Financial literacy isn’t something that’s given enough emphasis in everyday life. Perhaps this is the reason there’s such a polarized view of wealth. Most individuals are either introduced to commercial real estate investing based on:
- Someone they know who’s done it before
- Stumbling upon the subject, and then gaining interest
- Upgrading from single-home investments to multiple commercial investments
To be successful in this type of investment, or any other for that matter, investors much first invest in themselves – through financial literacy.
Commercial real estate investors should be aware of what constitutes:
A Bad Vacancy Rate – While no amount of vacancy is good, some numbers depict that the investment is not yielding good or sufficient returns. The ideal rate is 100%, which even non-investors know. For properties with very high vacancy rates, it may be due to a bad location, or the renters’ inability to get zoning approvals. Be sure to conduct a due diligence of the entire property before committing an investment. One invaluable advice is to check performance reports from previous years. This depicts a true reflection of how the property will perform in years to come.
An Effective Income to Expense Ratio: Commercial investors typically dedicate at least 45% of earnings to the overheads of managing the property. These overheads include taxes, insurance, management, etc.
Cash-on-Cash Return: When you make a capital investment in a commercial property, how long are you willing to wait for that same return? Before answering that question, here’s one key term to know: cash-on-cash return, which will help investors estimate this number. This term is one of the primary factors that veteran investors will examine, before making a purchase. It’s calculated by:
1. Determining the annual cash flow
2. Adding the initial investment, plus all operating expenses
3. Dividing the addition by the annual cash flow balance (before taxes)
4. Multiplying the result by 100.
As an example, here’s a hypothetical cash-on-cash return formula:
- An investor down pays $300,000 on a property
- The operating expense for the year is $35,000
- The annual cash flow is $50,000
- The cash-on-cash return would be $50,000/ ($300,000 + $35,000) = 15%
There are many other terms for commercial investing. To get acquainted with them, be sure to check out reliable sources of information, such as books in the library, or ebooks written by financial experts.
Investing in financial education doesn’t have to come with a high price. There are credible sources of information, such as Jason Hartman’s glossary of investments terms, which readers can peruse – cost-free. (Top image: Flickr | PNNL – Pacific Northwest National Laboratory)
The Commercial Investing Center Team