Determining Your Investment Property’s Cash Flow Potential
In the ever-evolving world of real estate investment, commercial properties continue to be an attractive option for savvy investors. When considering a commercial investment property, one of the key factors that can make or break a deal is the property’s cash flow potential. Understanding how to accurately determine the cash flow potential of a commercial property is crucial for making informed investment decisions and maximizing returns. Ali Choudhri, CEO of Jetall Capital, and one of Houston’s largest private commercial real estate owners provides some insight from his decades of experience.
To shed light on this important aspect of commercial property investment, Jetall Capital, a leading real estate investment firm, offers some expert insight and guidance. With three generations of experience in the real estate industry, the family behind Jetall Capital has compiled a comprehensive guide on how to evaluate and determine the cash flow potential of commercial investment properties.
Analyze Rental Income: The first step in assessing a property’s cash flow potential is to analyze the income generated by the existing tenants.
1) Gather Existing Tenant Cash-flow Data: Collect all relevant details regarding the property’s rental income. This includes the current rent being charged to tenants, the number of units or spaces being rented, and any additional sources of rental income.
2) Estimate Potential Future Rental Income: Evaluate the potential rental income by researching the market and comparing rental rates for similar properties in the area. Consider factors such as location, property size, amenities, and demand to determine a realistic estimate of the property’s rental income if it were fully occupied, and the time frame to increase occupation.
3) Deduct Vacancy and Credit Losses: Account for potential vacancies and credit losses. Vacancy rates can vary depending on the property type, amenities, location, external factors, etc. – so research historical vacancy rates in the area to estimate a reasonable percentage vacancy and bad debt in the future, and adjust expectations based on your estimates. Deduct this expected percentage from the potential rental income to account for vacancies and credit losses.
4) Calculate Effective Gross Income (EGI): Effective Gross Income is the rental income remaining after accounting for vacancies and credit losses. Subtract the estimated vacancy and credit loss percentage from the potential rental income to obtain the property’s EGI. This number is important in determining property value.
5) Account for Operating Expenses: Consider all the operating expenses associated with the property. This may include property taxes, insurance, property management fees, maintenance and repairs, utilities, insurance, and any other costs directly related to managing the property. Sum up these expenses to calculate the total operating expenses.
6) Calculate Net Operating Income (NOI): Subtract the total operating expenses from the EGI to obtain the Net Operating Income. The NOI reflects the property’s profitability before considering debt service or financing costs. This is your gross profits from the property.
7) Apply a Capitalization Rate: The capitalization rate, or cap rate, is a measure used to determine the property’s value based on its income potential. It represents the expected rate of return on the investment. Research similar properties in the market to determine the appropriate cap rate. Divide the NOI by the cap rate to calculate the property’s value.
It’s important to note that this is a simplified overview, and additional factors such as property condition, market trends, location, anticipated or planned improvements, and potential for future rental increases should also be considered when evaluating a property’s value. Engaging the services of a professional appraiser or advisor can provide more accurate and detailed analysis tailored to your specific situation.
“Property ownership sustains long-term value to you and your shareholders or family. Understanding the cash flow potential of a commercial investment property is vital for you if seeking to make informed decisions and achieve long-term success in your portfolio.” – Ali Choudhri, CEO at Jetall Capital.
Investing in commercial properties offers numerous opportunities for wealth creation, but it also carries substantial risks. By employing diligent research and analysis, prospective investors can mitigate these risks and identify properties with strong cash flow potential and high likelihood of long-term value appreciation.