Building your commercial real estate business
There are a couple of concepts you should know if you want to expand in this niche.
By James Myers, Cotributor
Traditionally, commercial real estate is defined as any non-residential property used for commercial profit-making purposes. T. Kyle Swicegood, CAI, BAS, GPPA, has an alternate definition.
“I believe it could also be called commercial property, investment or income property,” Swicegood said during a recent NAA iSeries webinar, “which refers to buildings or land intended to generate a profit, either from capital gains or rental income.”
Swicegood is an authority on the topic of commercial real estate as he’s had a career in it going on nearly 30 years. He started as a real estate broker in 1991 and shortly thereafter began investing in property, residential and commercial. He developed, built, leased and later sold a 41,000-square-foot retail shopping center before jumping into the auction business in 2009.
Swicegood claims the two best career decisions he made was earning his Certified Commercial Investment Member credentials and his CAI.
“I saw the light and got my auctioneer license,” Swicegood said during the webinar. “I have fallen in love with the trade.”
Swicegood said the two concepts he wanted to impart with his session involve gaining a better understanding of capitalization rates and the 1031 section of the IRS code, which covers tax deferments.
“It’s boring stuff,” he conceded, “but (they are) important ideas and concepts you can use to make money for your clients. And when you make money for your clients, you make money for yourself.”
Commercial buyers are looking for cash flow and an upside, he said. They want to make enough income on a monthly basis to pay debt or generate an income. Furthermore, they want the asset they buy today to be worth more money tomorrow.
With that in mind, Swicegood said it’s important that commercial real estate auctioneers are knowledgeable about the capitalization rate, often referred to as the “cap rate.” There are a number of variations, but the most common calculation is the ratio between the net operating income (NOI) produced by the asset, and the original capital cost, also called purchase cost.
NOI is a calculation used to analyze real estate investments that generate income. Per Swicegood’s example, if a commercial property has 12 units that are rented out at $1,200 a month, that’s a gross income of $172,800 per year. However, you have to subtract operating expenses, which includes an estimated vacancy rate, management costs, and other expenses that bring the total down significantly to a net operating income of something closer to $111,740.
“Decision are made on the knowledge of net operating income,” Swicegood said. “Take the NOI and the use the cap rate of 10 percent, you would consider paying $1,117,400. If it’s a risky investment, you can up the cap rate to 12 percent, which means you’d be willing to pay $931,166.”
Swicegood notes that cap rates are determined by the market, but when getting involved as a buyer, seller or auctioneer representing a seller, “you need to have an idea what the NOI of an asset is and what the going cap rates are for similar properties.” And this is why it’s good to make friends with appraisers, he said.
“Become friends with a lot of commercial appraisers,” he advised.
The second issue Swicegood covered in his session involves the 1031 IRS code, which allows investors to sell a property and reinvest the proceeds in a new property with the capital gains taxes being deferred. But the law says the tax deferment on capital gains only applies when that money is used to purchase a “like kind asset or assets.”
“That basically means you have to sell an income producing property for an income producing property,” he said.
Swicegood cautions that in order to do this, the money from a sale can’t be touched. When the property is sold, the money needs to go to a qualified intermediary, which is usually a title company. Furthermore, there are time limits. For example, a seller has 45 days after the sale to identify properties that they are willing to invest in. Then, they have 145 more days to close the deal on one or more of those properties.
“The government is letting you use your tax money to reinvest and expand your estate,” he said.
During the Q&A session following his presentation, one webinar participant new to the process asked how they could find sellers of commercial real estate properties. Swicegood recommended starting out at “your tax office, getting engaged. ICSC (International Council of Shopping Centers) is a great way of finding developers. Go to your GIS and do a little research.”