Commercial Real Estate Investment Strategy For 2008

by : Allen Cymrot



The dictionary definition for strategy is as follows: A plan of action or policy designed to achieve a major or overall aim. When applied to purchasing commercial real estate, it means setting the rules for achieving the desired return on investment with the least risk.

Before we set any rules, we need to know the current issues that will affect the value of commercial real estate. A perfunctory list would include the war in Iraq, terrorism, illegal immigration, the trade imbalance, energy dependence with unfriendly dictatorships, nuclear proliferation, the weak dollar, a softer economy, healthcare problems, environmental issues, a decline in educational performance, a subprime credit crunch, decreasing job creation, a questionable future for social security, increasing energy costs, and tax reform. Not exactly a favorable climate for investing in commercial real estate.

When NetGain analyzes the business cycles for the last one hundred years, history has shown that when compared to everything looking rosy, now is a better time to invest. Today's successful investors will be the ones who ignore naivety and greed. That said, current times dictate that you don't buy real estate using the greater fool theory (there will be a greater fool than you who will buy the real estate from you). The present economic climate dictates that you adhere to sound economic guidelines. Following is a composite list of those guidelines that NetGain believes are a necessary requirement for successfully investing in commercial real estate for 2008.

- Buy commercial real estate that has a positive spread. Positive spread means the capitalization rate is greater than the annual percentage rate (APR) cost for debt service. Negative spread is a guaranteed mathematical loss.

- Do not use projected income when computing the capitalization rate. Use current collected income.

- Do not use guaranteed income when computing the capitalization rate. Use market rate rents.

- Do not extrapolate physical occupancy into income when computing the capitalization rate. Use economic (collected) occupancy.

- Use current annual operating expenses when computing the capitalization rate. Do not use some short-term amount that is amortized into an annual amount.

- Include adequate operating expenses for a preventative maintenance program.

- Factor in all the costs for renewing short-term leases when computing the capitalization rate.

- Do not buy commercial real estate with a negative cash flow. Buying commercial real estate with a negative cash flow is the same as buying a failing business.

- Do not use the gross rent multiplier (GRM) as a leading indicator. Use it as a validating indicator.

- Do not use replacement costs as a leading indicator. Use it as a validating indicator.

- Set aside adequate reserves. Each property is unique as to age, amenities, lessees, etc. The current cycle (soft market or recession) will pass and you do not want to run out of money before it ends.

- Do not finance the property with a short-term maturity.

- Avoid a variable rate mortgage.

- Use NetGain's Economic Valuation System (EVS). As the leading proactive due diligence system on the Internet, it is a must when buying commercial real estate in today's market climate.