The #1 Prerequisite Piece of the Commercial Real Estate Puzzle

As a commercial real estate investor, you're spending large amounts of capital to buy property, either to hold it and turn it into a revenue stream, or to upgrade it and re-sell it on the market to make a quick cash out. And with anything involving large amounts of money, there are two words of critical importance: Due Diligence.

Due diligence when it comes to acquiring commercial properties means checking out the comps – the comparisons of how similar properties compare to the one you're about to acquire. You want to look at the actual sales terms, and sales conditions for a comparable piece of property, either improved or unimproved, and make a ruthless, cold hearted assessment on the property you're considering. You can't really rely on asking price – there's always some dickering going on for that. You do need to look at what the property actually sold for.

When looking at comparable properties, there are three things to assess, recency, relevance and proximity.

Recency is, bluntly, how recently the property sold. Market conditions fluctuate on seasonal and multi-year bases, particularly as new job sources open (or, sadly, shut down). Make sure that you're cognizant of all the factors that influence a recent sale when assessing how recent a sale was.

Relevance or similarity means you're comparing apples to apples, not apples to watermelons. If you're looking to gauge the risk, try and find the closest equivalent property that sold – if you're looking at a 50 acre property, you're going to want to look for sales prices for 40 to 60 acre properties that have sold recently. If your property has particular improvements (buildings, swimming pools, office space), you should look for properties with similar improvements, and try to work out the differential rate in the sale price (how much for the land, how much for the location and how much for the improvements) to make a good itemized assessment of the property you're considering.

Proximity means how close the comps are to each other, and how close they are to the property you're considering. Properties that are close together tend to have similar sale values, and you (as a commercial real estate investor) should be looking at aggregate and median sale prices in the region you're considering. Build a map and use highlighters to show what prices are commended where, by what market forces.

Now, some risk is always present in investment, even in real estate. (Or, with the current housing market, almost universally in real estate.) Let's analyze the risks and show how comps help you avoid them.

The first risk is "falling in love with a property". It's OK to fall in love with a property you're going to live on, or give to someone as a gift. Falling in love with a piece of commercial real estate is just plain foolish. You'll pay more for it, and get less out of it when you have to sell it. Comps give you a reason to step back from the property, and ask yourself the hard questions – how does the asking price compare to comparable properties? What's the local average for this type of property with these types of improvements?

The second great risk of not checking your comps is being unaware of what the market expects in a property. Now, this doesn't mean that you shouldn't buy a commercial property if it lacks a certain feature, or is dissimilar to recent commercial properties that have gone through the marketplace recently, but it does mean you need to be aware of the differences, and be prepared to accommodate them. For example, if all the commercial apartments that've sold recently had had swimming pools, and one you're looking to acquire does not, you should be able to get that prospective property at a discount, to cover the fact that you'll need a swimming pool on it to remain competitive.

Finally, the last risk you avoid by checking your comps is proximity. Three things are key to real estate – location, location and location. Comps let you assess what properties are "buy and re-sell" in anticipation of shifting demographics, and which ones are buy-and-hold. For example, if you know an employer is adding a lot of high end jobs in the next few years, buying properties near where that employer is setting up shop and upgrading apartments is a sound investment – but you need to be aware of the proximity to where that employer's facilities will be, and be able to provide good market value, possibly even condominium conversions.

Ultimately, checking comps is all about doing your homework, and making the commercial real estate acquisition process work for you. Don’t fall in love with a piece of property, and do look at all the ramifications with a dedicated, heartless, profit and loss perspective. Check your comparable properties carefully and make fully informed decisions, and your commercial real estate investments will be a much happier experience for you and your fellow investors.

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