Are you considering a Chicago real estate investment? Particularly in the commercial real estate sector?
Whether you are looking for a new investment opportunity or a new space for your business operations, breaking into the competitive and complicated commercial real estate industry in Chicago can be daunting.
As industry leaders in the market, our team of experts at Cawley Commercial Real Estate have compiled this handy list of the top 8 questions to ask as you start this challenging but rewarding process:
1) What do I need to know before buying commercial property?
2) How much money do you need to invest in commercial real estate?
3) How do banks value commercial property?
4) How much does an appraisal cost for commercial property?
5) How long is a commercial real estate appraisal good for?
6) How do you negotiate a commercial property purchase?
7) What is a good ROI on commercial real estate?
8) How can I improve my commercial real estate?
Read on to discover more about each topic to inform the next steps of your commercial real estate purchasing process.
1) What do I need to know before buying commercial property?
This is potentially the biggest question of the bunch. Generally, everything you need to know as you get started can be broken down into two categories: exploring your investment aspirations and evaluating market research.
The first point to consider is why you are interested in investing in commercial real estate. Do you want to diversify your investment portfolio? Are you looking for new space to expand your business? Do you want to become a developer or landlord? There are a lot of different nuanced ways to explore these considerations.
Then as you narrow down your interests and goals, you will start to gravitate toward different investment vehicles and strategies. Do you want to directly own a property or use different investment tools like a real estate investment trust (REIT), real estate investment group (REIG), or crowdfunding? You will need to consider the type of property that best suits your goals; the main types include multifamily, office, industrial, retail, and special purpose. Also, you will look at different property classes depending on whether you want to renovate, expand, or build new. Then you will need to prepare yourself and plan ahead for different levels of risks and rewards associated with each property type, class, and investment method.
Once you have your objectives clarified, diving deep into market research will help you become more familiar with the ins and outs of the Chicago commercial real estate market for your chosen property type and investment method. Examine supply and demand, get to know market cycles, current market rents, vacancies, expenses, and cap rates. Professional market data providers can help you gather the insights you need to make an informed decision.
2) How much money do you need to invest in commercial real estate?
The answer to this question varies greatly depending on the property type, class, and investment strategy. For example, if you are using a crowdfunding platform, you can get started in commercial real estate investment for $25,000. For some REIGs, partnerships accept around $5,000 to $50,000 to get started.
When buying on your own, the financial picture is very different per property type and class. For example, the price of a single office building will be much smaller than an entire retail center. Banks usually require you to front 20% of the purchase price as a down payment on the property. Then there are closing costs associated with the transaction itself, which average around 5%, plus whatever money you will need to develop or update the property to get it ready to lease. You will also need a cash reserve to cover emergencies and gaps in occupancy. A standard contingency budget is 5% to 15%, though again this differs depending on the asset.
3) How do banks value commercial property?
Commercial property valuation depends on a long list of different factors, but considerations include utility, demand, scarcity, transferability, cost vs price vs market value, and more. When lending money for the purchase of a commercial property, banks usually have preferred lender appraisal firms that use one or more of these six different methods
- Cost approach – how much would it cost to rebuild this property?
- Sales comparison approach – how does this property compare to the value and sales prices of similar offerings?
- Income capitalization approach – what is the property’s income-generating potential?
- Value per gross rent multiplier – what is the price of the property divided by its gross income?
- Value per door – how many units does the property have in relation to its sale price?
- Cost per rentable square foot – what is the price per usable square footage and how does that compare to the average cost per square foot for the market?
4) How much does an appraisal cost for commercial property?
As with other aspects of commercial real estate, the appraisal process is longer and more complicated than in the residential market, and this greatly affects the cost of each appraisal. Additionally, there are different types of appraisal reports according to the Uniform Standards of Professional Appraisal Practice, which include self-contained, summary, and restricted-use reports.
All reports cover key considerations such as property type and class, descriptions of the conditions of the land and buildings, proximity to transport, sales and rental rates, zoning issues, public records research, lifestyle and demographic data, value estimates, risk assessments, and negatives that might affect market value. The minimum cost for an appraisal on a commercial property starts around $2,000, with the average around $4,000. Larger scale commercial properties might cost $10,000 to $25,000 to appraise.
5) How long is a commercial real estate appraisal good for?
Technically, CRE appraisals don’t really expire, but different lenders have different perspectives on the length of time that they consider them to be valid. The time period during which lenders will accept an appraisal is often called the “term of validity” and the length of this term depends on the lender and market conditions. If a lender determines that an appraisal is too old, it will not honor it. Also, different loan types set different validity periods for appraisals.
Due to these variables, it is hard to estimate a general range, but roughly 90-180 days is the oldest appraisal range many lenders will accept. In volatile markets where conditions are changing rapidly, the term of validity might be shorter.
If an appraisal is out of date, there are other processes that can be implemented rather than paying to conduct a completely new appraisal. Two common procedures to this effect are recertification of value, if you need to prove that it hasn’t changed, and an appraisal update, if you want to prove that the value has changed.
6) How do you negotiate a commercial property purchase?
There are a host of successful tactics for negotiating the best deal for your commercial property purchase, including:
- Know your budget and top offer limit.
- Find good advisors.
- Search far and wide to find the best deal.
- Look at the deal from the seller’s point of view to understand their motivations.
- Boost your credibility – make sure you have your financing ready, allow for shorter contingencies, and offer a more substantial deposit.
- Act like you can walk away.
- Know the market and the competition.
- Do your due diligence and use potential issues or opportunities as bargaining chips.
- Negotiate face-to-face.
- Use awkward pauses to force self-negotiation by the seller.
- Win over the listing broker.
7) What is a good ROI on commercial real estate?
Return on investment can be measured through many different lenses, timeframes, and processes. ROI is also influenced by a number of other factors. For long-term CRE investments, the National Council of Real Estate Investment Fiduciaries (NCREIF) recently found that the average 25yr return for private CRE investment properties was 9.4%.
Looking at capitalization rates is another effective way of gauging ROI. Cawley Commercial Real Estate regularly reports on the average cap rates for the Chicago market. Generally, a good cap rate falls between 5.5% and 7%, depending on the market.
Another important statistic to look at is absorption rates. This is another important indicator of market activity. Your commercial real estate broker can help you determine how quickly properties are coming off the market in your specific area by looking at this data. For example, in the O’Hare submarket, net absorption for Q1 2021 was 1.5 million SF, while the 12 month absorption are has increased to 3 million SF. You can see the latest data for industrial real estate and office real estate in our quarterly reports.
8) How can I improve my commercial real estate?
If you want to boost your rate of return on your commercial real estate investment property, there are two general ways to do it: enhancing the net operating income (NOI) and enhancing the property’s value for eventually selling it. The first approach increases your current, ongoing rate of return while the latter increases how much you make when you sell in the future. Many actions benefit both near and long-term profits.
Here are a few tactics for enhancing NOI and overall resale value:
- Reduce vacancies
- Raise rents
- Reduce expenses
- Discover new streams of revenue such as storage rental and late fees
- Offer new amenities
- Make updates such as energy-efficient windows to improve your asset
- Add onto your property
- Revamp your property for a new use
Conclusion of Chicago Commercial Real Estate Investment
Whether you are a first-time investor looking for a solid initial purchase or a long-time property owner wanting to get the most out of your investment, Cawley Commercial Real Estate’s experienced advisory team can provide end-to-end support from gathering market insights all the way to signing the final papers.
We work collaboratively with building owners, landlords and managers, and CRE investors to deliver the best value for every investment. Our expert team offers a host of services, including the latest marketing intelligence to inform property research and positioning, leasing analysis and strategy, transactional assistance, and ongoing retention tactics. For the best commercial real estate investment experience in the Chicago market, contact us today.