Analyzing potential retail income property is an essential part of determining whether or not a particular property is a good deal. However, each commercial property type has specific factors that you will need to examine in order to get a complete picture of its potential value.
While there are certain well-known factors to look for when analyzing a commercial property – such as net operating income, expenses, and so on, there are several key factors that you need to consider when adding a retail income property to your portfolio.
Compare The Price Per Foot For Each Retail Income Property
The standard measure used to compare retail income properties is by price per square foot. It’s not only an easy way to compare properties who may differ greatly, but it’s also a good way to check if the seller’s asking price is in line with similar properties in the area.
However, be sure to check that the numbers you’re using are realistic for the type of property and location – it sometimes happens that sellers overestimate the property’s income while understating the expenses.
Make Sure To Use Recent Property Tax Rates In Your Analysis
If you calculate your estimated property taxes based on numbers given to you by the previous owner, you might be in for a quite a surprise.
If the previous owner of the property has owned the property for a number of years, they will be paying property taxes commensurate with the cost they paid for the property some time ago.
Your property taxes, however, can be as much as 3-5 times higher, since a tax assessor will re-assess the property’s value after you purchase it. To avoid this, contact the tax assessor’s office and ask how a transfer of ownership might affect your property’s taxes.
Check Your Expense Scenarios With An Experienced Professional
Unless you have extensive experience with similar properties in the same location, your estimate of certain expenses might be inaccurate.
Do your best to come up with a round-about number, but make sure to check your estimates with a professional who is experienced with your property type, and with the area, the property is located in.
For example, if you’re planning to add value to a retail income property by raising the rent, check the rents with a rent survey, or locate a broker in the area who can tell you the average rents.
Or if you’ve determined that you can increase your net income by cutting back on several expenses, check with an experienced property manager to determine if this is actually feasible for your class and type of property.
Be Wary Of Tenant Concessions
It’s not uncommon for owners of a failing retail income property to offer concessions to tenants in order to encourage them to lease a retail space or prevent tenants from leaving the property.
However, as the new owner, this could result in you losing a portion of your net income over a lengthy period of time – especially if there are several tenants with rent concessions. Be sure to ask the seller to note which tenants have concessions on the rent roll.
In the same vein, you’ll also want to match estoppels to rent rolls.
Estoppels are provided during the due diligence period and are used to confirm the details of a lease, as well as determine whether a tenant claims any defaults by their landlord.
The rent roll lists the names of each tenant, how much they pay to lease the retail space, and when the lease ends. Because estoppel is not sent by the owner, they may reveal additional “unwritten” agreements between the present owner (if any).
In addition to the above, tenant estoppel will also help you verify the total income of the investment property.
Determine The Parking Ratio
The space allocated to parking in a retail center is an important part of a retail property’s success; not having enough parking could present problems later on.
While different centers require different ratios of parking, generally there should be five parking spaces per 1,000 square feet. Four of these spaces should be in the front of the store, rather than the sides or the back.
Another important point is to consider where parking for employees will be. Most employees prefer to park in front of the store because it’s more convenient. Most employers prefer their employees go through the front door in order to minimize theft.
However, this often results in prime parking space being taken up by employees – which forces shoppers to park in the rear or to the sides. Although there is no easy solution, some owners have added clauses in the lease which require employees to park in the rear or sides of the parking lot.
Run the numbers by your lender early on in the process.
If you have a lender already lined up for your next retail income property, then it’s a wise idea to share your numbers with them early on.
They may be unwilling to lend money for certain types of properties – for example, strip or neighborhood centers. They might also have the insight to offer about whether or not the deal is actually as good as it seems, or have inside knowledge about one of the anchor tenants, or the location.
Account For Replacement Reserves
As a commercial property owner, you’ll need to set aside a certain amount of money each year to cover expenses related to improvements and repairs on your retail income property. Some lenders require owners to fund a replacement reserve account at the time the property is purchased.
These expenses differ from operating expenses, since technically operating expenses refer to expenses necessary for the day-to-day operation of the property. In addition, reserve money isn’t spent – it is merely moved from one place to another – and therefore cannot be deducted on your income taxes.
In order to determine how much money to set aside in a replacement reserve account, you should first list all major expenses that might need to be made in the future.
For large expenditures, such as replacing a roof or an HVAC system, take the industry standard for the lifespan of the item, and subtract the number of years already accrued. Then divide the cost of replacing the item by the number of years left in the lifespan of the item.
So for example, if a roof typically lasts 20 years, and ten years have already passed, then you divide the cost of a new roof by ten. The answer is the amount you would need to put aside each year in order to budget for a new roof.
Do this for every major expense. Once you have all the numbers, add them, then decide how often you’ll contribute to this fund. If you plan to contribute yearly, then upon purchase of the property you would set aside this amount of money. If you plan on contributing on a monthly basis, then divide the number by 12 – this is the amount you would be required to contribute monthly.
Once you’ve done this, you’ll have a good estimate of how much of your NOI will need to be siphoned off in order to fund this account. While for a newer property this should be less of an issue, an older property might need significant influxes of money in order to account for poor maintenance.
This would require you to find other ways to add value to the property in order to make such a property feasible, especially since it will probably need numerous cosmetic changes in order to appeal to new tenants.
A break-even analysis allows you to calculate the potential risk of a property investment before purchase. Lenders also use the break-even ratio to determine whether or not to provide financing for a property.
In order to calculate the break-even ratio, you’ll need these numbers first:
- annual operating expenses
- debt service
- gross operating income
Add the debt service to the annual operating expenses, then divide the resulting number by the operating income. This number will reveal what occupancy percentage you need to have in order to pay the mortgage and other expenses on the property without going negative.
However, if you end up with anything above that number, then you’ll end up with positive cash flow.