Mariwyn Evans writes about commercial real estate for REALTOR® Magazine. You can reach her at firstname.lastname@example.org.
Scaling New Heights
You may already have what it takes to make it in commercial.
November 1, 2004
Practitioners looking for a challenge—or simply longing to have their weekends free—might consider a transition into commercial real estate sales.
True, commercial hasn’t had the booming market residential has enjoyed these many years. But with the residential market leveling off and the economy picking up steam, commercial sales might be your next great career move. The key: Find a market need and gain the specialized skills needed to close commercial transactions.
First, the skill. Most intimidating for many residential practitioners are the technical financial calculations that enable commercial buyers and tenants to compare properties and leases. (See “Commercial 101.”)
Because commercial prospects are comparing properties based on the numbers—not the number of bedrooms—understanding the math helps. “Providing financial analyses such as net present value (NPV) gives clients the ability to easily and quickly compare leases or properties. Deals can be so different that without the commercial broker’s analysis, clients would be comparing apples to oranges,” says David Houston, SIOR, president of Colliers Houston & Co. in Teaneck, N.J., and 2004 President of the Society of Industrial and Office REALTORS®.
NPV is probably the most critical calculation in leasing transactions, agrees Patricia Lynn, CCIM, of Lynn + Associates in San Francisco. The most commonly used basic formulas for evaluating acquisitions and sales are capitalization rates, cash-on-cash return, gross rent multiplier, and internal rate of return, says Lynn, an instructor for the CCIM Institute.
But if you’re not a math whiz, does that mean you can’t succeed at commercial? “I’ve known literally thousands of successful commercial brokers who had strong social skills and relatively weak financial ones. You can always team up with an accountant who can run the financial models,” concludes Michael Lipsey, CCIM, CPM, of The Lipsey Co., a commercial real estate consulting company based in Longwood, Fla.
“You do need to know the basic [step] of reading an operating statement and be able to talk to investors on what their return on investment will be,” says Bob McMillan of Coldwell Banker McMillan and Associates in Decatur, Ala., “but you don’t necessarily have to know the whole alphabet soup of IRR and NVP.” Although most of his associates do residential sales, McMillan specializes in commercial brokerage and leasing.
In fact, people skills, which residential specialists need in abundance, are an often overlooked factor in commercial sales success, according to Frank Carone, president of commercial brokerage and services of RE/MAX Commercial Brokerage in West Los Angeles, Calif. “The ability to make and perpetuate relationships is critical because residential clients will probably buy a few times,” he says, “but commercial clients and investors are perpetually in the market.”
Nevertheless, Carone—who heads a two-office, 90-associate company focused on multifamily, industrial, and retail properties—doesn’t advocate a “hybrid” career trying to sell both residential and commercial. “As a practical matter, it’s tough to know the commercial market if you do only an occasional transaction,” he says.
A willingness to get out and prospect is another key success factor residential practitioners can bring to the commercial arena. “I’ve found that residential salespeople are generally very well-prepared and well-trained in prospecting,” says Lynn, who began her career selling residential before making the shift to commercial.
When John Michailidis, CRS®, GRI, of the Chicago Building Exchange at Keller Williams Realty, switched exclusively to commercial at the end of last year, he found the prospecting skills he’d acquired in more than 10 years of residential sales carried over. A commercial real estate career coach suggested he promote his fledgling commercial business using interactive voice mail and a newsletter, “things I’d been doing for years in residential,” says Michailidis.
Beyond Trophy Properties
Although the words commercial real estate often conjure up images of big national brokerages leasing multimillion dollar office towers and selling mega-malls to offshore investors, there’s plenty of commercial business out there in smaller deals and smaller markets. A 1999 estimate by the U.S. Department of Energy determined there were 4.66 million commercial properties in the United States.
“There’s a whole commercial segment that underlies the $40 million office towers. And all those properties and owners need real estate professionals,” says Les Wood, CRB, vice president of commercial and regional development for RE/MAX International in Greenwood Village, Colo.
Generally, the easiest transition from residential to commercial is selling residential income properties, says Carmela Ma, CCIM, CIPS, principal of CJM Associates Inc. in Beverly Hills, Calif. “There are some parallels to single-family home marketing. Sales associates just need to learn investment concepts and financial analysis,” says Ma, an instructor for both the CCIM Institute and the Certified International Property Specialist certification.
Michailidis’ experience in residential helped him identify an underserved niche in Chicago—small-scale multifamily properties. “I call them bread-and-butter properties. They’re deals larger national and regional companies often aren’t interested in, so I made them my concentration,” he says. Michailidis had put 15 such properties under contract through September 2004 and expects to close $8 million in volume by year’s end. “I’m very pleased with the way things are going, and I believe I could do even more if I could find the inventory,” he says.
An undergraduate degree in economics from the University of Nevada, Las Vegas, and a Northwestern University law degree with an emphasis on real estate transactions gave Michailidis his financial knowledge, but “it’s not rocket science. Office and retail are more complex, but what most multifamily investors really want to know is what the actual expenses of the building are, what’s the projected cash flow, and what’s the property’s repair history. Most of the investors I work with have a pretty good idea of how much it takes to run a property—generally 30 percent to 40 percent of income for small multifamily properties. To tell you the truth, the biggest leap moving from residential to commercial was in my head.”
Seeing a market gap and stepping in to serve it also played a big part in the commercial career of Sam Sanzone, with Keller Williams Realty in Victorville, Calif. Victorville, a bedroom community in the Ontario area, has had a residential boom for two years—but until recently, there was little demand for commercial. “Then we started getting calls from residential clients who were interested in moving their businesses up here, and the space just doesn’t exist,” says Sanzone.
Sanzone realized that if he wanted to do commercial transactions, he had to become a developer. Partnering with a local landowner, this year he began acting as the general partner and leasing agent for an eight-acre development that includes 40,000 square feet of mid-range retail, a two-story office building, and 30 condo units. To get the development started, Sanzone began attending city council meetings and worked with the local government on developing commercial zoning requirements. “We’d never had them before,” he says.
Now he spends most of his time acquiring land and helping commercial clients build space. “It just blossomed,” he says. His son Joe and an unlicensed assistant handle the residential sales.
“Getting control of the listing is the key to getting a commercial career going,” says H. Bland Cromwell, CCIM, SIOR, with Coldwell Banker Commercial Jim Stewart, REALTORS®, in Waco, Texas. “If you have the listing, companies coming into a market will find you. It will give you the opportunity to participate in transactions and create credibility.” Cromwell was the 2003 top international producer for Coldwell Banker Commercial.
But just as in residential, getting the listing isn’t the end of the job. “Commercial brokers also have to have the knowledge to solve the problems with title, environmental, or financing that inevitably arise in a commercial transaction,” Cromwell says.
The complexity and variety of commercial leases proved a challenge for Parham Shariat when he began representing small commercial clients looking for retail or office space. “In this area, there’s no standard contract, no guideline unless you work for a big commercial company. I had to do a lot of research and spend lots of time with my clients’ attorneys to ensure the lease terms were satisfactory,” says the sales associate with Long & Foster Real Estate in Falls Church, Va.
Reviewing the economic terms of the lease—such as price per square foot and passthroughs of common area charges—are the first things to look at when reviewing any commercial lease, says Jim Mayer, a partner at the law firm of Holland & Knight LLP in Chicago. “It’s also a good idea to get your space measured to ensure you’re not paying for dead space you can’t use,” he says.
Other clauses to read carefully are a tenant’s rights to extend the lease and to sublet the space or assign the lease.
Mayer advises against trying to use a standard, preprinted lease, which will usually require attaching multiple riders for special terms. “If you want particular terms in the deal, put it in the body of the lease,” he advises.
Besides extensive reading and a membership in local commercial real estate groups, Shariat gained most of his commercial knowledge from hands-on work with peers. “The beauty about the first deals I did—including finding 6,000 square feet of office space for an expanding Internet company—is that the brokers representing the owners were all from big companies like CB Richard Ellis and Grubb & Ellis. I saw how they interacted with the parties to the transaction and followed their example.” He also developed a team with other Long & Foster associates interested in commercial to share ideas. “Commercial is a team sport,” he says.
A career in corporate sales for Eastman Kodak, college economics courses, and the “school of hard knocks” helped Steve Porter of Weichert, REALTORS®, in Jackson, N.J., acquire both the ability to build long-term client relationships and financial analysis skills. “I had to do cost analyses all the time for Kodak clients, so I just translated that experience into commercial. Once you know the formulas and understand math, it’s pretty easy,” he says.
Although much of his commercial business centers on selling smaller multifamily properties, Porter’s most recent transaction is consolidating several parcels—including a bar, five homes, and an electrical contracting business—into a 13-acre parcel in a “prime commercial area” of Jackson, N.J. “Currently people in this part of town have to drive seven miles to a grocery, so I convinced the owners their property is much more valuable as a potential grocery-anchored strip mall than if I tried to sell each property individually,” he says. He’s listing the parcel at $5.5 million. In the meantime, he has closed 12 residential and three commercial transactions this year.
“Your job as a commercial broker is to identify opportunities for your clients—to look at a trade area (a business’s market area), see what’s missing, and build it,” says Silvia Gangel, CCIM, principal with SiGa International Commercial Real Estate in San Antonio. After moving from Mexico in 1979, Gangel sold residential for six months before moving to the company’s commercial department. Today her company specializes in site selection for fast food companies and other retailers.
Gangel also sees commercial real estate sales as a great vehicle for partnering with clients to develop her own investment portfolio. “We find the property, the tenants, and the investors, then put the deal together,” she says. “In the long run, it’s more exciting to analyze a property wearing an investor’s cap while still serving your client’s needs.”
Whether your interests lie in supplementing your residential business or making the leap to the world of large-scale office or retail brokerage, you’ll better serve your clients—and yourself—if you get the basics under your belt with a course such as the CCIM Institute’s “Introduction to Commercial Investment Real Estate Financial Analysis.” A free online tutorial of the two-day course, which covers such basics as how to determine net operating income, net present value, internal rate of return, and cash-on-cash return, is available at www.ccim.com.
Late this year, the REALTORS® Commercial Alliance will roll out an introductory commercial course for residential practitioners. See www.REALTOR.org/rca for more details.
Here’s a quick summary of a few essential commercial calculations, with the assistance of the CCIM Institute, that could help you take the first step in commercial real estate.
The net operating income of a property is the cash flow a property generates after expenses (but not debt service or taxes) are deducted. NOI is used to calculate property value using a capitalization rate.
The capitalization rate, or cap rate, is the rate of return used to determine the value of the property’s income stream. The higher the cap rate, the lower the value of the property.
The most basic formula for calculating a commercial property’s cap rate is Value = net operating income / cap rate. For example if a multifamily property has an NOI of $100,000 and sells for $1,250,000, the cap rate would be 8 percent ($100,000/$1,250,000).
A good way to determine a cap rate for a specific property is to find and compare recent sales of similar properties in the same market. By obtaining the purchase price and NOI from these sales, you can obtain a range of cap rates for the area.
Another measure of property value is cash-on-cash return, sometimes called equity dividend return. This formula enables investors to determine the return on their equity in leveraged properties.
Cash on cash = before-tax cash flow (NOI minus debt service) / initial cash outlay.
For example, assume your initial cash investment to buy a property was $75,000 and your NOI this year after mortgage payments was $13,341. Your return would be 17.8 percent ($13,341/$75,000).
The same formula can be used to calculate after-tax return. Just subtract both the mortgage payment and the estimated taxes from your NOI.
The gross rent multiplier is an easy rule of thumb to forecast a value. Gross rent is the total rental income you could realize from a building if it were 100 percent leased. To calculate the gross rent multiplier, divide the gross rent into the sale price. If your projected monthly rental income is $12,000 and your sale price is $160,000, your GRM is $160,000/$12,000, or 13.3. You can also make this calculation using net income, which is total possible rental income less vacancies.
More sophisticated income analyses—such as internal rate of return, net present value, and discounted cash flow—calculate the present value of investment returns and rents received in the future. These calculations, which require a financial calculator, such as the Hewlett-Packard 12C, or a financial analysis software program, such as planEASE or Argus, are based on the assumption that money received in the future is less valuable than money received today.
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