Where Should Borrowers Begin?
If you are looking to purchase commercial real estate to achieve your business goals, your initial evaluation should focus on the net lease payments — the lease minus any costs you might incur as the owner — and the likelihood that the lease revenue will continue in the future.
Many leases are triple net leases, often abbreviated as NNN. This indicates that the tenant is responsible for taxes, insurance, and maintenance. Reading the fine print is important here, as some NNN leases still contain potential maintenance items that might be the owner’s responsibility.
Equally as important as the lease payment is that payments will continue uninterrupted in the future. In the best-case scenario, you have a long-term lease with a strong, nationally known tenant that provides good prospects for reliable future lease payments. These types of tenants often command lower capitalization rates, or cap rates, due to their presumed cash flow safety. (We will explore cap rates more in the next section.)
In many cases — such as retail strip malls — the tenants might be small business owners with short-term leases. These types of properties are more susceptible to vacancies and missed lease payments. There is a greater degree of risk inherent in these leases, so they often have higher cap rates because investors factored in the risk of cash flow volatility.
Most people looking to purchase commercial real estate have a very general understanding of lending, and they have usually borrowed money from a bank in the past.
However, commercial real estate lending is full of intricacies these borrowers are often unprepared for; having a relationship with an experienced community bank can be invaluable.
Understanding Cap Rates
Again, one of the challenges presented during the commercial loan process is fully understanding cap rates.
Commercial real estate values hinge on a property’s cap rates. The cap rate is the return the market believes the property’s cash flow will provide, and it is always stated as a percentage (the market also sets cap rates, so they are easily identifiable). Think of this as the required return for an investor. The cap rate determines the value of the building, and it is influenced by factors such as lease length, the strength of the tenant’s business, and the building’s location.
Let us imagine that you have a commercial office building in St. Louis’ Central West End that leases for $55,000 a year and generates $50,000 in net operating income (NOI). It generates a certain amount of cash flow, and that cash flow has a specific cap rate that every investor will target; perhaps 6% or 8% return. To calculate the value of the building, you divide that $50,000 NOI by the cap rate percentage.
It can be difficult for business owners to truly understand cap rates. However, this is one of the most important concepts to understand if you are seriously considering commercial real estate investing. Our experienced relationship lenders are ready to discuss cap rates with you to ensure you are informed.
What to Know Before Securing Commercial Real Estate Loans
If you would like to move forward on securing commercial real estate, be sure to first consider these three important factors. Doing so will help you be fully prepared before reaching out to an expert lender:
Our experience with commercial real estate lending is extensive, and we are ready to help lay the groundwork for your investment. Once you have an investment idea in mind, reach out to our experts and get started.
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