Cash Is King In Commercial Real Estate? You’d Better Believe It

2 years ago

As a commercial real estate investor, you’re well aware of the fact that converting commercial real estate into a profitable venture takes time, particularly if you’re doing a “buy and hold” strategy, rather than a “buy, improve, and re-sell” strategy. In a nut shell, cash flow is “income in minus expenses going out” – every commercial transaction requires that you make some profit on the investment.

To succeed in commercial real estate, you need to have a cash flow position that works in your favor. There are several criteria to consider in this. You need to have a realistic assessment of both the initial costs to purchase the property, and what needs to be done to “keep the lights on” in a functional context.

In acquiring the property, it’s all too easy to look at the “down payment” as the initial cash outlay, without factoring in other expenses required to acquire it. First, look into the due diligence costs of getting the property – the legal assessments, the zoning checks, the residential and fire inspections. These will all act as a hidden source of initial expenses in acquiring the property. If you’re buying an option on a lot for further improvement with no existing structure, you’ll have to put down a deposit, and pay for engineering assessments and similar plans. Thus, the initial payment may be higher than the “down payment value”.

When you’ve paid for the property, you’ll also have monthly attendant costs. These range from construction costs for improving a vacant lot (ranging from materials, architect fees and labor) to monthly insurance premiums for fire and flood insurance, to interest on the initial payment to get the plot, to labor costs for running a leasing office. Regardless, to get your investment to pay out, there will be incidental and attendant monthly expenses to running your property.

This makes it critically important to have a healthy cash flow to make this commercial real estate investment work for you, and this cash flow has to be stable in the long term – even in the “buy, improve, and turn” market, it can take over a year, and often two or more to re-sell a property you’ve improved. To determine how much cash flow you’re going to need, look at the following:

How much is the monthly finance fee? This is the check you write each month to the bank for the commercial mortgage. If you’re part of an investment group, look at what your percentage share of the monthly income will be instead. In general, you want rental income to at least double your monthly payment on the property; most commercial properties run at 75% occupancy as a baseline, so set your rents accordingly.

Second, how much monthly labor and insurance costs are tied into maintaining the property? You may need to have an office on site to handle leasing, customer move-in/move-out, maintenance issues and light construction. This also needs to be debited from the account.

Ultimately, you want the property to generate some income for you in excess of its expenses each month to be worth holding on to, and it has to do this consistently, with less than complete occupancy. There are several strategies you can take on with this.

In the short term, look for immediate profit centers – if you’re renovating the property, and know it’s going to be a year long project, look to rent out the unrenovated sections as storage units to local businesses, or temporary warehouse spaces. Lots of small businesses in the midst of moving need month to month storage, and an apartment that’s due to be renovated (but isn’t rentable now) can serve as such – particularly as it’s climate control. Another place to look into rental income and short-term profit centers are by converting volume in the building to rental office space, particularly if you can get good Internet connectivity set up, or have a ramp suitable for bringing office equipment into the facility.

If, in assessing the property, you can’t make either of these short term revenue sources, consider bringing in multiple investors to share the risk and the profit centers. In particular, multiple investors can result in a solid cash cushion for the “buy and re-sell” strategy, particularly in the rapidly turning residential market.

If you have any success at this business, consider the revenue source of selling yourself; you have a rare and valuable knowledge and skill set if you’ve successfully developed commercial retail property, and can make a decent amount of money as a consultant. The best part about consulting jobs is that they can be fairly short term commitments – paid consultations and evaluations – which means that when your property needs your full attention (such as selling it, or preparing to sell it, after a renovation), that you’re free to do so. In a lesser light, if you have a knack for writing, consider an email newsletter, or an e-book, or even one you sell on through Lightning Source.

If you have properties with high occupancy rates and good net turn on rents, consider holding on to them to provide a cash flow for financing renovations and future acquisitions. Even if your commercial real estate strategy is to buy and turn quickly, having some revenue producing properties can really help to smooth out the ups and downs of an investment driven cash flow.

Tony Seruga, Yolanda Seruga and Yolanda Bishop of specialize in commercial and investment real estate. As of May, 2006, they and their partners are managing over $600 million dollars worth of new projects.

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