When Purchasing Commercial Real Estate, What Is a Fair Cash Flow Return and Expected Cap Rate?

May 14, 2015

There are many different sectors of commercial real estate making it difficult to determine a fair expectation of cash on cash return or paying a cap rate that is not excessive.

An investor in commercial property can select among groups such as retail (more expensive), office, warehouse, medical, apartments, storage, and student housing as typical examples. My suggestion if you can afford it is to diversify and homogenize the returns among different groups.

Retail and apartments today bring lower compressed cap rates for their returns making them more expensive.

Office and warehouse have HIGHER cap rates and higher returns.

Medical, student housing and storage in the middle of the pack. Cap rates can be as low as 4 percent and as high as 8 percent for decent investment property that is not considered low quality. The higher the cap rate the more risk is associated with the purchase.

commercial real estate

What Will Determine The Cash Flow Of Commercial Real Estate?

Length of leases, quality of tenants, location of investment property, type of building and tenant all determine the cash on cash return which is also controlled by the lenders and what the rate will be for the asset groups.

If the rate is low like for apartments as example the cash on cash flow can be higher for the margin between cap rate and loan rate is wider.

Other considerations when selecting commercial real estate is how much management, repairs and time needs to be spent on the property. After all most investors have other jobs and don’t have the time to spend on the commercial real estate or want to pay extra for managers to take care of the buildings.

Triple net property has the least amount of effort while apartments and student housing or multi tenant office the most. Management fees range from 3 to 5 percent of the gross rents collected.

Today for those that are considered accredited investors have other choices that can diversify with less equity placed into different asset groups but give up control of owning one building of their own.


Looking To Buy Commercial Property?

Find out why triple-net lease real estate investments should be part of your investment portfolio.