BUYING COMMERCIAL REAL ESTATE | WHITEHORSE

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Commercial Real Estate Listings for Wednesday, October 22nd 2014

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Determining the Value of a Commercial Property

  • Income
  • Expenses
  • Mortgage payment (debt)

By Knowing Income, Expenses & Debt, We Can Calculate…

  • Effective gross income = income x occupancy rate %
  • Operating Expense: tax, insurance, utilities, management, payroll, landscaping, maintenance, supplies, & repairs. (Mortgage payments & interest are not included)
  • Net Operating Income (NOI): Effective Gross Income – Operating Expenses
  • Debt Service = Annual Mortgage Payment
  • Annual Cash Flow: NOI – Debt Service
  • Cash-on-Cash Return is the time it take to recover your down payment: Annual Cash Flow ÷ Down Payment (min of 10% needed)
  • Capitalization rate (Cap Rate): NOI ÷ Sale Price (Min of 8% needed)

Property Value
(Sale Price) comes from NOI and Cap Rate. Sale Price = NOI ÷ Cap Rate
If the NOI is $100,000, the price you might offer is (100,000 ÷ 10%), or $1,000,000.

Professional Property Evaluation

  • Comparison analysis approach Compares sales of recently sold properties, in the same area, and the price per square foot in each comparable.
  • Income approach evaluates comparable properties based on revenue generation. We want calculate and compare capitalization rates by looking at the NOI and sales price.
  • Replacement value looks at the cost to construct a similar building on similar land, by comparing and taking into account property depreciation. For example:

Land value + building cost – depreciation = estimated property value

Breakeven Point
We need to know where income equals expenses and mortgage. For example:
Annual mortgage = $25K, Operating expenses = $100K, Gross potential income = $250K
($100K + 25K) ÷ $250K = 50% vacancy. 51% starts a positive cash flow.

What does the Bank Look at when Lending on a Commercial Property?

  • Property cash-flow is the main factor
  • Your credit score is also considered, to a lesser degree.

Working out Expenses (are you paying too much?):

  • Per unit (compared to other properties)
  • Expenses will likely be a minimum 50% of generated income
  • Per square foot (compared to other properties)
  • Parking should be 4 spots per 1,000 square feet of lease space

Taxes
The property will be reassessed upon the sale, and can go up considerably.
Find out what the taxes will be, based on the purchase price.

Increasing NOI, Increases Property Value
To do this, you increase income and/or decrease expenses. Find out what comparable rents are, in your area. Experienced property managers can provide valuable information.

The Bank
The property has to pay for itself. This will depend on the financials, realistic cash-flow projections and your down payment. If the bank requests a higher down payment, keep shopping for a lender to work with a down payment you can afford.

Lease Types: In Addition to Rent, what Might the Tenant Pay?

  • Gross lease: Tenant does not pay any operating expenses for the property
  • Modified gross lease: Tenant pays some operating expenses
  • Net lease: Tenant pays operating expenses, except for common area maintenance
  • Single net lease: Tenant pays property taxes.
  • Double net lease: Tenant pays property taxes and insurance
  • Triple net lease: Tenant pays all property-related expenses

What is a Lease
A lease is a contract by which a property is conveyed to a person for a specified period of time, in return for rent. A commercial lease is tough to break, and can last for 20 years. If you are leasing ,and your business fails, you are financially responsible for the lease unless the property is leased to someone else.

Take care to review all of the lease details: rent, term of lease, extra costs, subletting, deposit requirements, and cost to set up the location. Be thorough when you read a lease agreement. Have your lawyer review it for potential issues.

Where to Buy or Build a Commercial Property – Build in the Path of Progress! Look for areas in a growth phase. Find out what the city has planned for new development. Know the demographics of Whitehorse so you can pick an area that is most likely to make your investment successful: population trends, growth trends, and stability of those areas.

Types of Commercial Real Estate Investment

  • Cash-flow investors look for a monthly income.
  • Long-term investors look for appreciation and ability to pay down the loan.
  • Short-term investors look for a property to fix and sell.

Negotiating
Because my negotiating strategies are for my clients, I will simply say that my negotiating strategy is not necessarily about beating up the buyer or seller. We need to understand the other party’s needs and motivations. Each side will have major and minor wants and needs. With respect, communication and understanding, both sides can come to an agreement.

The Offer
Once you have an offer in place, with conditional clauses, on a commercial property, it’s time to find out if the property is a good deal or not. You will have a period of time for property and financial inspections to determine actual income generated, expenses, property defects, environmental issues, building code issues, contracts that pass with the sale, warranties, police reports, liens/debts. You will find issues, but you can go back to the table to renegotiate. Hire a qualified, professional, commercial building inspector for the physical inspection. Hire a qualified accountant, who works with commercial properties, for the financial inspection. Hire a qualified lawyer, who deals with commercial real estate, to check for things like defects in the title (easements, back taxes, judgments, liens, lawsuits, restrictions, and tax liens), survey, environmental issues, and easements/encroachments. Tenant leases need to be reviewed and audited. You want a complete picture. Don’t be cheap at this stage of the process. The money you spend can save you from an investment disaster. Be there for the entire investigation/inspection. For reference, commercial closings can take two or three times longer than residential closings.

To Do
Get site plans and specs, with docs on construction, building plans/schematics, floor plans, and land use. Take photos of exterior, interior, land and other structures
Get a structural inspection for walls, roofs, and foundation. Get a systems inspection. Verify age of roof, and any code violations, government compliance (physically impaired requirements). Get a mechanical and electrical inspection: heating, ventilation, air conditioning, plumbing systems, and control panels. Get receipts and docs for improvements for the past five years. Get a pest inspection.

Get annual income and expense statements and balance sheet for the past three years, and the previous year’s profit and loss statements. Verify: Rent rolls, Tax returns, Lease agreements, Utility bills, Property tax bills, Environmental inspection/s, Survey and title, Building code violations, Zoning code, Insurance policy, Licenses, permits and certificates, Service and vendor contracts, Property inventory, and Police reports. Stay in constant contact with your lender, or risk missing closing deadlines.

Commercial Real Estate Terminology

This is only the beginning. Once the deal closes, you have a lot of information to review and a business to manage. 

Commercial Lease Agreement FAQ – Canada – From LAWDEPOT.COM
(the following information is not intended to be legal advice.)

Finding commercial real estate for sale in Whitehorse Yukon

Buying Commercial Real Estate in Whitehorse, Yukon – AJ Malcolm – Dome Realty