The micro level: property-specific details
Once you narrow down the type or types of commercial real estate you wish to invest in, you can start a property-specific analysis.
Your research might entail geographical markets. If you wish to invest in a multifamily apartment building, for example, you'll want to know which cities are experiencing the greatest demand for apartments. You'll want to look at the city's migration trends—whether people are coming to or moving from the area—job growth, and median income.
You'll also want to analyze the competition. Are there other commercial real estate buildings like the one you're considering? And are they being used to capacity?
Next, you'll want to run the numbers on a commercial property by comparing the price of the property to the property's income and expenses. Mathematical formulas can help you determine whether a property will make a good investment. To use these formulas, you'll need to know a property's net operating income (NOI), cash flow, and capitalization (cap) rate.
- NOI: This is the property's gross annual operating income minus expenses. Income would be rent and any fees that are collected. Expenses include property taxes, insurance, utilities, repairs, maintenance, and property management. Note that renovations or improvements are not considered operating expenses for NOI calculations. They are instead capital expenditures.
- Cash flow: The cash flow is the NOI and minus any debt payments you have (like mortgage) and minus any capital expenditures.
- Cap rate: This figure shows your potential return on your investment, expressed as a percentage. You calculate the cap rate by dividing the NOI by the cost of the property. Note: The higher the cap rate, the better—but only to a certain point, as a high cap rate usually signals a riskier property. Commercial real estate investors usually want a cap rate between 4% and 10%.2
How to arrange financing
You can finance a commercial real estate loan as an individual or a business entity. Commercial loans are usually for terms between five and 20 years—often with a balloon payment—and are based on your credit score and financial history.3
In determining how much they are willing to lend you to buy a particular property, your lender will typically have a maximum loan-to-value ratio (LTV). This tells you the maximum amount of a loan you can get given the appraised value of the property. The commercial real estate loans typically have an LTV of between 65% and 80%. This means the bank will only lend you 65% to 80% of the property's appraised value.
The lender will also want to know the debt service coverage ratio (DSCR) to ensure the property will bring in enough annual income to service the debt. The DSCR is calculated by dividing the property's NOI by the annual debt service. Most lenders require the DSCR to be 1.25 or higher.4
Commercial real estate markets worth considering
Two of the hotter investing markets in the Southeast are Florida and Georgia. Here are some reasons why:
Florida provides a strong market for commercial real estate investors due to population growth, job growth, and an influx of capital from foreign investors. Here are some factors to consider when thinking about buying commercial real estate in Florida, according to MMG Equity Partners:5
- The Sunshine State has experienced consistent population growth since the 1990s and is slated to keep gaining residents through 2030.
- Florida ranks No. 3 regarding nationwide job growth.
- Business leaders often choose Florida because of the reduced tax burdens.
- The state ranks fourth in international investment activity.5
Atlanta is a strong market for commercial real estate investment due to population growth, economic growth, and a business-friendly environment. Here are some factors to consider when thinking about buying commercial real estate in Georgia:
- Atlanta has been experiencing population acceleration since the 1990s and was the fourth fastest-growing metro in the country in 2021.6
- With the busiest airport in the world (Hartsfield-Jackson), Atlanta is a known transportation hub and distribution center. The city has other thriving industries, such as FinTech (financial technology) film production, healthcare, and advanced manufacturing (including 3D printing and robotics).7
- Atlanta is a friendly city for investors because of low property taxes and operating costs.8
Investing in commercial real estate takes a few additional steps, but it can be a profitable passive income for many.
If you think you're ready to invest in a commercial real estate property, contact your Synovus financial advisor.