Commercial Real Estate Basics

Commercial real estate is a term that describes property that is used for business purposes. This includes a wide variety of property types, of which the popular categories are Apartment, Office, Retail, Industrial, Health Care & Senior Living, Restaurants, and Public Storage.

Since commercial real estate involves business use, property values are typically quantitatively determined. Commercial real estate prices are mainly determined by analyzing risk-adjusted cash flow estimates. Discounted cash flow (DCF) valuations are our specialty. Investing is about understanding and quantifying risks and balancing those considerations with cash flow yields on invested capital.

The most widely quoted measure of value for commercial real estate is something called a “cap rate,” or capitalization rate. It is akin to the “P/E ratio” often quoted as a measure of company stock value. Cap rates are calculated by dividing net operating income by a property’s value, or the price paid for its acquisition:

Commercial real estate statistics are tough to come by without paying professional subscription fees for investment research services. Here are some free cap rate statistics we came across from RealtyRates:

Commercial real estate risk is often analyzed as a premium over “risk-free” rates, or treasury yields. Essentially, investors need to ask themselves how much they value commercial property cash flows relative to risk-free investments. The answer comes to a determination of relative risk for those cash flows. Here’s a table calculating commercial real estate cap rate spreads over 10-year treasury bond yields:

The risk spread table above shows us that market participants in 1992 considered Industrial properties to be the highest risk, with cash flows least certain as evidenced by investors requiring a 6.33% risk premium for holding this property type. Self Storage and Restaurant properties followed closely behind with risk premiums of 6.31% and 6.1%, respectively.

Markets change, and so do investors’ return expectations and risk perceptions. In 2010, risk premiums show that investors now perceive Restaurants, Self Storage, and Retail properties to be highest risk, while Apartment buildings remain in the #1 risk position.

There is a good deal of analysis that can be done for commercial real estate investing. Contact Us for more information.

South Bay And Manhattan Beach Commercial Real Estate Statistics:

Our team is currently working on compiling historical and current South Bay and Manhattan Beach commercial real estate statistics. Understanding Manhattan Beach cap rates and commercial property cash flows and risks to cash flows is absolutely necessary before deciding to invest in this market. Our team consists of local Manhattan Beach and South Bay residents who know this market and can provide candid advice.

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