works out well in your favor, take the terms of the mortgage note in return for a higher absolute price.
photos courtesy of businessfinancespecialist.com, 123rf.com, melbournehomeloans.biz, whatsthepointofaventura.com, thealternativeinvestor.net